Pension funds are increasingly shifting their focus from merely accumulating ESG-labelled assets to emphasising the quality and impact of these investments, according to a study by asset manager DWS and Create-Research, published on Tuesday.
The report, «Passive Investing 2024: ESG Regulatory and Policy Measures,» underscores how recent regulatory and policy initiatives are reshaping the ESG investment landscape, thereby influencing institutional investors› asset allocation strategies. The study surveyed 156 pension funds across 13 countries.
From quantity to quality
The study reveals a significant transition in the approach of pension funds towards ESG investments. This shift from quantity to quality is driven by demands for greater transparency, robust regulatory frameworks, and alignment with both financial and social outcomes. Pension funds are now insisting on more rigorous due diligence and clearer evidence of the long-term benefits of ESG investments.
Growing role in asset allocation
According to the DWS study, pension funds are increasingly integrating ESG factors into their strategic asset allocation. This integration is predicated on the belief that ESG factors will eventually serve as offset risk factors, enhancing investment performance.
The survey indicates that 56 per cent of respondents plan to increase ESG allocations in their passive portfolios, reflecting growing confidence in the potential of ESG investments to deliver long-term value.
Debate in Dutch politics inspired by Republicans
In the Netherlands, the discourse on ESG investments is prominently featured on the political agenda, especially as a right-wing majority in the Lower House demands measures against pension funds that are divesting from fossil fuel companies.
Liberal-conservative MP Thierry Aartsen recently tabled a motion opposing «activist investment policies» at state pension funds, arguing that high returns should take precedence over activism. Aartsen stressed that pension funds› primary role is to ensure a secure retirement, and he contends that green investments are only favourable if they generate returns.
Optimism for ESG investing
Despite the political debate, pension investors remain optimistic about the future of ESG investing, according to DWS. As regulatory and policy measures continue to evolve, they are expected to further integrate ESG factors into investment strategies, thereby contributing to a more sustainable and inclusive financial ecosystem.
The DWS study cites an unnamed Dutch pension fund which asserts that ESG leaders are more competitive and profitable due to superior risk management, making them less vulnerable to market shocks. However, it is noted that ESG does not guarantee high returns.
Increasing frequency of ESG risks
The study highlights that ESG risks are no longer distant concerns but are becoming more acute and frequent due to ongoing global warming and declining biodiversity. In response to a series of new regulations over the past four years, it is anticipated that capital markets will increasingly account for these risks and opportunities.
The best current strategy for achieving good returns is through stewardship and proxy voting, both of which are essentially forward-looking. «With credible means, they can materially improve the quality of our alpha and beta ESG assets,» the pension fund stated.
Key regulatory developments
Key regulations, such as the Corporate Sustainability Reporting Directive (CSRD) in the EU and the US Inflation Reduction Act, are creating a more structured and reliable environment for ESG investments, according to DWS. Notably, the CSRD is regarded as a pioneering initiative, requiring large companies to report their ESG risks and transition plans.