Key elements of ESG integration at Pensioenfonds Metaal & Techniek (PMT), the $112 billion Dutch fund for metal and technical workers, centre around an ongoing engagement program with the oil and gas industry, data gathering, divestment, and working with other investors to coalesce around climate action.

The pension fund has created bespoke equity and bond indexes across all its developed and emerging market liquid allocations, most recently introducing additional screens barring ESG laggards from the indexes and raising the threshold to entry.

All investments are assessed to see if they can be part of the climate solution and PMT is targeting allocating €10 billion to impact investment by 2030. All the while diligently reporting progress back to members, said Hartwig Liersch, PMT’s chief investment officer, speaking at FIS Maastricht.

Data quality

One of the biggest challenges in PMT’s ambitious strategy is data access and quality. Movement and progress on corporate transition plans requires data to assess if corporates are  on a sustainable path and will reach their objectives, explains Liersch.

It’s important to see if companies are transitioning on a path of 2 or 1.5 degrees, and extracting data on corporates’ Scope emissions is challenging. Liersch noted how the war in Ukraine has influenced companies net zero pathways.

“Plans are different to what they thought,” he said.

At NOK 786 billion ($78 billion) Kommunal Landspensjonskasse (KLP), Norway’s fund for local government employees and healthcare workers, strategy is shaped around engagement and working with other investors. The passive investor is systematically shifting from high to low emitting companies and sectors and monitors and cajoles 7000 companies across 50 countries tracking MSCI and Barclays’ equity and bond indices, of which it currently excludes over 200.

In a second approach, fellow panellist Arild Skedsmo, senior analyst, responsible investments, KLP, explained how KLP is also expecting its emissions to fall in line with the real economy.

It’s a strategy KLP supports by trying to influence companies to make ambitious climate commitments and put credible plans into action. Success depends on KLP working with other investors, said Skedsmo.

“We have limited leverage. We need society to work together.”

Alongside influencing corporate behaviour alongside other investors KLP works with regulators and governments to wield influence. Challenges include mobilising this collective force to convince company boards to act; persuading corporates that climate change is also an opportunity, and that investors expect them to make long term transition plans is difficult, he said.

Skedsmo echoed previous comments about the importance of data. However, he noted that it isn’t always necessary to ask for complete data sets. KLP is invested in thousands of companies and tapping top-down portfolio analysis is not always necessary. Focusing on how a company is doing within its sector, using monitoring tools and working with other investors, stakeholders and civil society is sometimes more beneficial – supported by KLP’s own bottom-up analysis of emissions within sectors.

Sovereign engagement

For sovereign bond investors looking to integrate ESG, engagement includes working with governments. Climate change is a threat to sovereigns, said Jens Waechter, senior global macro and research analyst, Franklin Templeton Investments.

“Mitigation is financially beneficial.”

Franklin Templeton invests in global sovereign bonds and corporate bonds in developed and emerging markets. Engaging on ESG issues includes talking “behind closed doors” with governments and addressing challenges within the wider context of ESG analysis.

“As a private investment group, it’s tricky to walk up to an elected government and tell them what they should do,” he said.

ESG analysis comprises three steps, he continued. The investor gathers forecasts on the transition progress of investee countries over the next three to four years. He noted that countries don’t need to be rich to transition.

Although wealthy countries have the resources to transition, progress in emerging markets particularly catches his eye.

“When you see countries with limited means take small steps they deserve as much capital as those countries that are capital rich.” He noted that it is financially more rewarding to invest in countries moving in the right direction.

He noted that investments aren’t possible via tactical allocations, but require an investment case, analysing to what extent sovereigns and companies are improving or backtracking.

Franklin Templeton aims to use robust data sources that draw on a methodology that doesn’t change all the time. Waechter noted how in many cases, plans corporates make around net zero are aligned with sovereign progress.

Assessing Singapore’s commitment to net zero by 2060 involves understanding what the policies are and the State’s capex plans in a way that will offer insight on corporate net zero progress too.

“This is macro data, and it is very important to get it – we can’t create it ourselves,” he said.

He also noted the importance of finding a general trend rather than seeking to unearth every detail, focusing on which key indicators to follow.

 

Europe must prepare for recession and negative economic growth, warned Clemens Kool, Professor of Macroeconomics and International Monetary Economics at Maastricht University, speaking at FIS Maastricht.

The spike in energy prices has had the biggest impact on European inflation, said Professor Kool who is also chair of the academic board at Studio Europa Maastricht. Central banks have been pushing to exclude variable items like energy from the inflation basket, yet energy and food are the most important signals of inflation.

“Energy prices are volatile and an important component of the total basket,” he said.

Moreover, energy has an impact on the supply and demand side of the economy. Energy impacts the input prices for key goods and is an increasingly large part of demand in the consumption basket.

“Energy is influential as a driver of other prices,” he said, adding that inflation comes from too much demand chasing too little supply – at which point fiscal and monetary policy attempts to break demand.

Wage spiral

When demand and supply interact, it can cause a wage price spiral.

Prices are currently rising so fast in Europe it is triggering a wage price spiral. People in work are experiencing a cost-of-living crisis and demanding pay rises. Firms must go along with it because of the scarcity of labour, in a vicious circle that translates back into prices and a new round of wage increases.

Anchor

Central banks have a vital role anchoring inflation expectations. Policy promises to maintain inflation close to 2 per cent helps anchor inflation expectations. But if central banks fail to convince people they are serious about anchoring inflation, the spiral continues leaving central banks with more difficult choices, he said.

Kool said that Europe has not tipped into recession yet. Mostly thanks to robust private demand and the lingering impact of expansionary monetary and fiscal policy as economies continue to come out of the pandemic.

The more inflation expectations edge higher, the harder it gets for policy makers. It is key to ensure expectations of inflation stay as low as possible and is particularly “crucial” for financial and labour markets. Expectations play such a big role, once high inflation is embedded in peoples mind it is difficult to dislodge.

Positively, he predicted that prices will gradually shift lower as energy demand drops off. However, tightness in energy supply will continue for as long as it takes Europe to find alternative sources of energy either nuclear or green, sustainable energy.

Kool said the ECB is reluctant to change its inflation benchmark. However, he noted that the Federal Reserve has a more flexible approach – raising the target is more likely in the US than Europe. He said statistically, inflation looks like it will remain high because it mostly derives from the energy squeeze.

Expansionary policy

A key challenge is the fact monetary policy in Europe is still expansionary. High inflation in the 1980s was also characterised by high interest rates. In contrast, although interest rates are rising today, they are still close to zero. Liquidity remains in the market because QE is still pervasive. It leaves central banks with a challenging balancing act – raising interest rates and taking out liquidity. For the ECB this will involve difficult policy decisions that suit northern and southern Europe.

“The ECB has to think about tensions between northern and southern Europe; raise rates and the gap increases,” he warned.

Kool said it remains unclear whether liquidity in the system will be reduced – the ECB can still buy government bonds – sentiment in the bond market [that they will] remains optimistic. The most likely outcome ahead is stagflation. He questioned whether Europe is poised to enter a long period of low or no growth but said that recession is likely.

“How long or deep is difficult to say. My crystal ball is no clearer than yours.”

It was in 2020, a few months after the start of the Covid-19 crisis that Klaus Schwab, executive chair of the World Economic Forum, called for The Great Reset – a clarion call for the world to act ‘jointly and swiftly’ to revamp all aspects of our societies and economies.

Saying the tool to do this is stakeholder capitalism – and fundamental to this is a much-needed transition to a ‘fairer, more sustainable post-COVID world where companies have a responsibility, and a rare opportunity, to rethink organisational and workplace structures and to invest in their workforces’.

Over the last decade or so, conversations around the future of work have been largely linked to job automation. However, the pandemic has rapidly widened this conversation to also include where we work, how we work and the ways in which workplaces and the workforce is organised.

It has also had a big impact on employee-employer dynamics – effectively the give and the get – with more employees demanding improved flexibilities and employers struggling to catch up.

With productivity and organisational culture on the line, leadership engagement on the topic has mushroomed. The focus has often been on emblematic issues such as hybrid working, shortened work weeks and the redesign of workspaces to create more magnetic offices. However, there are some wider themes which we have observed through our work with investment organisations:

1. The hybrid work journey remains messy

It is clear that the future of work is hybrid. In a CFA Institute’s survey on the future of work, 81 per cent of investment professionals stated that they would like to spend more time working remotely, with employers having to rapidly adapt to meet this demand through more flexible working policies.

However, hybrid design needs strong execution, with value being currently derived through considering social interactions, space utilisation and time optimisation and future value being developed through the presence of networks, relationships, shared norms and trust. There is a real opportunity here to think about what hybrid working actually means, with better policies involving a degree of co-creation with employees and where work is adapted based on location, synchronicity and connectivity needs.

Part of the hybrid challenge isn’t just about getting employees into the office – it’s also about making the most of their time. Microsoft’s latest Work Trend Index notes that despite the fact that 44 per cent of hybrid employees and 43 per cent of remote attendees don’t feel included in meetings, just 27 per cent of organisations have established new hybrid meeting etiquette to ensure that everyone feels included and engaged. Leaders need to make the office worth the commute and employees now have different expectations as to what the office experience should deliver. Social capital and the value that it adds through collaboration, belonging, trust and goodwill should be seen alongside human, intellectual and financial capital in organisations as a key enabler of value creation. Innovation is also powered by social capital. So the challenge for leaders is to reconfigure their workspaces to prioritise social engagement and set aside time for in-person activities where interaction is facilitated.

2. While talent is everywhere it is unnecessarily scarce

We are in the midst of The Great Reshuffle – a term broadly used to describe the mass movement of workers seeking roles that better meet their work/life requirements and/or are better aligned with their values.

US academic, Anthony Klotz – who coined the forerunner term The Great Resignation – notes that individuals are now seeking opportunities that allow them ‘to fit work into their lives, instead of having lives that squeeze into their work’.

Talent is dispersed globally and there is an opportunity here for leaders to become more creative in using global talent and to think about how it can be used to create a more agile and distributed workforce. The shift to a more networked structure requires moving from traditional approaches where employees are boxed into projects based on their current job role to a more holistic, flexible approach which matches employees’ varied skillsets to relevant projects. This requires the collection of more data on employee experiences, a better understanding of a workforce’s skills and embracing technological innovations that allow teams to work in more global and continuous real-time ways.

With in-person time being reduced, we also find that the T-shaped qualities of people and teams becomes more valuable in the new world of work. T-shaped individuals and teams seek to connect dots better through building inner ties and developing outer networks. There is a real opportunity here for leadership to transform existing teams into superteams – by combining diverse and talented individuals within a strong culture and having excellent governance – to deliver exceptional outcomes.

3. The rise of the human-centric organisation

The COVID-19 crisis has been a defining leadership and transformation moment, where leaders have been called to reset their future of work agendas and lead the way to better and more human-centric workplaces and workforces.

We are now in the era of human-focused company culture where workers are re-evaluating what matters most to them. This has prompted employers to focus on the wellbeing and personal satisfaction of employees though increasingly flexible work arrangements, investing in wellness programs and boosting diversity, equity and inclusion efforts.

LinkedIn’s 2022 Global Talent Trends survey notes a 147 per cent increase in the share of job posts that mentioned wellbeing since 2019 and a 73 per cent increase in companies’ posts about wellbeing. According to the survey, employees that feel cared for at work are 3.2x more likely to be happy at work and 3.7x more likely to recommend others to work for the company. The same survey notes that work-life balance trumps even bank balance for job seekers.

Productivity is multi-faceted. Work has long shifted from simply a function of time, activity and effectiveness and viewed solely through the lens of the value delivered to the organisation. Instead, the employee value proposition has become more central and includes work flexibility, work/life integration, personal growth, employee experience and wellbeing. There is an increasing appetite for a new leadership model to deal with these challenges that is less hierarchical, more networked, more versatile and is driven by more soft power. This new model needs to encourage empowerment, joined-upness and humanism with positive stakeholder outcomes at its core and which champions connections and collaboration while focusing on behaviours.

It’s a juggling act.

Successful work design in this new world will require finding a fairer balance between employee and organisation, where employees crave flexibility and meaning and employers require productivity, impact and a culture that aligns with its purpose.

A key ingredient of success will be an emphasis on how work is done. This is the sweet spot where organisation and employee can meet around belonging and teamwork at the same time as values and expected behaviours. Finding this balance will require some juggling and enlightened leaders will need to think deeply about these wider themes.

Marisa Hall is the co-head of the Thinking Ahead Group, an independent research team at Willis Towers Watson and executive to the Thinking Ahead Institute.

The historical undervaluing of water as a resource, combined with climate change, is impacting communities around the world and posing a systemic risk to investor portfolios.

Water deserves the same attention from investors as climate and the growing water crisis poses a systemic risk to portfolios around the world, argued Brooke Barton, a key figure behind the Valuing Water Finance Initiative which has gained the backing of dozens of the world’s largest institutional investors.

Humanity has underestimated the degree to which climate will be a threat multiplier to freshwater resources, said Brook Barton, vice president, innovation and education at the Boston-based non-profit sustainability advocacy organisation Ceres.

Climate change is driving the hydraulics cycle, or water cycle, into overdrive and increasing the intensity and frequency of droughts and floods, she said, speaking at Conexus Financial’s Sustainability in Practice forum held at Harvard University.

This has disproportionate impacts, with 2.1 billion people currently lacking access to fresh water on a reliable basis. Recent examples in the United States include the flooding of a water treatment plant in Jackson, Mississippi which has led to an ongoing public health crisis.

“We have now weeks of residents either without water or on boil water notice in a predominantly black city,” Barton said.

Barton said one of the more compelling and simple statistics that illustrates the importance of water is that the average human can only live without it for three days.

“Water and water risks that we are seeing across the world run really fundamentally to the survival of the human species in the near term,” Barton said. Despite this, “we have countless examples of mismanagement and a general tendency to undervalue this resource,” she said.

Companies are finding it increasingly challenging to grapple with water issues in various geographies where there is either too much, too little, or it is too dirty for industries dependent on extremely clean and safe water, she said.

Conflicts are emerging between the rights of companies to water, versus the rights of people and farmers, she said, pointing to Coca Cola’s groundwater pumping in India, Barrick Gold’s closure order and sanctions in Chile, and the impacts on shipping in Europe due to low river levels.

However investors still tend to view water risk as an idiosyncratic risk specific to certain locales, geographies and sectors, rather than a more systemic risk to portfolios, she said.

In response, comprehensive data sets are emerging on corporate disclosure, driven by the CDP. And Ceres in conjunction with the Center for Water Security at the University of Saskatchewan has released the first comprehensive scientific review of corporate water impacts on freshwater.

Ceres is coordinating the Valuing Water Finance Initiative, partly modelled on Climate Action 100+, where institutional investors are committing to engage with the world’s 72 largest corporate water users to convey six expectations around water risk management and stewardship.

These expectations align with the United Nations’ 2030 Sustainable Development Goal for Water, and actions laid out in the Ceres Roadmap 2030.

The initiative was launched with 64 signatories representing US$9.8 trillion in assets under management.

An associated framework for assessing corporate progress against these expectations will soon lead to benchmarking, Barton said.

The growth and availability of data is allowing investors to see progress on their de-carbonization efforts and contributing to increased investor confidence around decarbonization, said John Quealy, chief investment officer, Trillium, the asset manager with nearly 40 years at the forefront of ESG thought leadership and responsible investing.

Speaking at FIS in Maastricht, Quealy also outlined enduring challenges regarding investors ability to impact the climate transition, including agreement around a common definition of sustainability. Investors are also struggling to conceptualize the real-world impacts of their investments; how to measure “changing the world for the better” and the integrity of the process. “It’s very difficult to achieve outcomes over three to five years,” he added.

Three Pillars

Delegates heard how European policy makers are working to bring uniformity and clarity to sustainable investment. Europe’s sustainable finance strategy is built around three pillars comprising the EU taxonomy and its common classification of activities, and disclosure requirements aligned with the taxonomy encapsulated in the EU’s Sustainable Finance Disclosure Regulation, explained Alain Deckers, head of unit, asset management, directorate general for financial stability and capital markets union, European Commission.

A third pillar revolves around a series of tools to promote sustainable finance including climate benchmarks and regulation around green bond standards, still in negotiation. Other proposals and initiatives in the pipeline include work on ESG ratings and developing impact assessments. This work involves close coordination with the International Sustainability Standard Board, aligning as much as possible to these standards but also considering the EU’s quest for a double materiality framework, explained Deckers.

He said much of the process around the strategy is still bedding down and involves “learning by doing” as policy makers grapple with new and difficult topics. War in Ukraine has also complicated the transition because it has created a short-term energy crisis.

However, Deckers maintained that conflict in Europe has also heightened the importance of moving away from dependency on Russian energy. “The way ahead is to push on with the transition to renewables and achieve our climate objectives,” he said. Moreover, he pointed to encouraging current indicators that suggest gas prices might come down including healthy storage capacity, demand destruction and LNG ships waiting to dock.

Almost all Dutch investors now view climate as a fundamental risk, said fellow panellist Marcel Jeucken, founder and managing director of SustFin, an independent advisory on sustainable investment. Investors stress-test their asset allocations in terms of fiscal and transition risk but are also tapping opportunities in the transition. In another trend, Jeucken said that investors increasingly measure how divestment supports decarbonisation efforts and engage to bring about real-world impacts to help finance the transition.

Jeurcken dissented from other conference voices on the challenges of decarbonizing high carbon industries.  Stephen Kotkin, Birkelund Professor Emeritus at Princeton University said decarbonizing industries like cement, steel and travel looks increasingly unlikely. In contrast, Jeurcken said he believed as renewables become increasingly cheap, “[decarbonization] could be much faster than the fossil fuel industry thinks.”

However, Decker warned that it will take time to achieve the transition. It is not possible to just switch off existing energy sources. Still, he said setting objectives is an essential part of the process; without which the world is navigating in the dark. “It is a challenging process, but not one we can pass on,” he said.

The conversation turned to building momentum behind the transition in Australia where regulators and the government are now lea­ding with policy initiatives. Australia is still in the early stages of understanding how private capital will invest in the transition.

Portfolio ResiliEnce

An increasingly key issue for investors is the impact of climate change on their portfolios. Fires, droughts, and other impacts of climate change are happening, raising questions around portfolio resilience. Moreover,  investors shared stories on the challenge of reducing their carbon footprints when it comes to investing in the construction projects needed to transition.

Delegates discussed the need to engage not just on fossil fuel supply but on demand. Others discussed the need for visibility on impact and stressed the importance of allying with other investors in risk sharing and accessing an increased set of opportunities in blended investments with governments.

Other investors noted how integrating ESG has gone through board and governance processes and is now in a digestion phase. Companies have improved on their reporting processes in a standardized fashion. The level of conversation and detail is stronger.

Panellists concluded by reflecting on the need for transparency and clarity on the objectives they are trying to achieve. Investors need clear reporting processes and to show how they are delivering on objectives. Decker warned of huge change and steep learning curves ahead but  concluded on a note of encouragement. “We will fix teething problems and it will get easier and easier. We will also have a higher quality of information on what to base our decisions.”

The United Kingdom’s University Superannuation Scheme, USS,  has developed several strategies to protect the portfolio from inflation. These include a comprehensive interest rate and inflation hedging program alongside investing in assets that are sensitive to inflation including infrastructure and emerging market inflation linked bonds. Another source of return this year has come via USS’s active currency allocations, continued Mirko Cardinale, head of investment strategy, USS, speaking at FIS Maastricht.

USS doesn’t set an FX hedging policy, but independently decides its appetite for FX risk and the appropriate mix of currencies. “Having a diversified portfolio of the main, liquid currencies with a focus on more defensive currencies including the euro and yen, has been very helpful,” he said.

At USS, governance is structured to ensure enough flexibility to respond quickly to changes in the environment, an agility that is also enabled by the pension fund’s inhouse team and derivatives expertise, said Cardinale.

USS uses leverage to hedge its interest rate risk, and protecting the portfolio from the recent sharp move in UK interest rates has been challenging. However, the pension fund has remained resilient partly thanks to a framework that provides risk analysis going back to the 1970s. “We are conservative, and took action before things got difficult,” he said. The framework provides a basis on which to balance liquidity and collateral and is operated by the in-house team. “We moved assets to rebalance without a major issue,” he said.

APG: the impact of interest rates

Investment strategy at APG Asset Management, the largest pension provider in the Netherlands, is currently focused on the impact of reform in the Dutch pension sector. Laws, about to be approved in Parliament, could impact asset allocation if regulatory restrictions on taking risk are eased. Reform may also lead to pension portfolios becoming more transparent, allowing individuals to better see the volatility in their pension pot. This could have the effect of making strategies more defensive, predicted Onno Steenbeek, managing director, strategic portfolio advice, APG.

On one hand, rising interest rates might lead to bigger allocations to interest rate swaps and hedges, but on the other, such allocations may not be necessary in a new system.

“If we move the portfolio in one direction, is there a chance we have to reverse that move?” he asked.

IMCO: a focus on inflation

Strategy at Canada’s $79 billion Investment Management Company of Ontario, IMCO, is similarly focused on inflation where fellow panellist Rossitsa Stoyanova, CIO, IMCO, said the investor’s 5-10-year outlook predicts a higher and more volatile role for inflation ahead.

“We do think given what is going on in the world that structurally inflation will be higher or more volatile. There will be cycles where inflation overshoots and needs to be bought down.”

IMCO doesn’t have a tactical or dynamic asset allocation and is focused on long term trends. However, a broad mandate allows the team to move tactically when needed. The investor has increased its allocation to inflation linked bonds and continues to build investments in real estate and infrastructure.

“We are looking for more inflation linked assets in infrastructure,” she said.

Away from inflation, Stoyanova noted how heightened levels of volatility will provide an opportunity for active investment. Indeed, she noted that beta will be increasingly challenged. The fact that integrating ESG and sustainability is increasingly difficult in passive strategies, also builds the case for active investment. IMCO is building its private market capabilities and wants to invest more in the energy transition.

“We are building expertise to invest alongside strategic partners,” she said.

the importance of Modelling

At USS, strategy includes frequent scenario analysis. Rather than hunting for probabilities, analysis focuses on playing out different scenarios and exploring portfolio implications across the main asset classes to reveal resistance in the portfolio.

“This is a better use of time,” said Cardinale.

Similar scenario modelling at APG reveals an ever-widening possibility of outcomes. Steenbeek noted that although risk scenarios are helpful in explaining what could happen, they are difficult to apply to an actual asset allocation.

“What is good in one scenario is bad in another,” he told delegates. “Do we cover the whole spectrum of possible outcomes?” Elsewhere he noted how higher interest rates have led to discussions around higher interest rate hedges and liquidity at APG.

Stoyanova outlined the challenges of designing a long-term portfolio around stagflation. “A portfolio just needs to withstand stagflation,” she said.

She noted the risk of private markets lagging public markets after a sell off. She also said that every time IMCO considers investment opportunities in private markets, the team also compares the risk and return in public markets, discussing if they would do better buying the public market as it may be at a discount.

Private markets must outperform because of the illiquidity factor, and because investments may contain leverage or involve restructuring, she concluded.

“We recognise this, and require a spread over the benchmark,” she concluded.