Despite an underperformance of ESG strategies compared to traditional broad markets last year, pension funds still believe the sustainable transformation is underway and inevitable, according to the results of a study by a DWS unit and UK-based CREATE-Research released June 12.
The ESG investments of 58% of pension funds surveyed have performed worse than the comparative benchmark. However, pension managers surveyed cite market effects as a result of interest rate increases and rising energy prices as main reasons, among others.
The study, which involved 148 pension plans in Europe, Australia, Asia and North America with total assets of EUR1.7 trillion ($2.45 trillion), was commissioned by exchange-traded funds (ETFs) and exchange-traded commodities (ETCs) provider Xtrackers by DWS.
A quarter of pension institutions surveyed state that the underperformance is related to ESG-specific factors. Meanwhile, almost two-thirds of pension funds believe that ESG investing is a fundamental trend that has not been interrupted by market volatility.
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The end of the era of cheap money and the resulting downward correction in equity prices has coincided with the rise of ESG investing, says Simon Klein, global head of Xtrackers sales, DWS. “But while stock markets are inherently cyclical, the trend towards ESG investing appears to be here to stay. ESG has fundamentally changed the way we invest.”
Klein notes in his foreword to the “Passive Investing 2023: The future of ESG after the bear market” report that the war in Ukraine turbo-charged the fossil fuel sector to the relative detriment of ESG-tilted investments.
While being underweight in energy and defence stocks, ESG portfolios also tended to be overweight in tech stocks with good ESG ratings, which registered price falls in response to aggressive interest rate hikes, he adds. “At the same time, however, geopolitical uncertainty has focused minds on the ‘S’ and the ‘G’ parts of ESG. The ability of ESG to identify opportunities and risks traditional financial analysis fails to reveal — especially in the area of climate risk — is becoming increasingly recognised. More and more clients expect their managers to invest expressly in line with their individual ESG goals.”
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The majority of pension funds want to expand their share of ESG-related assets in the next three years. This applies both to their entire portfolios as well as to the passively mapped portions.
The pension fund managers cite several growth drivers for the increasing importance of ESG strategies. One example is new regulations on the fiduciary management of pension assets.
Following the global financial crisis, regulators in key regions such as the EU, Scandinavia and the UK have legislated that pension plans must pursue ESG objectives as part of their fiduciary duty.
The second growth driver is the growing role of stewardship, or the promotion of the ESG agenda through, among other things, the exercise of voting rights.
For 60% of pension funds, stewardship is part of long-term value creation. The stewardship model, on the other hand, seeks to minimise conflict through a shared agenda aimed at mutual interest.
This progress has been made possible by the EU Sustainable Corporate Reporting Directive 2022 and 2022 Climate and Investing reporting in the UK, say the study’s authors.
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The third driver of growth is the increased search for good long-term returns as capital markets enter a prolonged era of low returns.
Pension plans are becoming more selective in the companies they hold, preferring those they can pressure as shareholders to promote the ESG agenda over companies whose core business might not survive in a post-climate change world, say the authors.
