PASSIVE INVESTING 2021 - Rise of the social pillar of ESG - 2021 SURVEY - DWS
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2021 SURVEY PASSIVE INVESTING 2021 Rise of the social pillar of ESG
Foreword
When last year’s CREATE-Research report was frontline health professionals in Africa, Asia and
launched, the world was in the early stages of Latin America to generate research results that
getting to grips with the global pandemic. As aim to prevent epidemics and disease in the
this year’s report comes out, there is light at poorest countries.
the end of the tunnel. The vaccine roll-out is
underway, and the hope is that the increasing Sponsorship of worthy social initiatives is one
levels of protection afforded will allow for some way companies can play their part in creating
kind of return to normal. a better future, but it is not enough. The bigger
challenge is working out how to weave the ‘S’
In this context, the key theme of this year’s pillar into all business activities. This is difficult
report, the ‘S’ pillar of ESG (environmental, because the ‘S’ in ESG is less tangible than the ‘E’
social and governance) investing, is highly and ‘G’, which makes it harder to define objectives.
pertinent. As politicians and policy makers For our part, DWS has determined three social
across the world aim to ‘build back better’, development goals that are material to our ESG
we as an investment community need to take strategy and corporate social responsibility efforts.
the time to fully understand the social part of These are: decent work and economic growth,
ESG. We live in an age where the politics of reduced inequalities, and climate action. The first
inequality and ‘social justice’ cannot be seen two clearly fall within the ‘S’ pillar category.
as external to the investment process.
As the report highlights, the ‘S’ pillar is
Here at DWS we are working to integrate the acquiring its own distinct identity, but only
‘S’ pillar into our investment processes but also gradually. The rate at which the investment
to ensure we act responsibly as a corporate industry is embracing ESG suggests that distinct
citizen. This can be seen in a number of identity will emerge sooner rather than later.
donations we have made over the past year
to mitigate the effects of Covid-19, including, This timely report will play a part in developing
for example, the funding we have given to that distinct identity, while also highlighting the
the ‘Global Health Research Accelerator’ ever-growing importance of passive investment
programme. Launched by the University of solutions for pension funds. I hope you find it as
Oxford, this 10-year project brings together enlightening as I have.
Asoka Woehrmann
CEO, DWS
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Just click on the selected chapter.
Acknowledgements Contents
“The wise investor recognises that success is a process
of continually seeking answers to new questions.”
Sir John Templeton
British investor
6
8
9
This is the fourth annual pension survey in a I would also like to especially thank DWS for 9
research programme first started by DWS and sponsoring the publication of this report without 12
CREATE-Research in 2018 to highlight the forward influencing its findings in any way. Their arms- 16
parallel rise of passive funds and environmental, length involvement has helped to canvas a wide 18
social and governance investing. spectrum of practices in the pension landscape
and deliver the findings in an impartial manner.
The 2021 survey shows how Covid-19 has
exposed the long-concealed failings of today’s My grateful thanks also go to IPE for helping
market economies and raised questions about to conduct the survey and especially to its 22
their ability to continue providing decent pensions editor Liam Kennedy for his wise counsel and 25
to millions in the post-pandemic world. constructive support throughout the project. 27
28
Appropriately, it highlights the heightened Last but not least, I would like to thank three 31
interest in the social pillar of ESG on the part immediate colleagues at CREATE-Research: Lisa
of pension investors. Terrett for survey administration, Anna Godden
for desk research and Dr Elizabeth Goodhew for
My foremost thanks go to the 142 pension plans editorial support.
who participated in this survey. Many of them 34
continue to provide unstinting support that has, If, after all the help I have received, there are 37
over time, served to create an impartial research errors and omissions, I am solely responsible. 40
platform now widely used in all pension jurisdictions.
43
44
Amin Rajan Author: Prof. Amin Rajan
Project Leader, CREATE-Research First published in 2021 by CREATE-Research and DWS
Telephone: +44 (0) 1892 78 48 46 Email:
Mobile: +44 (0) 7703 44 47 70 amin.rajan@create-research.co.uk
© CREATE-Research, 2021
All rights reserved. This report may not be lent, hired out or otherwise disposed of by way of trade in any form,
binding or cover other than that in which it is published, without prior consent of the authors.
II IIIExecutive summary – Introduction and aims
Introduction and aims
“We are gradually coming to the realisation that a more holistic understanding
of fiduciary duty is critical to preserving capital over the long term. Issues such
as climate change or social disruption caused by inequality pose long-term
systemic risks that ultimately affect our fund performance, and these risks
cannot be hedged away through traditional portfolio diversification.”
Hiro Mizuno
Former CIO of the Government Pension Investment Fund of Japan
From the Plague of Justinian and the Black Death schemes, industry-wide bailouts and other fiscal
to the 1918 Spanish flu, history shows all too vividly support measures. Although necessary, these
how pandemics can expose and amplify the deep- have tackled the symptoms, not the causes, of
seated inequalities that exist in societies. Covid-19 the underlying structural malaise.
has made today’s inequalities in key areas like
human health, job security and racial discrimination Before then, the rise of populism had been a wake-up
impossible to ignore. They undermine the economic call on the manifest failings of the prevailing model
foundations of a sustainable society. of capitalism, which puts profit before people and
finance before the real economy. Recognition of
Worldwide, many young adults are now joining this came into sharp relief in August 2019, when
the workforce in an age of job scarcity, digital Business Roundtable, a powerful US corporate
apartheid and mounting disillusionment. Many lobbying group, made a historic U-turn.
of them are experiencing their second major
global crisis in a decade, affecting their education It ditched its age-old declaration that “corporations
progress, job prospects and mental health. exist to principally serve their shareholders” in favour
of “we share a fundamental commitment to all our
Without adequate pathways to a better future, stakeholders – customers, employees, suppliers,
the social contract between the capitalist system communities, and shareholders”. The world’s
and citizenry now faces its stiffest test in living top companies are now enjoined to increasingly
memory. Long-neglected ills such as stagnant demonstrate their societal purpose by overtly
incomes, job insecurity, underfunded public health orienting their operations to benefit all stakeholders.
systems and environmental damage have become
lightning rods for political backlash, as shown by Around 200 signatories, including a ‘Who’s Who’ of
the rise of populism on both sides of the Atlantic the American business establishment, thus binned
in the last decade. the old orthodoxy of shareholder supremacy by
embracing an all-inclusive purpose.
Since March 2020, major central banks and govern-
Executive summary ments have committed around USD 25 trillion
in an attempt to avert large-scale economic
devastation wreaked by the pandemic. Unusually,
Since the worldwide adoption of the UN’s
Sustainable Development Goals in 2015, pension
plans’ interest in environmental, social and
these new measures bypassed financial systems governance (ESG) investing has been rising –
by channelling help directly to businesses and steadily, at first, and dramatically, latterly.
households in real time – such was the severity of The environmental and governance pillars
the calamity. In the emotional climate of insecurity spearheaded the first wave of growth, while
and precarity, governments have reframed the the social pillar lagged behind due to its highly
‘social contract' of corporate life with furlough qualitative and normative nature.
5 6Survey highlights (% of respondents)
PASSIVE FUNDS CENTRED ON THE ‘S’ PILLAR ARE AT THE NASCENT STAGE OF THEIR LIFE CYCLE
Now, mandated lockdowns in the global economy material to its financial performance: shareholders,
have provided vivid confirmation of the old adage:
sustainable economies need sustainable societies.
With the rise of this stakeholder mindset, the
employees, suppliers, customers and the
communities in which it operates. 33% 19% 19% 51%
Are now in either Are at the 'close Now have these Report data
spotlight has been turned on the financial The survey aims to address four issues:
the 'mature' or to decision funds accounting challenges as a
materiality of social responsibility in all areas • adoption: what is the current state of adoption
'implementation' making' phase for more than major constraint
of corporate operations. of socially related passive funds in pension
phase of their 5% of their total on their current
plans’ portfolios?
life-cycle passive portfolio allocations
As the pandemic entered its second year, the ESG • coverage: which asset classes and vehicles are
conversation has moved from risks and returns being used to access them?
to a more fundamental question: what role do • outcomes: how have they performed since
companies have in creating a fairer and more the big market dislocation in March 2020? THE ‘S’ PILLAR IS ACQUIRING A DISTINCT IDENTITY – GRADUALLY
sustainable society, as today’s capitalism faces • future growth: what are its prospects in the
its worst challenge in living memory?
As a result, our 2021 DWS–CREATE pension
post-pandemic world?
The survey attracted responses from 142 pension
14% 46% 66% 59%
survey aims to shed light on how pension plans plans in 17 jurisdictions with a collective AuM Use core social- Use broader ESG Regard employees Cite Covid-19 as
worldwide are reacting to this shift. of €2.1 trillion. Forty of them were also involved related indices indices due to a dearth as financially the a key driver of
in post-survey interviews to add the necessary currently, rising to of core social-related most material their heightened
Our last two annual surveys highlighted the depth, colour and nuance to our findings. Their 26% over the next indices currently, component of interest in the ‘S’
simultaneous foundational trends marking the rise demographic details are given in Figure 1.0. three years rising to 49% over the ‘S’ pillar pillar because of its
of ESG investing and passive funds by respectively the next 3 years growing materiality
covering the ‘G’ and ‘E’ pillars. This year’s survey The rest of this section presents the survey
marks a logical extension by focusing on the ‘S’ pillar. highlights and the four key findings that emerged THE ‘S’ PILLAR TARGETS A DOUBLE BOTTOM LINE
when the survey data were combined with
It relates to how a company manages relationships interview insights.
with its five stakeholder groups that are most
58% 36% 22% 62%
Seek to do well Seek to manage Report that their Think that it’s too
FIGURE 1.0
financially and do hard to model fat- ‘S’ pillar passive soon to judge the
Which sector does your pension plan cover, and what is the nature of your plan?
good socially from tail/far-off risks by funds outperformed performance of
% of respondents
their allocations to investing in the the wider markets their ‘S’ pillar funds
the ‘S’ pillar ‘S’ pillar in the March so far
Sector: Nature: 2020 crash
12% Hybrid 55% Pure DB plan
THE ‘S’ PILLAR IS NOW SET TO ATTRACT FRESH NET INFLOWS
4% Mix of DB and DC
34% Public
66% 70% 62% 67%
Expect to increase Will target a Expect to use Will select their
their allocations tracking error equities as their index managers on
to ‘S’ pillar passive of below 1% for favourite underlying the basis of their
29% Pure DC plan funds over the their ‘S’ pillar asset class of choice track record on the
66% Private
next 3 years passive funds over the next 3 delivery of their
years, rising from clients’ social agenda
53% currently
Source: CREATE-Research Survey 2021
7Executive summary – Key findings Executive summary – Key findings
“The ‘gig economy’ is an example of how insecure cheap labour is
branded to bestow a cloak of legitimacy to unviable business models.”
Key findings An interview quote
1. The pandemic has brought social to decision making’ or ‘awareness raising’ phase in a) The barriers whether a stream of revenue provides a social
risk to the forefront by exposing the the current life-cycle. benefit remains a challenge. This is because the
stark failings of market economies Many factors have conspired against growth in the overwhelming majority of indicators of the ‘S’
The implication is that there remains considerable recent past, as listed in Figure 2.1 in Section 2, and pillar currently measure company policies and
That the pandemic has hastened the tectonic potential for growth before passive funds based on cited below. procedures, not their real-world outcomes.
shift towards ESG investing is not in doubt; nor the ‘S’ pillar reach the maturity phase.
that it has sparked interest in the ‘S’ pillar, which It shows that 58% of our respondents find that Besides, 51% of our respondents believe that there
is starting to translate into allocations in pension That much is also evident when their current share their time horizons are not long enough to realise is strong interdependency between the three pillars
portfolios (Figure 1.1). in total pension portfolio is taken into account the investment benefits of the social pillar, because of ESG. Hitherto, good governance has been widely
(Figure 1.2). of the immediate funding challenges caused by accepted as the basis of strong environmental and
Whereas 65% of our respondents already have a the pandemic. social standards that show how a company’s vision
‘mature’ portfolio of passive funds in general, the Whereas 33% of respondents do not currently have and business practices are aligned to delivering the
corresponding figure for passive funds specifically any allocation to the ‘S’ pillar in their total portfolio, 51% cite the lack of consistent definitions, sustainability goals on the ground.
targeting the ‘S’ pillar is 11%. Those currently in the the corresponding figure for allocation to the standardised methodology and reliable data on
‘implementation’ phase is 22%. social-related passive portfolio is 67%. the ‘S’ pillar due to its qualitative and normative However, Covid-19 has shown that ESG risks, long
nature, which works against meaningful KPIs as considered fat tailed and far off, are becoming
Thus, funds related to the social pillar are At the other extreme, 31% have an allocation of well as universal singular ‘social’ benchmarks. Even more apparent, more frequent and more
advancing into the pension portfolios of around above 15% in their total investment portfolio. The when a relevant social factor has been selected, immediate (Case Study 1a).
one in every three respondents to our survey. That corresponding figure for social-related passive its impact can be hard to measure. Defining
leaves the remaining two-thirds either at the ‘close funds is 7%.
FIGURE 1.1 Case study 1a: The ‘S’ pillar is coming of age
In which stage is your pension plan currently with respect to the following types of investment portfolios?
% of respondents
Ageing demographics have forced us into negative cash So far, we have tended to put more emphasis on
flow status, exposing us to the sequence of returns risk: the governance part of ESG, backed by shareholder
Passive funds in general Passive funds specifically related to social factors
the time taken for our portfolio to recover after a big engagement. For us, governance forms the basis of
3% drawdown. For ESG investing, therefore, we divide the strong environmental and social standards that are
11 % risks associated with our investee companies into two indicative of the day-to-day operations of a business
9% 48%
types: event risks and erosion risks. and how it interacts with wider society.
The first is driven by short-term events – like governance However, Covid-19 has forced a rethink on the event
lapses, labour disputes, tax frauds – that can have an risks inherent in the social factor. The presence of
22% immediate effect on stock prices. A recent example the so-called gig economy shows how fanciful labels
includes the precipitous implosion of Wirecard in have served to conceal deep sources of structural
23% Germany, once the fraud was uncovered. instability and insecurity in our society. Reliance
on governance alone is no longer enough. Our ESG
65% The erosion risks, in contrast, can decrease market investing is becoming more granular as its inherent
19 %
value over a period of time, as they unfold gradually investment risks are becoming more apparent, more
and continuously. Climate change is a good example. immediate and more consequential.
Social factors, in turn, are exposed to both types
of risk. Poor labour relations can harm short-term
Already mature Implementation phase Close to decision making Awareness raising profitability via industrial disputes and long-term A Dutch pension plan
competitiveness via low productivity.
Source: CREATE-Research Survey 2021
9 10Executive summary – Key findings Executive summary – Key findings
“Return expectations of the social pillar are “Stakeholderism may smack of socialism, but ignoring it could
the same as for other forms of investing.” be bad for shareholders in the age of rampant inequalities.”
An interview quote An interview quote
b) The drivers Finally, for their part, governments and regulators To compound the problem, existing regulations
The transition has not been just, however. Both in various pension jurisdictions are now keen to diverge by region. They use differing standards for
In hindsight, the pandemic may prove to be a globalisation and digitalisation delivered benefits ensure that the fiduciary role of pension plans voluntary ESG disclosures – from the Sustainability
watershed moment for the ‘S’ pillar, as shown by in the West. But these have accrued to many embraces the sustainability agenda. Covid-19 has Accounting Standards Board to the Global
Figure 2.2 in Section 2. in their role as consumers, not as workers or profoundly and painfully impacted society and Reporting Initiative, the Carbon Disclosure Project,
citizens. So, fresh emphasis on the ‘S’ pillar reflects shaken our assumptions about the way we live. and the UN Global Compact – all with different
It shows that 59% of our respondents cite the need both the need to have a just transition as the The gig economy – offering no employee benefits needs and principles around the understanding of
to tackle the inequalities exposed by the pandemic global economy advances towards a low carbon such as paid sick leave, healthcare and retirement what the standards should be.
as a key factor driving their allocations to the future and the desire to address the prevailing benefits – is an example of how socially undesirable
‘S’ pillar. Widening societal divisions have strained inequalities that have built up over time and job practices have acquired a cloak of legitimacy Above all, the qualitative aspects of the social
already weak safety nets and economic structures undermined economic stability. and undermined the long-held social contract. pillar – like health, welfare and education – are
beyond capacity. seen as generating positive externalities that
This imperative is underscored by the fact that Hence, 49% of our respondents see this policy are observable, not measurable. As such, they
Such divisions had been building up over the past 48% of our respondents recognise the growing intervention as an influence on their allocations to are ‘public goods’ that come under the realm of
40 years as the rise of turbo-charged globalisation materiality of social issues in business performance the ‘S’ pillar. Many among them harbour doubts government responsibility, not capital markets;
and digitalisation created winners and losers, and investment outcomes and 58% are seeking about the emerging stakeholder model and equate according to 49% of our respondents (Figure 2.1
mainly in the West. Governments struggled to good long-term risk-adjusted returns by investing it to creeping socialism – with an overweening in Section 2).
re-equip and reskill those who suffered job losses in them. This focus on the long-term is deliberate state flexing its muscles in different areas of
and stagnant incomes, as the centre of gravity in because their liabilities stretch over the next business conduct. But currently they have little b) The ‘S’ pillar is being accessed via broad
global manufacturing migrated to the low-cost 40 years. choice other than to go with the flow. It seems the ESG indices
emerging economies. only viable option for making today’s capitalism
work for all, rather than a select few. The use of core–thematic social-related funds is
currently confined to only 14%. This number is
FIGURE 1.2 likely to nearly double over the next three years
What is the approximate share of all social-related funds in your pension plan's 2. The ‘S’ pillar is gradually acquiring (Figure 1.3, right chart).
two investment portfolios currently? a distinct identity
Similarly, the reliance on social bond indices is
In light of the identified barriers, the recent small (6%) but is set to rise to 28% over the next
Total investment portfolio Portfolio covering only passive index funds
evolution of the social pillar in passive funds has three years. It provides an effective mechanism
7% remained narrow in its construct in four respects. for financing social projects, while providing the
31% 33% 6% best platform to engage with issuers to increase
a) The ‘S’ pillar trails well behind the other their activities in socially impactful products and
6% ESG pillars services.
As Figure 1.3 (left chart) shows, hitherto, our Thus, the use of selective targeted indices in both
respondents have been focused on the ‘E’ pillar these areas is somewhat limited currently due to
14% (58%) followed by the ‘G’ pillar (31%), with the ‘S’ a dearth of indices. But it is set to rise appreciably
3% pillar trailing behind (11%). over the next three years. Currently, for every ten
thematic sustainability indices in the marketplace,
10% 23% 67 %
They have historically prioritised environmental only two cover the ‘S’ pillar, forcing investors to
factors, so issuers have developed systems and make do with what is available.
reporting frameworks on issues such as carbon
0% 1–5% 6–10% 11–15% Above 15% emissions, fossil fuel reserves and the use of clean Currently, 46% of respondents use broader ESG
energy. On the other hand, few companies have indices to achieve their social goals. This number
Source: CREATE-Research Survey 2021 the necessary data-reporting frameworks on is likely to rise to 49%. The two key contributory
social issues. factors are the interdependency between the
11 12Executive summary – Key findings Executive summary – Key findings
“The pandemic storm hit us all, but it showed “The pandemic has profoundly shaken our assumptions about the way
that some of us were in stronger boats than others.” we live and exposed the financial materiality of social issues.”
An interview quote An interview quote
‘E’, ‘S’ and ‘G’ pillars and the lack of clear social Currently, 53% of our respondents rely on and proxy voting at AGM. Our respondents in particular. Both are now being recognised as
benchmarks, as mentioned earlier. equity-based passive funds to invest in the ‘S’ highlighted the difficulty of holding year-round financially material to investment returns (Figure 1.4,
pillar. This figure is likely to rise to 62% over the conversations with bond issuers. left chart).
That the broader indices will continue to retain next three years (Figure 2.3 in Section 2). The
their importance is further shown by the use of corresponding figures for fixed income are 28% Notably, however, there is now an evolution in These stakeholders are employees (cited by 66%
Sustainable Development Goals-related indices. and 50%, respectively. progress from ‘green’ bonds to ‘sustainable’ bonds of the respondents) and the local community
Currently, 29% rely on them and this reliance is and on to ‘sustainability-linked’ bonds. The latter (41%). The other two stakeholders – suppliers and
likely to rise to 52% over the next three years. The implied concentration is dictated by a make coupon adjustments, if the issuer does not shareholders – are deemed material by many fewer
The sheer breadth of issues covered by the ‘S’ number of factors. meet the predefined sustainability targets by a respondents (31% and 28%, respectively).
pillar is one factor. Another one is the growing specified date. Although they carry low coupon,
attention that the SDGs are now receiving from To start with, equities have attracted a higher they are expected to benefit from price action, as Two parallel events underpin this assessment, as
policy makers in the key economies, as the impact share of ESG indices than other asset classes. and when they are included in the bond-buying discussed in Case Study 1b. The first is the stark
of climate change on human health is becoming In contrast, because of its overly quantitative programmes of central banks. inequality and unfairness at the workplace as
graphically visible via the rise of infectious diseases nature, the range of fixed income indices that revealed by the lockdowns forced by Covid-19.
and large-scale human migration. explicitly target social ends is limited – for now. d) The ‘S’ pillar’s financial materiality is confined These can no longer be ignored by shareholders.
Furthermore, the booming equity markets of to immediate stakeholders
c) The ‘S’ pillar has relied mostly on equities the last decade have delivered investors’ return The low-paid, insecure, service occupations
expectations, while zero-bound rates have turned The Covid-19 crisis has concentrated minds on the were not only expected to continue to work
As with indices, so with asset classes, coverage of fixed income into more of a capital conservation ‘S’ pillar in general and two stakeholder groups after being classified as ‘key frontline’ workers
the ‘S’ pillar is skewed towards equities and, to a tool. Finally, equities are more amenable to
much lesser extent, bonds. stewardship activities like direct engagement
FIGURE 1.4
Which of the four key clusters covered by the What is/will be your preferred target
social factor do you regard as a financially when investing in social factors?
FIGURE 1.3 material to investment returns?
When considering ESG investment currently, What are the main vehicles used to invest in
which component do you consider to be the social-related passive funds currently and which % of respondents % of respondents
single most important one? ones will be used over the next three years? 70 0 10 20 30 40 50 60
60 66
% of respondents Broader ESG themes 56
% of respondents 50 50
52
49
46 40
40 41 Overarching aims 51
31% 58% 30
31
28
30 20
29 28
26 Specific themes 28
10
20
8
0
14 Employees Local Suppliers Share- None of Specific stakeholder
10 15
8 community holders the above groups
11% 3 6
0
Source: CREATE-Research Survey 2021
Core thematic Smart beta Broader Sustainable Social
social- funds based ESG Development bond
related on social indexes Goals-realted indexes
indexes factors indexes
Environmental Social Governance Currently Next 3 years
Source: CREATE-Research Survey 2021
13 14Executive summary – Key findings E x e cut i v e sum m a r y – Ke y f i n d i n gs
“How companies treat their employees is now a “Respect for human rights is closely linked with
key proxy on how they can respond to other shocks.” value chain resilience and business stability.”
An interview quote An interview quote
3. The ‘S’ pillar is about doing well The relative weight of societal goals is meant to
financially and doing good socially increase as investors transition to impact investing,
Case study 1b: The tumultuous events of 2020 were a wake-up which is essentially about targeting measurable
call for capital markets Our respondents’ sustainability journey so far has financial and societal outcomes. Collectively, they
broadly followed the path first developed by are seen as one of the key solutions to internalising
The Impact Management Project. It shows how, various negative externalities caused by companies
Along with other asset owners, we have filed a Similarly, institutional shareholders forced the
shareholder proposal to the board of Amazon, resignation of Rio Tinto’s CEO and his top colleagues within an investment portfolio, the relative weights that impose uncompensated costs on wider society
calling for an independent audit of the company’s for authorising the blasting of caves at an ancient of investors’ financial and societal goals change with while retaining all the financial benefits.
policies and practices on issues such as civil rights, heritage site that belonged to Aboriginal landowners. the three newly emerging forms of investing:
diversity and inclusion, and we demand to know This was seen as a blatant case of destruction of So far, the indices used by our respondents in
what risks they pose to its business. cultural heritage and violation of human rights. • Exclusionary screening: avoiding companies targeting the ‘S’ pillar have relied mostly on
The events of 2020, especially the death of George The increased prominence of racial injustice has engaged in activities deemed unethical, such exclusionary screening and best-in-class ESG to
Floyd, Ahmaud Arbery and and other people of colour, propelled our investee companies to do a root and as tobacco, lethal weapons, pornography, achieve three goals: doing well financially as well
have blown open the ongoing struggle around racial branch reform of their workplace ESG standards. child labour, abuse of human rights and as socially (58%), seeking risk-adjusted long-term
equality, sparking worldwide demonstrations and Many of them are now involved in a new initiative environmental degradation. returns (55%), and building a defensive portfolio
galvanizing the movement for racial justice. The called the Human Capital project. It is led by the • Best in class ESG: overweighting companies against fat-tail/far-off risks (36%), as shown in
proposal cites a big gap between the rhetoric of Sustainability Accounting Standards Board (SASB), a
company employment policies and the daily reality. global body supported by 170 institutional investors
with high and/or rising environmental, social Figure 1.5, left chart.
holding roughly USD 55 trillion in assets. and governance scores and avoiding those with
Black Lives Matter considerations are increasingly low scores in the belief that success is as much The focus on a double bottom-line is based on
material to us as shareholders. For example, in June It’s hard to believe that capital markets will ignore about avoiding losers as picking winners. the belief that government support for companies
2020, Facebook dropped about USD 60 billion in social issues after all that happened in 2020.
• Impact investing: seeking measurable outcomes during this pandemic has come with strings
market value over a two-day period. This happened as
prominent brands, such as Coca-Cola and Starbucks, from targeted social and environmental attached. These may well expand the scope of
pulled ads from the social media giant in protest projects that support specific SDGs via a more public interventions in both financial markets and
against the spread of hateful content on the platform. A US pension plan imaginative deployment of financial capital. corporate policies in areas such as share buybacks,
FIGURE 1.5
What benefits do you expect your asset manager Which of the following statements applies to your
to deliver when deciding to invest in social- investment in social-related passive funds either
and were therefore the people most exposed to around work that are now material to related passive funds? singly or as part of broader ESG indices since the
the virus, their vulnerabilities were amplified by the financial worth of a company. big market dislocation in March 2020?
their underlying health issues – like poor diet,
overcrowded living conditions and inadequate These two events focused on areas where % of respondents % of respondents
healthcare. investors and their investee companies can 0 10 20 30 40 50 60
make an immediate difference in deference to Doing well financially
58 22%
The second event was the worldwide Black enlightened self-interest: namely, employees and doing good socially
Lives Matter protests in the wake of the death and the local community.
Good risk-adjusted
of George Floyd in the US at the height of the long-term returns 55
pandemic. Like the famous civil rights marches However, until the current range of more
led by Dr Martin Luther King Jr in the 1960s, customised indices is expanded notably, our A defensive portfolio
36
they exposed widespread institutional racism respondents will continue to rely on the ones that targeting fat-tail/far-off risk
16%
embedded in many societies that have continued target broader ESG themes (56%) and overarching Lower portfolio
62%
to overtly marginalise and disadvantage racial aims set by the Sustainable Development Goals 16
volatility
minorities from mainstream society in many (51%), as shown in Figure 1.4, right chart. 0%
countries. Covid-19 has exposed injustices Better diversification 11
Perform better Perform the same
Source: CREATE-Research Survey 2021 Perform worse Too soon to say
15 16Executive summary – Key findings E x e cut i v e sum m a r y – Ke y f i n d i n gs
“It is time now to dump the term ‘non-financial’ from the corporate “Companies are becoming aware that they
lexicon and treat ESG issues with the same rigour, diligence and need a social licence to operate.”
auditing as ‘financial’ reporting.” An interview quote
An interview quote
business governance and employee relations. On Notably, though, the ‘S’ pillar performed much
past form, mission creep will be inevitable. Employer better during the market meltdown in March 2020 The EU’s review of the Non-Financial Reporting Before the crisis, new inflows were seen by many
policies on human rights will come under increased (Figure 1.5, right chart), showing that ESG investing Directive is a major step towards consolidating as merely a momentum trade in a 10-year raging
scrutiny (Case Study 1c). is not just a bull market luxury. It proved far more progress made so far and taking ESG reporting bull market. It was believed that the viability of
resilient than its naysayers predicted. 22% of to the next level of progress. the three ESG pillars will be best judged not by
Similarly, the focus on long-term returns is dictated respondents reported that passive funds based the inflows when markets are rising, but by their
by two considerations. on the ‘S’ pillar performed ‘better’ than the rest resilience when the inevitable correction comes.
of the portfolio during the market crash in March 4. The ‘S’ pillar is now set to attract
First, as we saw in Case Study 1a, some social 2020; 16% reported that they did the ‘same’ as fresh net inflows Now that ESG investing has passed the acid test,
indicators are long term in nature and exposed the rest; and 62% reported that it was ‘too soon attention has turned to whether ESG pillars are
to event risk as well as erosion risk, which remain to say’. None reported that they performed ‘worse’ During the market crash of March 2020, 82% of risk factors akin to traditional ones such as value,
elusive to today’s generation of risk models, based than the rest of the portfolio. Indeed, by the end of ESG indices have seen less drawdown during quality, size and low variance. Two schools of
on past price behaviours. Above all, the ‘S’ pillar is 2020, total assets in sustainable funds hit a record of periods of extreme stress than their respective thought were evident among our respondents:
about pricing the future into the present. almost USD 1.7 trillion, up 50% over the year. non-ESG parent indices; and 81% of ESG indices believers and pragmatists.
have outperformed their non-ESG indices since
Second, as a structural shift, passive funds are The implied resilience has intensified demand for the March sell-off in 2020, according to DWS Based mostly in Europe, believers contend that
increasingly venturing into core buy-and-hold improved ESG reporting, which has traditionally estimates*. Their resilience has continued to markets in their region are gradually pricing in ESG
pension portfolios with rising holding periods. been referred to as ‘non-financial’, creating the attract fresh net inflows. So, when asked how risks selectively, putting more emphasis on the
However, their pro-cyclical nature exposes perception that such information is not financially the share of social-related passive funds in their ‘E’ and ‘G’ pillars than on the ‘S’. Consumers and
passives to momentum risks and they therefore material. This misnomer fails to reflect the total portfolio is likely to change over the next governments have become stronger supporters of
require longer periods for mean reversion to kick considerable value investors place on ESG as a three years, 66% of our respondents expect it to sustainability ever since the adoption of the 2015
in after a big market drawdown. credible investment tool that manages risks and ‘increase’, 32% expect it to ‘remain static’ and 2% Paris Agreement. Large European countries such
delivers returns. expect it to ‘decrease’ (Figure 1.6, left chart). as France, Germany, Italy and the UK have also
FIGURE 1.6
How is this share of social-related passive What is the extent of the tracking error that your
Case study 1c: Human rights will come to the fore in the funds likely to change over the next 3 years? pension plan is willing to accept in your social-
post-pandemic world related passive funds?
% of respondents % of respondents
The UN-backed Principles of Responsible Investment As a signatory, we are implementing this guidance. Our 2%
have now adopted a more muscular approach by index managers are now expected to deploy two 6% 8%
enjoining its more than 3000 signatory asset owners stewardship levers: engagement – or direct dialogue –
and asset managers – with over USD 100 trillion of that demands to see progress on the ground; and tabling 66%
AuM – to ensure that their investee companies identify motions at the AGM that force senior executives to be 16%
and remedy human rights abuses in their businesses. publicly accountable for their actions.
The PRI advocates that employees must have the Companies are especially prey to reputational risk 32%
right to be treated with dignity and fairness, as when wrongdoing is detected and publicised by the
defined by the International Bill of Human Rights. ‘Twitter fire hose’ and other social media. These are
This includes the right to health, to an adequate increasingly influential in highlighting good and bad
living standard, to freedom of expression, to privacy, examples of company behaviours. Their narratives 40%
to a living wage and to form a union, among others. alongside other alternative data sources add further 30%
To convert aspiration into action, the PRI enjoins its information to enable our assessments on the ‘softer’
members to have a clear policy around human rights, aspects of corporate conduct.
integrating it into their governance and strategy and Increase Remain static Decrease 0% 0.1–0.9% 1–1.9% 2–2.9% 3% and above
embedding it in due diligence as well as shareholder
activism processes. Source: CREATE-Research Survey 2021
A Swedish pension plan
*Past performance, actual or simulated, is not a reliable indicator of future results.
17 18Executive summary – Key findings E x e cut i v e sum m a r y – Ke y f i n d i n gs
“The neglected middle child of E, S, and G is now coming “There is a trade-off between societal impact and tracking error.”
into its own, in a new incarnation as a ‘stakeholder’.” An interview quote
An interview quote
made the most progress towards implementing thought is how much tracking error they are of the ‘S’ pillar currently. Our respondents expect the ‘S’ pillar will most likely become so ingrained
carbon pricing, according to the OECD data. The prepared to tolerate when investing in the ‘S’ to see some demonstrable benefits, without that they will, over time, become a standard part
EU’s directives on non-financial reporting and the pillar via passive funds. It measures the level of sacrificing baseline outcomes. Thus, they are of good business practice, rather than being a
taxonomy on climate change are reshaping the active risk each fund takes versus its parent index. looking for a free option that gives an upside specific collection of metrics tracked by investors.
ecosystem of markets and orienting them towards By its very nature, there is a trade-off between as markets start to price in the ‘S’ pillar and
risks with no historical precedent. high exposure to the ‘S’ pillar and low tracking downside protection if they don’t. Hence, there is every expectation that the ‘S’ pillar
error. And therein lies the paradox uncovered will outlast the crisis that catapulted it to prominence
The pragmatists, on the other hand, argue that by our 2020 survey report, Addressing climate However, as the infrastructure of skills, data and become a permanent feature of passive investing.
for ESG to be a risk factor it needs a long history change in investment portfolios. and technology improves, pension plans may
across regions, asset classes and time. In the well tolerate a higher tracking error in order to With Covid-19, some tipping points are not hard
meantime, the impacts of major wildfires, flooding On the one hand, our respondents expect good accelerate positive social change in areas that to spot in real time. This is one of them, according
and droughts are becoming evident with greater long-term risk-adjusted returns from their passive are materially important for investment returns. to the majority of our respondents.
intensity and frequency. The same applies to funds covering the ‘S’ pillar (Figure 1.5, left
governance lapses and corporate wrongdoing. chart). Yet, they are not willing to tolerate big As the performance track record builds up, the
As if that were not enough, Covid-19 has blown deviations from the parent index that is used as a demand for more customised indices will accelerate.
the lid off socioeconomic inequalities. Hence, the benchmark (Figure 1.6, right chart). 40% of them
pragmatists are treating ESG investing as a way of would prefer their tracking error to be below 1%. In conclusion, the cultural and legal norms around
harnessing the informational inefficiencies while At the top end, only 22% are willing to tolerate
markets are slow to price in their inherent risks an error in excess of 2% that comes with a more
(Case Study 1d). concentrated portfolio.
The immediate question for both schools of The paradox is explained by the nascent nature
Case study 1d: Is ESG a risk factor or a momentum trade?
The headlong increase in ESG investing in the past Clearly, analysing a company’s past financial
three years has given rise to debate on whether it is numbers is akin to driving using only the rear-view
simply a momentum trade with a good bandwagon mirror. The past is a poor guide to the future when
premium or a risk factor – on top of the traditional there is so much change around us. So, we look
ones like value, quality, low variance and size. forward and factor in that change. Capital markets
are taking note, as ever more institutional investors are
To qualify as a risk factor, ESG needs to have a common throwing their weight behind sustainable investments.
definition across time, space, style and region. This In the post-pandemic world, conventional probabilistic
has yet to happen. In addition, most risk factors are risk models – based on historic price behaviours –
not readily observable, obliging our asset managers are likely to be more therapy than anything useful.
to use their investible proxies. For example, the
value factor is proxied by quantifiable measures like So far, the returns on our ESG portfolio based on
book-to-price or p/e ratios. As yet, there are no widely passive funds has exceeded our expectations since
accepted proxy metrics for ESG, nor a consensus on 2015. It also proved more defensive in the turbulent
what weights to accord to each of its components. markets of 2020. It delivered more by losing less.
Thus, we are left to make judgement calls.
A French pension plan
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19 20Th e ri se of t h e ‘ S ’ p i l l a r: Wh at a re t h e ke y b l o cke r s a n d d ri v e r s?
What are the key blockers
and drivers?
So far, the advance of passive funds covering the ‘S’ pillar in pension portfolios has been modest
because of mismatches in time horizons, the interdependency between the E, S and G pillars
and the shortcomings of the available investible information.
Yet, the winds of change are evident. The inequalities exposed by the pandemic have heightened
awareness that sustainable pensions require sustainable societies. The materiality of the ‘S’ pillar
has been further bolstered by the increased regulatory tempo.
So far, equities have been the key vehicle for investing in the ‘S’ pillar via passive funds. Fixed
income will soon follow as more index funds incorporate social and community development
bonds. Private market assets, too, will see an advance, albeit from a very low base.
Manager selection for passive funds covering the ‘S’ pillar is now largely driven by three criteria:
business culture, as evidenced by a good track record on social agenda, stewardship capabilities,
and a meritocratic fee structure.
Future growth in passive funds will be broad based. But it will be mainly spearheaded by ESG
funds, other theme funds and ETFs. However, there is only so much that capital markets can do.
Today’s societal problems are so deep-seated that only governments can take the lead.
1. Key blockers For example, in Europe, 66% of plans are already
in negative cash flow status as ever more members
The ESG pillars have emerged as material to are retiring each year. Of those still in positive
pension portfolios, especially in the wake of two status, around 53% expect to go negative in
seminal events in 2015: the worldwide adoption the next 5 years and around 81% expect to go
of the UN’s Sustainable Development Goals and negative within 10 years. Ageing demographics
the Paris Agreement on climate change. Until very is forcing around 90% of respondents to de-risk
recently, the environmental and governance pillars their portfolios via liability-driven investing, even
have attracted the most attention. Three sets of though nearly 65% of them are still underfunded.
constraints have conspired against the rise of the They cannot afford to withstand losses that
‘S’ pillar (Figure 2.1). require longer recovery periods. The situation in
The rise of the ‘S’ pillar a) Mismatches in time horizons
North America and Japan is not too dissimilar.
As a result, pension plans are obliged to draw
58% of our respondents cite that their time a distinction between ‘event’ risks, which are
horizons are not long enough to realise the idiosyncratic in nature with an immediate effect
investment benefits of this pillar. Their current on a company’s share price, and ‘erosion’ risks,
funding issues favour shorter horizons. which are systemic and materialise gradually
21 22The r i s e of t h e ‘ S ’ pilla r : Wh at a re t h e key blo cker s a n d driver s? Th e ri se of t h e ‘ S ’ p i l l a r: Wh at a re t h e ke y b l o cke r s a n d d ri v e r s?
“Few companies have the required frameworks “The old adage ‘you can’t manage what you don’t measure’
to report on data relating to social issues.” aptly captures a key feature of today’s ESG investing.”
An interview quote An interview quote
over a longer period (see Case Study 1a in the Yet, both groups harbour a common belief. The Today, the best practice governance model in the between ‘E’ and ‘S’ as demand for fossil fuel drops.
Executive Summary). qualitative aspects of the social pillar – like health, West envisages corporate attributes that are most Clearly, the notion of ‘social licence’ to operate is
welfare and education – are seen as generating conducive to the sustainability agenda. These fine in principle but not in practice.
Governance risks fall into the former category, as positive externalities that are observable, not include: a competent and experienced board of
exemplified by the recent collapse of Wirecard. In measurable. As such, they are ‘public goods’ directors, capable of giving clear strategic direction c) Data shortcomings
contrast, environmental risks sit in the erosion risk that come under the realm of government to the full-time executives, whose compensation
category, as exemplified by the recent wildfires in responsibility, not capital markets, according to is linked to long-term sustainable value creation Index providers have made progress in
America and Australia, attracting extensive media 49% of our respondents. and who are accountable to all stakeholders with devising indices that combine and benchmark
attention worldwide. Social risks sit in the middle. whom they have a regular strategic dialogue on various environmental, social and governance
b) Interconnections between E, S and G ESG and other matters pertinent to stakeholder components. However, the proliferation of specific
In general, financial markets tend to be focused interests. So, the synergistic link between ESG indices has been dominated by environmental
on events that immediately affect company As Figure 2.1 shows, 51% of our respondents governance and other ESG pillars is clear. issues, with far fewer indices specifically targeting
valuations, thus favouring the G pillar more than believe that there are strong interconnections social issues. Worse still, there is no industry-
the E and S pillars. Those pension plans now in between these three pillars of sustainability. But the matter gets complicated when wide, singular ‘social’ benchmark that most
the decumulation phase with negative cash flow environment and social factors are considered investors would agree on (as cited by 43% of our
status tend to pay more attention to a company’s Good governance is widely accepted as the basis in isolation. This is exemplified by the dilemmas respondents). Data problems remain formidable
share price in the short term. The rest who are of strong environmental and social standards around the current large reserves of fossil fuels. (Case Study 2a).
concerned about far-off/fat-tail risks prefer to invest that show how a company's vision and business As the global economy transitions towards a
in the ‘E’ and ‘S’ pillars. practices are aligned to delivering sustainability low-carbon future, these could be abandoned The qualitative nature of many social programmes
goals on the ground. as stranded assets, well ahead of their economic makes it difficult to translate them into meaningful
life, causing undue social hardships in their local KPIs that investors can use effectively. Compounding
FIGURE 2.1 communities. Thus, there is a complex trade-off this problem is the lack of consistent definitions,
What are the factors currently constraining your pension plans from investing in social-related funds?
% of respondents
0 10 20 30 40 50 60
Case study 2a: Data remain the Achilles heel of social investing
Time horizons are not long enough for the social pillar 58
Lack of clear definitions, methodology & reliable data 51 While data vendors are grappling with the ‘E’ and outcomes. Many appear to cherry-pick a ‘base scenario’
‘G’ factors in ESG in response to rising user demand, that serves to overstate the scale of ESG action by
Interconnection between E, S and G factors 51 the ‘S’ factor has remained elusive. There is a lack of corporates and their final outcomes.
consensus on what it covers simply because of the
Social issues are seen as government responsibility 49 sheer variety of qualitative factors that come under We are thus forced to use an array of definitions used
the ‘S’ umbrella. However, all agree that it sits at the by 150 different data compilers, whose proprietary
Lack of an agreed industry-wide singular social benchmark 43 intersection point between ‘E’ and ‘G’. scoring methods often yield a radically varied assessment
of the same company. The result is greenwashing:
Companies are not mandated to report their ESG risk 39 The crux of the matter is that there is no universal short-cuts taken by some asset managers to repurpose
agreement on what constitutes a socially ‘good’ their old funds with an ESG label, without rejigging the
Inconsistencies in the social scores from data vendors 23 company in practice. Hence, governments worldwide investment process.
mostly do not mandate companies to provide data on
Lack of a performance track record of social factors 21 their ESG practices within a consistent framework. The only solution is to access data from a variety of
sources and enrich them by direct engagement with
Difficulty in delivering both financial and non-financial returns 15 As a result, data collecting and reporting by companies their investee companies so as to separate fact from
is largely self-directed and often self-serving. Companies fiction. That’s what we do.
Social risk is already captured by other risk factors 8 may choose inappropriate outcome indicators, or they
may choose the right indicators but use calculation
Financial markets are not yet pricing in social risk 5 techniques or ambitious assumptions that exaggerate
A Danish pension plan
Source: CREATE-Research Survey 2021
23 24The r i s e of t h e ‘ S ’ pilla r : Wh at a re t h e key blo cker s a n d driver s? Th e ri se of t h e ‘ S ’ p i l l a r: Wh at a re t h e ke y b l o cke r s a n d d ri v e r s?
“Social media is now increasingly influential in “Sustainable economies require sustainable societies.
exposing good and bad corporate behaviours.” They are two sides of the same coin.”
An interview quote An interview quote
standardised methodology and reliable data on the ESG disclosures. Until then, the best that investors luxury: financial returns would, perforce, race to the top increasingly factoring in how business operations
social pillar (cited by 51% in Figure 2.1). Investors can do is regard available data on the ‘S’ pillar as a of their agenda. If anything, the reverse has happened. can potentially harm people and the natural
have historically prioritised environmental factors, guide, not a single source of truth. environment, and attract lawsuits and penalties
so issuers have developed systems and reporting The crisis showed all too clearly how external that damage their brand value, as revealed by
frameworks on issues such as carbon emissions, However, the winds of change are evident. physical forces could roil the markets and whipsaw the sudden collapse of the Pacific Gas & Electric
fossil fuel reserves and the use of clean energy. On asset portfolios in ways previously unimaginable. Company in 2019.
the other hand, few companies have the necessary Investors had a foretaste of some of the much-
data-reporting frameworks on social issues. 2. Key drivers discussed ‘unknown unknown’ impacts of climate Thus, 48% of our respondents recognise the
change and societal upheavals. Unsurprisingly, growing materiality of social issues in business
To compound the problem, existing regulations Long before the Covid-19 pandemic, ESG investing therefore, 59% of our respondents cite the need to performance and investment outcomes; and 58%
diverge by region. There are differing standards for was widely recognised as a foundational trend tackle the inequalities exposed by the pandemic as are seeking good long-term risk-adjusted returns
voluntary ESG disclosures – from the Sustainability in pension portfolios. Since then, three mutually a key factor driving their allocations to the ‘S’ pillar. (Figure 2.2). In this context, the focus on the long-
Accounting Standards Board to the Global reinforcing factors have increased momentum, while term is deliberate because their liabilities stretch
Reporting Initiative, the Carbon Disclosure Project turning the spotlight on the ‘S’ pillar (Figure 2.2). These inequalities had been building up over over the next 40 years. They rely on sustainable
and the UN Global Compact – all with different the past 40 years as the rise of turbo-charged economies to meet them.
needs and principles around application and a) The inequalities exposed by Covid-19 globalisation and digitalisation created winners
understanding of what the standards should be. and losers in the West. Governments failed to In general, pension plans’ ESG exposures are now
Unsurprisingly, the International Organization When capital markets plunged in March 2020 at re-equip and reskill those who suffered job losses seen as critical to conveying information about
of Securities Commissions has recently been the start of the Covid-19 pandemic, many observers and stagnant incomes, as the centre of gravity in future risks that remain obscure to conventional
obliged to assemble a task force to deliver a more predicted that pension investors’ interest in ESG global manufacturing migrated to the low-cost risk models. As economies have evolved and
cohesive, transparent and standardised form of investing would only prove to be a bull market emerging economies. progressed, new forms of risk have emerged. ESG
investing is seen as focusing on the latest and
The transition has not been just. Both globalisation most severe risks that modern societies face.
FIGURE 2.2 and digitalisation delivered benefits in the West.
What factors are/or will be driving your pension plan's interest in investing But these have accrued to many in their role as c) The rising regulatory tempo
in the social factor over the next 3 years? consumers, not as workers or citizens. So, fresh
emphasis on the ‘S’ pillar reflects both the desire European governments and regulators, for their
% of respondents to have a just transition as the global economy part, have been keen to ensure that the fiduciary
0 10 20 30 40 50 60 advances towards a low-carbon future and role of pension plans embraces the sustainability
Tackling the inequalities in our societies exposed by Covid-19 59
addresses the prevailing inequalities that have agenda. 49% of our respondents see this
built up over the decades. 40% of respondents see development as influencing their allocations to the
Seeking good long-term risk-adjusted investment returns 58 this desire as simply delivering their plans’ vision ‘S’ pillar, as shown in Figure 2.2.
of a more sustainable society consistent with
Responding to regulatory pressures as part of fiduciary duty 49 affordable pensions. Currently, the EU has the most advanced suite of
ESG regulatory measures of any global region.
Recognising the growing materiality of social factors 48
b) The growing materiality of the ‘S’ pillar These are expected to crystallise into a benchmark
Aligning with your pensions plan's vision of a more sustainable society 40 standard over time and form a template for other
The expected increase in the allocations are as jurisdictions to adapt. The measures have two
Supporting international initiatives on societal standards 32 much about enlightened self-interest as about goals. The first one is to channel private capital
their social responsibilities. towards financing genuinely sustainable economic
Managing reputational risk while creating social benefits 24
activities that fulfil the EU’s SDG and Paris
Responding to the aspirations of your plan members 24
Pension plans are all too aware that they invest Agreement commitments. The second goal is to
in companies to earn decent returns but the require financial services firms to integrate ESG
legal structure of the corporate entity does risks both into their own balance sheets and their
Source: CREATE-Research Survey 2021 not take away their moral responsibility for the clients’ investments.
actions of these businesses. Hence, they are
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