AP7 and ESG: “In the long run, this pretence around ESG integration is going to dissolve”
CEO Richard Gröttheim and sustainability head Johan Floren discuss what it really means to be a responsible investor, the SDGs and blacklisting vs. litigation.
The fifth of our in-depth series looking at Sweden’s AP funds features Sjunde AP-fonden. For an outline of the law changes discussed, see here.
AP7 is not included in Sweden’s Council of Ethics with the first four AP funds, and is not governed by the recently-passed legislation on ESG. Instead, it is ploughing its own furrow.
“The AP funds are among the best in the world on sustainability, but you wouldn’t know if from reading the newspapers” – CEO Richard Gröttheim
In November, the SEK376bn (€36.5bn) fund hit headlines when it announced it was considering starting legal proceedings against Alphabet (Google) over its record on sexual harassment. It is not AP7’s first attempt to warn some of the world’s biggest corporations to ‘do the right thing’, as Google’s own slogan demands. In 2017, it took legal action against Facebook over its attempts to reclassify its share structure – a move which would have potentially resulted in significant share dilution – and has been involved with a slew of other cases against companies including Vivendi, Sino-Forest, Petrobras, Toshiba, Volkswagen, Allergan, Cobalt International Energy, Deutsche Bank and Mitsubishi.
“I’ve been very involved on a personal level with the litigation activities,” explains CEO, Richard Gröttheim, describing law suits as one of four tools the fund currently works with on ESG (the others are engagement, voting and exclusion; although it may formally introduce a fifth this year: filing resolutions).
“To go through the courts, we have to be able to prove that we lost a lot of money. In the case of Facebook, it was minority investors like us that stood to lose the most from the share reclassification. With Alphabet, we would argue that the company didn’t release financially material information to shareholders in relation to the sexual harassment allegations.”
He adds that there is a lot of scrutiny on AP7 from the general public and the mainstream media, who often overlook the fact that much of the fund’s holdings are in passive equities, so exclusion can be tricky.“People are always telling us we shouldn’t own certain companies, and that can be frustrating because there are other ways, like litigation, to tackle sustainability,” he says, adding: “The AP funds are among the best in the world on sustainability, but you wouldn’t know if from reading the newspapers. That’s part of the deal when you’re a public pension fund, and it’s right that it should be that way. But, as long as I know we are taking action to deal with some of these issues, then I can live with it.”
Gröttheim is backed by his Head of ESG, Johan Floren, who points out: “When there is a scandal like Facebook we are simply asked: are you going to sell? But for the kind of problems that these companies have, norms-based blacklisting isn’t very useful. You have more influence remaining in the stock and engaging.”
Floren says AP7 is “very strict” about excluding companies. However, that didn’t stop it in 2017 axing firms including giants Exxon and Gazprom, saying they were “in direct violation of the Paris Agreement”.
“When there is a scandal like Facebook we are simply asked: are you going to sell? But for these kind of problems blacklisting isn’t very useful” – ESG Head Johan Floren
Floren said at the time that the thinking was “to put pressure on these companies and change their behaviour through blacklisting” and Gröttheim hopes other investors will begin follow suit. Around €300m was divested.
“Then we decided to take the same amount of money and invest it in green impact equity,” Floren added. Those two mandates are aligned with the two Sustainable Development Goals that AP7 has chosen to prioritise over coming years: Goal 6, Clean Water and Sanitation, for which KBI now runs a portfolio; and Goal 13, Climate Action, managed by Impax.
“We’ve also put into the contracts with these managers that we’ll work with them to develop metrics and methodologies around measuring the impact itself,” says Floren. “There’s a lot of measuring output going on, and some attention given to outcome. But what’s the actual impact?” he asks, observing that the current tendency to “put a grid on the investments you already do… doesn’t create much value”.
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“I think a fair dose of cynicism is important when it comes to the SDGs,” continues Floren. “I was pretty overwhelmed when they first happened: suddenly the global financial markets started talking about impact investing. I used to be the head of Swedsif [the Swedish Sustainable Investment Forum], and I remember how small the allocation to impact investing was whenever we did our surveys – it was hard to make it show up on a diagram. And then, all of a sudden, the SDGs appeared and these huge players – MSCI, BlackRock, UBS – they started talking about impact investment.”
“If it’s relevant to performance then of course you will use it to inform your investment decisions. That’s not what being a responsible investor is.” – Floren on ESG data
The role of the SDGs and ESG in investment, though, must be framed differently, he argues.
“We need to stop using these frameworks and this data just to help us with our returns. Any data that’s financially material will be used by everyone eventually. If it’s relevant to performance then of course you will use it to inform your investment decisions. That’s not what being a responsible investor is. In the long run, this pretence around ESG integration is going to dissolve and it will just be another part of the normal investment process.”
“But this can’t be instead of real responsible investment, where we look at the impact of our decisions on people and the planet, how we are supporting sustainable development. And there enter the SDGs.”
AP7’s approach has been to identify its two focus Goals and spend three years working with each.
“There are different opinions on this approach,” admits Floren. “Some say we’re just cherry picking the easiest ones and ignoring the others, but we have the opposite view: if this is going to be operational and useful for investment decisions, then we have to narrow it down to something we can work with.”He hopes the work AP7 is doing can become a kind of “blue print” for working with the other SDGs in future.
Through an SDG investment initiative convened by Swedish body SIDA, AP7 also engaged with Swedish municipalities on how they could structure green bonds linked to sustainable water projects – something Gröttheim is keen on, repeating some of the comments from other AP funds that fixed-income and sustainability is a challenge.
“We basically buy green bonds. That’s the only way we can really support ESG in the asset class, because currently we hold mainly Swedish government bonds, municipal bonds and mortgage-backed bonds, and none have much room for engagement.”
One of Gröttheim’s frustrations is the lack of supply of green and other ‘sustainability’ bonds. “There just aren’t enough that we can buy,” he says. The pair have mixed feelings about the tendency for non-ESG focused investors to buy green bonds incidentally – without any interest in the environmental credentials – with Gröttheim saying he’d “prefer AP7 to be holding these bonds because we’re interested in the sustainability element and, for them to achieve their purpose, they shouldn’t be held by those that don’t care”. Floren describes the news in November that central banks are major ‘incidental’ green bond buyers, as “frustrating” on one level, but “on the other hand, it does create legitimacy and in the long run it could help foster the market”.
Alongside Clean Water & Sanitation and Climate Action, AP7 plans to prioritise its work on human rights in 2019. It has already excluded nearly 30 firms on human rights grounds, and is working with responsible investment advisor GES on labour rights issues in food supply chains.
“We will hold these stocks for a long time,” Gröttheim tells RI. “And it is our fiduciary responsibility to make companies act in a decent way.”