Ethical investing ‘should be part of sovereign wealth fund strategy’

6 Jul 20

Sovereign wealth and pension funds should seek investments that couple financial returns with societal and environmental benefits, researchers from the Inter-American Development Bank have argued.

 

The economists said investors are becoming increasingly likely to consider factors such as pollution, deforestation, gender equality, labour conditions, data security and tax evasion when making decisions.

And these factors, known collectively as environmental, social and governance (ESG) factors, are particularly important for sovereign wealth funds and pension funds, the academics argued in a report.

“Governments should understand the impact of companies on communities and invest in those that promote values consistent with societal objectives, regardless of whether those investments and impacts are local or global,” the report states.

The economists said unethical and unsustainable practices such as high carbon emissions and poor labour conditions create costs that fall on societies, and just as governments intervene in markets through spending or regulating, their investments should also be aligned with their aims.

Sovereign wealth and pension funds also often have a long investment horizon, they said, during which time ESG risks are more likely to materialise and harm financial returns.

The report also found that the academic literature on the subject “points to a positive correlation” between ESG performance and financial performance.

The researchers said this was “hardly surprising given that better management of ESG risks often implies better [overall] management, which can lead to cost savings and process improvements”.

Looking at Chile’s two sovereign wealth funds – it’s Pension Reserve Fund and its Economic and Social Stabilisation Fund – the experts conducted several exercises to estimate the impact greater consideration of ESG would have on returns.

They found that utilising ESG indexes as benchmarks when making decisions “would not have systematically and substantially changed the financial returns”.

But they found a lack of standardisation in ESG data reporting by companies, which makes it difficult for investors to compare performances across companies or even between different years, and often companies’ own ratings and those from third-party agencies are “strikingly different”.

They called for more work to be done on creating standardised, easy-to-understand ESG reporting methods, as well as more research into sustainable investing.

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