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The Case For At Least Some SRI

By: Dr. Matthew J. Kiernan

In late October this year, the Canada Pension Plan Investment Board (CPPIB) made what I believe will prove to be a watershed announcement. It adopted its first formal Policy on Responsible Investing. With assets of more than $90 billion, CPPIB is a leader in the world of Canadian institutional investment – by virtue of both its size and its vision. Its new policy is ambitious, yet appropriately measured. By any standard, it is the most comprehensive and thoughtful to appear in Canada to date. It is hoped that CPPIB’s counterparts at other pension funds will take serious notice.

Absolute Forefront
In one sense, the CPPIB policy is really only an acknowledgement of the blatantly obvious – environmental, social, and strategic governance (ESG) factors can, in fact, materially affect the financial risk and prospects of their portfolio companies. Sad to say, however, this recognition places CPPIB at the absolute forefront of pension fund thinking in North America. Only the two giant California funds (CalPERS and CalSTRS) have moved further and faster.

With this move, CPPIB has, ironically, leapfrogged ahead of the US$28 billion pension fund of the United Nations itself, based in New York City. The UN fund, despite its promotion of a new set of ‘Responsible Investment Principles,’ has yet to actually use ESG research itself. It might be instructive to reflect on the reasons why the UN and so many other North American pension funds have been so passive.

I believe there are at least five major reasons for this state of affairs:

The combined impact of these five macro-level factors is already demonstrably clear – the competitive and financial significance of companies’ ESG performance is increasing markedly. Few knowledgeable observers would dispute this. Yet despite this, resistance from the mainstream institutional investor community persists.

Nothing Will Change
Our own firm has recently completed some research into this phenomenon, interviewing dozens of portfolio managers, financial analysts, and investment consultants in Canada and elsewhere. Our conclusions were unequivocal. Unless, and until, the owners of capital (read: pension fund trustees) actively and insistently direct their staffs, investment advisors, and money managers to address ESG factors in a comprehensive and sophisticated manner, nothing will change. The inertia throughout the entire investment management food chain is simply too powerful and pervasive. I have yet to hear a single persuasive argument as to how studiously ignoring major issues such as climate change adds value to the stock selection process or to the level of fiduciary prudence.

Despite this, however, it is currently a universal practice in North America. No pension fund of which I am aware currently assesses its portfolios systematically for climate risk, nor does any incorporate climate risk research into portfolio construction.

Fortunately, though, there is something of a salutary ‘perfect storm’ brewing – a confluence of developments which seems certain to give ESG factors greater prominence in the world of pension fund investment. The three most powerful of these conflicting occurrences are:

In Canada, it can only be hoped that as the CPPIB moves forward to execute its new policy, other pensions funds will rapidly follow suit. Canadian beneficiaries deserve nothing less.

Dr. Matthew J. Kiernan is chief executive at Innovest Strategic Value Advisors.

1. See for example, Bauer et al (2005) ‘The Eco-Efficiency Premium Puzzle in the U.S. Equity Market,’ Financial Analysts Journal, Volume 61, Issue 2, 2005; K. Gluck and Y. Becker (2005) ‘The Impact of Eco-Efficiency Alphas,’ Journal of Asset Management, Volume 5, 4, 2005.
2. Mercer Investment Consulting (2005), ‘AClimate for Change.’
3. Freshfields Bruckhaus Deringer ‘A Legal Framework for the Integration of Environment, Social, and Governance Issues into Institutional Investment.’

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