As some plan sponsors increasingly adopt environmental, social, and governance (ESG) factors across investment verticals, the pressure to jump on the ESG train continues to accelerate for asset managers. Plan sponsors shared their expectations, strategies, and goals within sustainable investing at Skytop Strategies’ Generating Alpha conference held on October 30 in New York City.
While the $192 billion New York State Common Retirement Fund’s investment due diligence process includes a risk management framework that contemplates ESG factors across asset all classes, challenges persist, particularly within private markets, according to Gianna McCarthy, a director of corporate governance at the fund.
“We have an expectation for a level of disclosure on ESG issues and [certain private market managers] are not there yet,” McCarthy said on a panel discussion. “But, this is something that we engage with them on.” For example, McCarthy cited the fund’s desire to perform a carbon footprint analysis of its portfolio and the obstacles presented by some managers given their lack of disclosures and transparency.
Similarly, the $215 billion California State Teachers’ Retirement System (CalSTRS) has incorporated the CalSTRS 21 Risk Factors, which outlines the consideration of ESG factors as part of its manager due diligence.
“Whenever we sign on an external fund manager, the fund manager has to comply with the policy, has to review the risk factors, and also report back to us on an annual basis how they incorporate these risk factors within their investment management process,” said Travis Antoniono, an investment officer at the fund.
Considering ESG factors with a risk management lens is fundamental to both of the funds’ strategies. “We see ESG as an opportunity to be able to have a little bit more downside protection rather than upside capture. …[We see] it as operational risk management,” said Antoniono.
The New York State Common Retirement Fund also believed that the incorporation of sustainable factors could lead to opportunities. “We consider ESG factors in our process because they can influence both risk and return,” said McCarthy. “Public pension funds will move towards a model of risk mitigation [and to] the opportunities in ESG.” Some of the plan’s ESG managers include: Generation Investment Management, Sustainable Insight Capital Management, and Osmosis Investment Management.
While divestment has long been a popular way for funds to express their ESG views, both CalSTRS and New York State are not proponents of the tactic. “We don’t believe in divestment,” Antoniono said. “In fact, we continue to track the performance of the divestment, the opportunity costs we have essentially lost, and it’s alarmingly high. Tobacco alone is nearly $5 billion since we divested.”
“Don’t divest, think about how to invest,” added McCarthy. “The discussion has shown there are a lot of different ways to invest in ESG.”
For example, CalSTRS committed about $1.2 billion to a low-carbon strategy, managed in-house, and expects to expand the strategy to non-US developed markets next year and eventually emerging markets. The plan also invested more than $1.1 billion to a dedicated public equity fundamental ESG strategy and plans to ramp up the allocation to an undisclosed amount in the coming months.
“Further ESG integration, specifically along the alternatives, private equity, and infrastructure assets, diving deeper into the valuations when we do co-investments or syndicates is a next step,” Antoniono asserted.
Shareholder engagement is another popular tool employed by the funds, particularly in addressing issues that are material. “Since 2007, there has been increased shareholder activity [by the fund]. It’s a critical component of our ESG strategy,” McCarthy told CIO. The fund filed 56 proposals during the 2016-2017 shareholder season, compared to 46 filings the year prior. Climate change, labor relations, cyber security, and diversity were among the key focus areas for New York State.
“We are going to start looking at our private market managers and engaging them more on diversity. We think it’s really critical that our funds and portfolio companies are identifying the deepest pool of talent,” she said. The fund also has affordable housing investments in its pipeline.
In terms of the investment challenges within the ESG landscape, “there is a lack of institutional quality investments that can be scalable,” McCarthy said. As a large institutional investor, the fund relies on larger scale investments than are readily available among ESG product offerings.
Finally, both Antoniono and McCarthy emphasized the importance of senior management and board support for sustainable investing. “The tone from the top has allowed us to effectively integrate ESG into our investment process,” said McCarthy. “Staff education is definitely a key element to get buy in from investment officers. If you bring in the right folks, people will not see this as another box to check, but really as another level of generating alpha or mitigating against risk.”