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Viewpoints: Teachers’ pension fund is serious about responsible investing

January 31, 2017 Derek Brodersen, Chief Investment Officer, Alberta Teachers’ Retirement Fund

Teachers’ pension fund is serious about responsible investing
An important, but complicated, issue that has been gaining more attention in recent years for pension plans including the Alberta Teachers’ Retirement Fund (ATRF) is responsible investing. ATRF has held a responsible investing strategy for years, but there is no doubt that this topic is challenging for any pension plan to navigate.

There are many different ways to define responsible investing, but ATRF subscribes to the following definition: “Responsible investment is an approach to investment that explicitly acknowledges the relevance to the investor of environmental, social and governance (ESG) factors, and the long-term health and stability of the market as a whole.”

What are ESG factors?

Environmental factors refer to issues pertaining to land, air and water. Social factors generally relate to issues such as human rights and labour safety. Governance factors deal with issues pertaining to shareholders’ rights, board diversity and independence, and executive compensation.
One of the reasons why responsible investing is a complicated issue is the potential for ESG issues to come into conflict with the mandate of a pension plan.

In Canada, trustees of pension plans have a fiduciary duty to act in the best interest of the plan beneficiaries (or members). The primary purpose of a pension plan is to provide periodic payments to individuals after retirement and until death. With this in mind, one might ask whether consideration of certain ESG issues is even relevant to the purpose of the pension plan. A more important question might be whether the plan’s fiduciary obligation to its members could be violated if ESG considerations were put ahead of financial goals.

ATRF believes that the solution involves a balanced approach. Our view is that, over the long term, organizations that do well at identifying and managing ESG risks and opportunities are more likely to represent good long-term investments.

Applying ESG factors to investing

Investors can consider ESG factors in a number of ways. One approach, known as negative screening, refers to what people often think of as “ethical investing.” The strategy behind negative screening usually revolves around specifically excluding investment in certain things that don’t match with the morals or principles of a certain group, be they religious, political or environmental.

Two things make negative screening very difficult to put into practice. First of all, with a few exceptions, it is usually very difficult to gain a consensus on what to exclude and how to do it. Second, it is very hard to identify where to draw the line in applying an ethical screen.

Let’s look at the tobacco industry as an example.

It may be easy to say: “Smoking is bad. We should avoid investing in that business.”

But when you look at that statement, what does it really mean? Do you avoid investing in the cigarette companies? What about tobacco farms? Or fertilizer companies that help them grow their crops? Do you exclude the paper companies that supply the paper and packaging? And what about the railroads that transport the product? Do you exclude them for making these products available to people?

You can appreciate the dilemma an investor faces. Applying negative or ethical screens reduces our investable universe which, if taken too far, could have a negative impact on the risk and return of the plan’s assets and ultimately contribution rates.

Two more common approaches to ESG investing are “active ownership and engagement” and “ESG integration.”

Active ownership and engagement is an approach that sees shareholders, either on their own or collectively, communicate directly with companies to discuss ESG issues and promote positive change.

ATRF is involved with a number of organizations that engage directly in this way with the boards and management teams of companies. ATRF was a founding member of the Canadian Coalition for Good Governance, an organization dedicated to improving corporate governance and promoting shareholders’ rights.

Further, ATRF exercises its rights as a shareholder in companies through its proxy voting. For example, we have guidelines that encourage companies to adhere to the Organization for Economic Cooperation and Development (OECD) Guidelines for Multinational Enterprises, which is a set of principles and standards for responsible business conduct.

ESG integration refers to incorporating the analysis of ESG issues into the investment process. An example of this might be assessing the long-term sustainability of a company that is a heavy water user or identifying an investment opportunity in a company that might benefit from changing environmental regulations.

In summary, ATRF agrees that companies that consistently ignore key ESG issues are often riskier investments that may not produce high returns in the long run. However, it is important to recognize that assessing ESG issues forms an important part of the investment decision, but cannot be the only basis for the decision.

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