In my role at CFA Institute, market participants often ask me why they should comply with our Global ESG Disclosure Standards for Investment Products, particularly when our European colleagues already must comply with the EU’s Sustainable Finance Disclosure Regulation (and potential future regulations around carbon dioxide removal).

Similarly, our US colleagues that are awaiting rulemaking from the Securities and Exchange Commission, tell me they wish to wait until the dust settles and comply with what is mandated. I certainly understand and fully appreciate these reservations, but I worry my colleagues may not be seeing the full picture. Let me explain.

While consideration of ESG factors has become a highly charged political issue in the US, outside the US, there is less debate about whether it is appropriate to consider ESG factors. In both jurisdictions, however, there is still much concern about “greenwashing”— that is, advertisements or other disclosures that contain false or misleading information about an investment product’s environmental characteristics or impact.

There is a common root cause that underpins these seemingly disparate problems. ESG factors can be viewed through various lenses, including risk and return, personal values, and impacts on other people or the planet. When investment professionals, asset owners or investors evaluate a fund or strategy, it’s often not clear which of these lenses they are using. Some, but not all, markets have begun to address this problem through new regulatory disclosure requirements or guidance. However, uncertainty remains due to ambiguities in the requirements themselves as well as if and when new regulations will take effect.

In response to these problems, CFA Institute developed the Global ESG Disclosure Standards for Investment Products—global voluntary standards for disclosing how a fund or strategy incorporates ESG information or issues into its objectives, investment process, and stewardship activities.

We have found that often, standards are an effective way to resolve misalignments in the expectations of buyers and sellers. And, we have experience in this area. For example, prior to our development of the CFA Institute Global Investment Performance Standards (GIPS®), it was difficult to make meaningful comparisons of the historical investment performance among different funds and strategies.

The GIPS Standards solved this problem by establishing standards for the calculation and presentation of historical investment performance. Today, these are recognized by firms, regulators and investment professionals as the performance standard in the industry.

Similarly, investors today have difficulty making meaningful comparisons of ESG approaches used in investment products. The Global ESG Disclosure Standards for Investment Products address this challenge by requiring managers to provide prospective clients with an ESG Disclosure Statement, a document that provides key information about the fund or strategy, including:
• Environmental and social impact objectives
• Sources and types of ESG information
• Systematic consideration of financially material ESG information in investment decisions
• The use of an ESG index as an investment universe
• ESG screening criteria
• Targets for portfolio-level ESG characteristics
• Allocation to investments that have specific ESG characteristics
• ESG considerations in proxy voting, engagement, and other stewardship activities

Our Global ESG Disclosure Standards for Investment Products help asset owners—and their intermediaries—better understand, evaluate, and compare funds and strategies irrespective of whether there are local regulations in place, particularly because capital markets are global. We say this because an ESG Disclosure Statement can be a valuable input into an asset owner’s due diligence process and can help an asset owner ensure that a fund or strategy aligns with its investment policy statement. The Global ESG Disclosure Standards for Investment Products give asset owners an easy way to obtain higher-quality information about a fund or strategy by simply requesting an ESG Disclosure Statement.

The Global ESG Disclosure Standards for Investment Products help managers as well, by, for example, helping them explain to clients how ESG information and issues are considered in the design of a fund or strategy. These statements can save manager’s time and effort when responding to requests for proposals (RFPs) and due diligence questionnaires (DDQs). They can reduce risk by helping managers ensure that they have fully and fairly disclosed how and where ESG information and issues are considered in the design of a fund or strategy.

We know that asset owners and managers will continue to be scrutinized by clients, beneficiaries, regulators, and politicians.

The Global ESG Disclosure Standards for Investment Products provide asset owners and managers a mutually beneficial way to help them meet rising expectations for clarity and precision when communicating about the use of ESG factors in investment funds and strategies.

Instead of asking why market participants should embrace these standards, the better question may be: why wait? The wheels of regulation turn slowly and don’t always capture all the essential elements of the markets. Industry standards allow market participants to solve problems proactively.

As such, we urge all our constituents to adopt the Global ESG Disclosure Standards for Investment Products.

Paul Andrews is managing director for research, advocacy, and standards at CFA Institute.

Diane Griffioen, the new head of private equity at €228 billion PGGM, asset manager for the Netherland’s second largest pension fund PFZW, has a clear vision for the €23 billion portfolio in the years ahead.

More co-investment, sweeping Paris-alignment and a boosted allocation to 3D portfolios that incorporate risk, return and impact promising a shake-up in PGGM’s 90-odd GP relationships.

“Our GPs know that just because we have invested in one fund with them, we won’t automatically invest in another,” she says in her first interview with Top1000funds.com since joining PGGM, describing a highly critical, rigorous process of partner selection.

Co-investment

Around 70 per cent of the private equity allocation is invested in some 180 funds where PGGM typically pays fees of 1.5-2 per cent (depending on the fund) plus carried interest. The co-investment sleeve of the portfolio is currently around 20 per cent, below its 30 per cent target.

“We want to increase our co-investment exposure because it means we can have a direct influence on where we invest and it lowers our cost base,” she says. “The universe is too big for us to invest directly, but we can increase our direct exposure through co-investments.”

She says one of the biggest obstacles to increasing co-investment is finding capacity within the team to analyse attractive co-investment opportunities that come through the door.

Paris Alignment

In another strand of portfolio transformation underway, PFZW targets Paris-alignment across private equity by 2040 that includes all underlying portfolio companies.

“It means that from 2030 we will not commit to any GPs that are not Paris-aligned as it will take GPs many years to ensure their portfolio companies are net zero. In practice, this is a really high ambition,” she says.

None more so than for PGGM’s GP relationships in the wider allocation outside niche impact and SDI sleeves where Paris-alignment is an easier fit with GP ambition and strategy. She notes “a handful” of predominantly European GPs are Paris-aligned, but says the vast majority of PGGM’s relationship GPs are not, particularly in the US.

“There aren’t enough GPs out there who are Paris-aligned. That’s why we are engaging with them.”

Things are beginning to change, evident in GPs’ ESG scores improving. In another example, over the last year the asset manager has engaged with GPs to join the ESG Data Convergence Initiative. Developed with other investors, it asks GPs to use the same format to report ESG data in portfolio companies, developing a standardized set of ESG metrics and a mechanism for comparative reporting. “75 per cent of our GPs are now complying with the project,” she says.

Impact

She is equally determined to boost the impact allocation. Around 5 per cent of the private equity portfolio is currently invested in a specific impact seam focussed on four core themes (climate, health, water, and food security) and she says the aim is to increase it to 10 per cent.

The challenge is finding the right GPs to partner with. Although she notices a growing number of impact investments within private equity, aligning fund structures with impact is challenging due to the wide variation of impact goals amongst LPs and a lack of common standards on impact measurement.

“It’s much harder to do impact,” she says. “Setting financial KPIs is much easier – it just involves money!”

Still, changing the structure of PGGM’s relationships so that KPIs are linked to impact rather than just financial metrics is an area she is determined to develop.

“The fee structures are too focused on financial alignment. It would be nice if we could also use impact metrics.”

Looking to the future, she expects impact to become much more central. PGGM (and its client PFZW) have high impact ambitions for the total portfolio, she says.

For example, a commitment made in 2020 to have 20 per cent of PFZW’s investments SDG-aligned by 2025 has already been met.

“Things go faster than you think,” she says. “We thought that 20 per cent would be difficult but now we are thinking about what to develop and how to innovate to 2030. Things go fast in our society, and pension funds should work hard to catch up. PFZW wants to play a leading role in this area.”

Influence

The ability to influence corporate behaviour was one of her key motivations for joining PGGM’s private equity team.

A seasoned investor, Griffioen was CIO at ABP for four years until 2022, before which she spent much of her career in the listed market where small ownership stakes equate to much less influence. Private equity is better suited to steer corporate behaviour via ownership rights and an LPAC seat than listed investment, she says.

Moreover, in the listed space she notes investors are increasingly seeking active strategies over index funds.

“Active ownership is increasingly more important,” she said. “You can see that many investors aim for a more focused strategy – ten years ago a majority moved to index products, but this has now shifted to a demand for focused strategies.”

She also believes that private companies are closer to the real economy and hold many of the solutions to the climate crisis.

“Innovation doesn’t tend to come from the listed space. I joined private equity because of the growth and sustainable innovation possibilities in this segment.”

Her 30-strong team is grounded in principles of autonomy, involvement (“everyone belongs and everyone is welcome”) and competence. She describes a culture where people can work on their own and “handle things, take initiative and don’t wait” and where diversity (she counts ten nationalities) and the absence of silos, allowing juniors to learn from everyone, are engrained.

Going forward

The private equity allocation is overweight (10 per cent) its 6 per cent target allocation. It means PGGM will allocate slightly less to funds this year compared to previous years, currently targeting €2.5 billion in dispersions.

Although she stresses the importance of continued, steady investment and not “missing a year” she is also mindful that in the current climate, drawdown times have got longer and she is increasingly aware of the risk of too much leverage.

“Nowadays, leverage is more expensive with higher interest rates, so returns are likely to come down a bit.” Elsewhere, she is concerned that the slowdown in IPOs and exits will impact liquidity. “This is really on the radar for our funds, and we notice the environment is a bit more difficult. But we are a long-term investor.”

Half the portfolio is invested in the US; 40 per cent in Europe and 10 per cent to the rest of the world. Diversification ensures the portfolio isn’t over or under-allocated and that different segments are tapped, she concludes.

Alecta, Sweden’s biggest pension fund with $110 billion of assets under management, has fired its chief executive Magnus Billing following nearly $2 billion of losses incurred from last month’s US banking crisis. The pension fund is also beginning an enquiry into how it manages equity, due to report in the summer.

Alecta, known for maintaining a very concentrated equity portfolio, has also begun reducing risk from its large stakes in companies far from its home market, focused particularly on holdings in the US.

In a statement, Alecta said a strategic review will explore how it will conduct equity management going forward, headed up by Ann Grevelius, now acting head of equity.

Alecta began investing in SVB in June 2019 and made its last investment in November 2022. The pension fund is the fourth largest shareholder in SVB. It also had investments in Signature and First Republic Bank.

management change

Grevelius is a member of Alecta’s board, a position she will resign during her time as head of equity. She was previously head of SEB Investment Management and will take over from Liselott Ledin who has left her post as head of equity following 28 years at the pension fund. The statement said the review is expected to be ready for board analysis in good time before the summer.

Deputy CEO Katarina Thorslund has been appointed acting CEO, and the recruitment process to find a new CEO will begin immediately. In the meantime, Ingrid Bonde will support the organization as chair of the board.

Alecta head of asset management, Henrik Gade Jepsen, is currently on long-term sick leave due to complications following a Covid infection. He is expected to have recovered and be back in the role after the summer. Until he returns, Kerim Kaskal has been appointed as acting head of asset management. Kerim Kaskal has extensive experience in asset management, including as head of asset management at AP3.

Losses

The statement said  that following large losses in three American niche banks last month – SVB, Signature Bank and First Republic Bank – management and the board have worked intensively to isolate the losses and work through the processes within asset management to understand how the situation arose.

Alecta’s management has made the assessment that the investment decisions were within the framework and mandate established by the board. The board shares that assessment and welcomes the Financial Supervisory Authority’s review of the course of events, said the statement.

SVB was the largest bank since the 2008 financial crisis to collapse when California regulators closed it, sparking market disruption and heightened stress across the banking sector. It led to Credit Suisse, already in trouble with losses, being forced to merge with UBS by Swiss regulators to prevent wider contagion.

The announcement of Billing’s departure follows attempts to reassure in the fund’s latest annual report, published last week. Billing wrote how the spike in interest rates had caught the investor unaware.

“Since 2016, we have invested in three banks in the US with completely different business models and with operations in different parts of the country. These investments developed well during the first years, but in 2022 the situation worsened as interest rates rose. Although we saw that there were challenges ahead, our assessment was that they could be resolved. We, like most analysis houses and credit rating agencies, misjudged the rapid negative developments for US banks that occurred in March 2023,” he wrote, adding.

“The impact on pensions is small, partly because the loss corresponds to less than 2 percent of our managed capital.”

AP2, Sweden’s SEK 400 billion ($38.8 billion) buffer fund, recently divested its allocation to three Chinese asset managers overseeing an allocation to China A shares despite spending many years carefully building up the successful stock picking portfolio. High points of the strategy included the portfolio returning an average alpha of 30 per cent in 2017.

The decision to build an externally managed Chinese equity allocation back in 2013 was a marked change of tack from AP2’s quant approach across global developed and emerging market equity. The only other fundamental allocation is to Swedish equity where market knowledge and expertise is close at hand.

Now the allocation to Chinese companies  is back under that quant umbrella where it accounts for 20 per cent of the pension fund’s 11 per cent allocation to emerging markets and where investment decisions are drawn from models fed by a huge data pool. Around 70 per cent of AP2’s assets are invested in risk assets of which 50 per cent is equity and 20 per cent is real assets including property and forestry.

The decision to divest the mandates was driven by the buffer fund’s quest for efficiency and cost savings which has led to around 80 per cent of assets now being managed inhouse including all public markets, explains CIO Erik Kleväng Callert who joined AP2 in May 2022.

“Managing money in house allows you to be lower cost, more dynamic and more flexible in your investment process,” he says. “We can’t invest in China with the same fundamental approach we have in our home country. It would be impossible to have a fundamental approach to managing Chinese equities from Sweden.”

The shift in strategy also comes against the backdrop of AP2’s integration of key themes amongst which is growing geopolitical tension.

“Of course, we remain concerned about developments in China, and follow it really closely,” he continues. “Geopolitical tensions are emerging that will impact many of our allocations and assets but we still have a fair share of Chinese equities.”

In the quant allocation AP2 seeks the highest risk adjusted returns via a multi-factor approach that includes value, quality, low volatility and ESG factors that favour the most sustainable companies in line with AP2’s Paris-aligned benchmarks.

Brown opportunties

Another key trend influencing strategy is the climate transition. Much of the investment team’s time is spent understanding how to adjust the portfolio, getting to grips with not just the financial risk from climate change but how the companies AP2 owns will impact the environment and climate change going forward.

It calls for a particular approach to investment that is more active than quant.

“You cannot be 100 per cent passive in ESG. You must have some kind of smart beta; you have to have a more fundamental process,” says Callert. “We have a lot of ESG data and research on every company we own. If a company doesn’t do the right thing, we will look into it and we will potentially sell it off.”

AP2 mitigates climate risk in the portfolio by avoiding investments in high emitting sectors in line with Paris-alignment and its own emission targets. It also actively invests in solutions like new energy infrastructure, green bonds where the funds are earmarked for solutions, and has a large allocation to forestry.

But Callert, who draws on years of experience in sustainable investment from previous roles at PRI Pensionsgaranti, PP Pension & Insurance and Nordea Life & Pensions, says ESG integration is far from straightforward.

“We must be careful to always look at all our investments from a risk and return perspective. Investments must have a good business case as well as support the climate transition. Sustainable development doesn’t just involve green investments, investments must have the right risk return.”

Carefully picking winners and avoiding stranded assets is leading the team to research cheaper brown investments in the hope they grow in value as they transition their operations.

“We are thinking of investing in businesses that have yet to become green, i.e. companies that are focusing on transitioning their operations. This might include energy companies that are focusing their investment budget on switching from fossil fuels to renewable energy or steel companies developing new processes,” he says. “We see a value if you can buy them a little cheaper because many investors don’t like brown companies. We can buy them and fix them and this is a good option.”

For all AP2’s long term view, stable asset allocation and risk levels and determination to ignore short term market volatility, Callert will tilt the portfolio to a short term view or dislocations.

Today that includes opportunities in the undervalued Swedish Krona, currently cheap compared to its long-term equilibrium.

“We can change our exposure to FX in the portfolio so today we have a little less exposure to foreign currencies because see them as overvalued against the Swedish krona,” he concludes.

 

Recent returns in Oregon Public Employees Retirement Fund’s (OPERF) $13 billion real estate portfolio are linked to a combination of factors including a strategic pivot to multi-family and industrial exposure and the growth and performance in the fund’s boosted allocation to separately-managed accounts which have improved alignment and allowed significant fee savings.

The portfolio’s performance is also attributable to its large allocation to core, income-driven real estate at a time of sustained, strong core performance. OPERF’s predominantly core allocation means investments are at the lower end of the risk spectrum with a focus on high quality, lower leverage, relatively liquid assets in established markets.

A strategy that dates from 2016 when the investment team began to gradually de-risk the allocation, liquidating opportunistic investments in favour of more sustainable, long-term portfolio and reduce embedded risk.

“We have achieved outperformance without taking outsized risk,” said Christopher Ebersole, investment officer, real estate, at Oregon State Treasury which invests Oregon’s state funds including the $95.4 billion OPERF portfolio, speaking in a recent council meeting.

For the period ending September 2022 the portfolio returned 20.54 per cent earning a 10 year return of 11.21 per cent. The real estate portfolio has generated $2.4 billion in net cash flows since 2010.

Still, looking ahead, Ebersole flagged that the allocation will be increasingly buffeted by higher financing costs and challenges around price discovery characterised by sizeable bid ask spreads in most transactions. He also noted that OPERF has substantial uncalled capital commitments to evergreen structures (like openend funds and separately managed accounts) as managers remain selective on the acquisition side, waiting to capitalise on distressed and discounted buying opportunities.

Around 70 per cent of the portfolio is in evergreen structures meaning distributions from income will become an increasingly large component of future portfolio cash flows.

“The market reached an inflection point in late 2022 with the 4th quarter ushering in an expected near-term trend of meaningful write downs across sectors due primarily to rising financing costs, increased cap rates and uncertainty around commercial tenant demand,” said board documents.

Positively, 2022 brought a resumption of travel for the real estate team, resulting in a return of in-person manager meetings, enabling analysts to better assess assets.

Approvals and fees

Last year the team approved nine real estate commitments totalling $1.75 billion. All 2022 commitments represented continuations or expansions of existing manger relationships in a reflection of the investment team’s high degree of conviction in its manager roster and the ability of these groups to execute.

Also underscored by the emphasis on evergreen partnerships which has meant that the frequency of new partnership underwriting has fallen.

According to board documents, last year’s core commitments resulted in management fees that averaged a 40 per cent discount to average fee structures for comparable open ended vehicles.

Non-core commitments included management fees that averaged a 15 per cent discount to average fee structures for comparable closed-end vehicles.

Targeting risk

The portfolio targets a long-term net return 50 basis points above the NFI-ODCE (26 largest equity open ended real estate funds in US) and aims to reduce risk among the portfolio’s investments through diversification by strategy, investment size, geography, and tenure.

The riskier corner of the portfolio comprises an allocation to value add and opportunistic strategies that use higher leverage and focus on investments driven by exits. Higher interest rates have particularly impacted these strategies, the council heard.

Real estate is currently within OPERF’s policy range of 7.5 per cent to 17.5 per cent but above the midpoint range of 12.5 per cent. The council heard how future discussions will review a strategy that currently holds onto core assets long term, rather than sell them as well as how to build international exposure to increase diversification.

DEI and ESG integration in the portfolio remains a work in progress as Oregon develops these themes collaboratively with its managers.

Investors are currently facing the end of uncertainty around assumptions they have made for decades, and need to shore up their portfolios with greater inflation protection, more active management, and by fostering innovation, according to chief strategist at the Investment Management Corporation of Ontario, Nick Chamie who spoke to Amanda White in the Fiduciary Investors Series podcast.

 

 

What is the Fiduciary Investors series?

Through conversations with academics and asset owners, the Fiduciary Investors Podcast Series is a forward looking examination of the changing dynamics in the global economy, how decision making should adjust for different market pressures and how investors are positioning their portfolios for resilience.

The much-loved events, the Fiduciary Investors Symposiums, act as an advocate for fiduciary capitalism and the power of asset owners to change the nature of the investment industry, including addressing principal/agent and fee problems, stabilising financial markets, and directing capital for the betterment of society and the environment.

Like the event series, the podcast series, tackles the challenges long-term investors face in an environment of disruption,  and asks investors to think differently about how they make decisions and allocate capital.