Text by Robert Eccles, Visiting Professor of Management Practice at the Said Business School, University of Oxford, a former Professor at Harvard Business School and a current member of the Misum board.
Given the well-deserved reputation Scandinavian investors have for being on the forefront of sustainable investing, it is not surprising that seven of them are in the data base of The Investment Integration Project (TIIP). These funds are the Swedish AP2, AP3, and AP4; Denmark’s pension funds ATP Group and PFA Pension; Norges Bank Investment Management (NBIM), Norway’s sovereign wealth fund; and the Finnish pension fund Varma Mutual Pension Insurance Company (Varma). In this blog, I will explore the extent to which this reputation is deserved using a database of 100 asset owners and asset managers developed by TIIP.
TIIP is a research services firm under the leadership of Steve Lydenberg (Founder and CEO) and William Burckart (President and COO). It’s mission “to help institutional investors understand the feedback loops between their investments and the planet’s overarching systems that make profitable investment opportunities possible.” Just as modern portfolio theory extended analysis of individual stocks to a basket of stocks, TIIP helps investors to move their level of analysis beyond just portfolios to include the context in which these portfolios exist. This is important because failure to do so will lead to dramatic disruptions (e.g., the Financial Crisis of 2008) and steady or even dramatic degradations (e.g., from climate change and inequality) that will make it impossible for investors to earn the returns necessary to meet the expectations of their beneficiaries and clients, respectively.
TIIP is a very welcome initiative since it is the first one to look at systems-level considerations from an investors perspective. The database, which can be used by investors as a guide for what their peers are doing to contribute to the system level, is just one aspect of TIIP’s efforts. The organization is developing a significant body of research and analysis regarding the importance of systems-level thinking and how to ensure its viability. In addition, TIIP fosters collaborations among investors interested in addressing common issues, works with other organizations that have complementary goals and objectives, and provides customized solutions for investors.
Underpinning all of those activities is TIIP’s framework on the “Tools of Intentionality”—a set of 10 strategies investors can use to have a positive effect at the system-level:
- Additionality: Invest to add to the wealth-creating potential of systems.
- Diversity of Approach: Offer diverse products or use numerous approaches to address systems-level issues.
- Evaluations: Place a non-financial value on difficult-to-quantify wealth-creating elements of systems.
- Interconnectedness: Increase the flow of information about systems-level considerations.
- Locality: Invest in the development of resilient systems in targeted geographic areas.
- Polity: Engage in policy debates about systems-level risks and rewards.
- Self-Organization: Build organizations to increase investors’ capacity to address systems issues.
- Solutions: Utilize vehicles that target specific systems-level challenges
- Standards Setting: Limit investments that transgress the bounds of normative conduct.
- Utility: Align asset classes with systems-level concerns.
TIIP has also identified five “on-ramps” to system-level investing: ESG integration, impact investment, investment stewardship, long-term value creation, and universal ownership. These are stepping stones to investing in a more system-focused way. Finally, TIIP has the “key investment activities” for each investor in its database: investment belief statement, security selection and portfolio construction, corporate engagement, targeted investment program, and manager selection, directives, and monitoring.
”The second major finding is that with this group of asset owners, the Swedish funds (AP2, AP3, ad AP4) and NBIM are relatively more advanced. Possible reasons for the Swedish funds are Swedish financial regulations and the fact that they are all raising the bar for each other.”
In terms of the “Tools of Intentionality,” the overall pattern is the relatively limited number of them being practiced as shown by the simple ratio of the number of tools being used by all seven investors (18) to the total possible (10×7) which is .26. This suggests that even these advanced asset owners are in the early stages of thinking about their investment strategies in the context of system-level considerations. Not a single one of these asset owners is using Additionality, Evaluations, Locality, or Utility. AP2 is the only one using Solutions. Diversity of Approach (AP2 and AP4) and interconnectedness (AP2 and NBIM) are being used by two. Three are using Polity (ATP, NBIM, and PFA). The most popular tools are Self-Organization (all but PFA and Varma) and Standards Setting (all).
Seen from the perspective of the investors, AP2 is using five of these tools, NBIM is using four, AP4 and ATP are using three, AP3 and PFA are using two, and Varma is using only one. This raises the question of whether only a limited number of these tools can be used, perhaps as a function of size and investment strategy, or whether all of these investors have substantial room for improvement.
The pattern is different for the on-ramps, with relatively more of them being used (a ratio of .40). The most popular one is long-term value creation which is being used by all except for PFA, followed by ESG integration being used by five (the exceptions are AP3 and PFA). AP3 and NBIM are using universal ownership, only AP3 is using investment stewardship, and none are using impact investment. The latter is probably due to the fact that “impact investing” still largely connotes small, private investments in specific projects at funding levels too small to be of practical significance to these large asset owners.
In terms of key investment activities, all seven are integrating system-level investment strategies into their security selection and portfolio construction. All except for ATP and PFA have targeted investment programs—that is investment programs specifically targeting system-level challenges. Only the Swedish funds of AP2, AP3, and AP4 are using corporate engagement to address system-level challenges. None of these investors have included system-level considerations in their investment belief statements (easy to do if the will is there) or have incorporated system-level thinking into their manager selection, directives, and monitoring processes (harder to do because this is a complex process).
Finally, in terms of addressing specific environmental, societal, and financial systems-level themes, the pattern, like with the Tools of Intentionality, is one of relative sparseness with a similar ratio of 0.36. Not surprisingly, the theme of climate change is of relevance to all investors, six (AP2, AP4, ATP, NBIM, PFA, Varma) of which have leveraged the Tools of Intentionality (Diversity of Approach, Polity and Standards Setting) to address this. Human rights is another theme that all seven investors are addressing. All seven are doing so using the Standards Setting tool in their security selection and profile construction, and some are also using the tools of Self-Organization (AP2, AP3, AP4, NBIM) and Interconnectedness (NBIM).
After that, five (AP2, AP3, AP4, NBIM and PFA)—all through the Standards Setting tool in their security selection and portfolio construction—are addressing corruption. There are four investors addressing natural resources (AP2, AP3, AP4 and NBIM), consumer health and safety (AP2, AP4, NBIM and Varma), corporate governance (AP2, AP3, AP4 and NBIM) and employment, labor rights and working conditions (AP2, AP3, AP4 and PFA), and three addressing oceans (AP2, AP3 and AP4), renewable energy (AP2, NBIM and Varma), and transparency (AP2, ATP and NBIM). Only two investors are addressing water (AP3 and NBIM) and social equality and diversity (AP2 and AP4).
On environmental themes, sustainable land use is the focus of only AP3 and on financial themes, stability is the focus of only PFA. None of these investors are focusing on biodiversity, waste management, food production and security, income inequality and financial inclusion, infrastructure or shareholder rights.
AP2, at 11 of the 20 themes, and AP3, AP4, and NBIM at nine stand out. PFA is only focused on five, Varma only four, and ATP only on three.
There are two major findings from this analysis. The first is that even these seven Scandinavian asset owners are in the early stages of addressing system-level issues in their investment processes. If a similar analysis were done for all 100 investors in the TIIP data base, it would be possible to compare the Scandinavian funds to the global average. The reasonable hypothesis would be that they’re better but that would have to be confirmed.
The second major finding is that with this group of asset owners, the Swedish funds (AP2, AP3, ad AP4) and NBIM are relatively more advanced. Possible reasons for the Swedish funds are Swedish financial regulations and the fact that they are all raising the bar for each other. In terms of NBIM, it has long been a leader in the narrower domain of sustainable investing and its sheer size means it has the resources to also lead the way on system-level issues.
Robert Eccles is a Visiting Professor of Management Practice at the Said Business School, University of Oxford, a former Professor at Harvard Business School and a current member of the Misum board. Follow Robert Eccles on Twitter: @rgeccles