Philippe Desfossses: is there an environmental ‘impact’ from a best-in-class ESG strategy?

When it was first set up in 2005, ERAFP decided to invest in accordance with a specific, in-house SRI Charter. The Charter is structured around the three major ESG pillars and includes a number of criteria for the assessment of potential investments. ERAFP’s “best-in-class” investment policy (investing in the best ESG-rated companies) is fully consistent with the institution’s aim of investing over the long term to cover the scheme’s commitments. It has produced satisfactory results because, contrary to what you sometimes hear in the market, having an SRI policy does not have a negative impact on the portfolio’s return; au contraire, the portfolio has outperformed in financial terms. But, looking beyond financial performance, investors who have adopted a best-in-class approach are regularly asked what ‘impact’ it has. In this context, ERAFP wanted to measure the impact on its equity portfolio’s carbon performance of stock picking based on the environmental criteria in its SRI assessment grid. With the assistance of Trucost, ERAFP analysed its equity portfolio. This showed that the average carbon intensity its portfolios is 19% lower than that of the reference benchmark equity portfolios. Although by definition ERAFP’s best-in-class policy avoids the exclusion of any given sector, the investment managers may nevertheless slightly over- or under-weight certain sectors. Correcting for this sector-allocation bias, the scheme has still out-performed very significantly, since the reduction in the portfolio’s CO2 emissions relative to that of the benchmark portfolios’ emissions attributable solely to the selection of stocks stands at 11%.ERAFP believes that public institutional investors should measure and disclose the carbon footprint of their portfolios. This transparency obligation on what is,
after all, a risk (beyond the risk for the planet there is also a risk that a portion of investors’ assets may be subject to significant impairment) is owed to those who entrust us with their savings or their future pensions.
It is hard to dispute (1) that carbon is a risk, so how can we fulfil our duty of trust if:
• we don’t implement the systems necessary to assess this risk in order to reduce it and, worse still,
• having measured the risk, we don’t disclose it to stakeholders. That would amount to concealing information that we knew could certainly influence their decision to continue or withdraw their investment.
This duty of trust is compounded by a civic duty for a public sector fund. It is inconceivable that governments and the public, who ultimately will undoubtedly have to bear the cost of global warming, should not be kept fully informed of how their public sector funds are invested.
The first, very significant, step is to ask public sector investors to disclose their carbon footprint. This would show the public authorities’ determination to set an example. There is certainly no need to require all investors to do the same overnight. In practice, once public sector funds start disclosing their carbon footprint, how can other funds justify not following suit? How could they sustain the argument that carbon does not represent a risk to their assets? Or that it is a risk but that they won’t disclose the extent of that risk to their principals?

Asking public sector investors to disclose their carbon footprint would also trigger a virtuous circle. In effect, it would encourage index providers such as MSCI, FTSE, EDHEC to develop new benchmarks, following which investment managers would immediately start offering solutions or products to de-carbonise their portfolios. Investment manager Blackrock is working on this subject. In Europe, investment manager Amundi has already developed a product meeting this expectation. Compared with the use of project financing to finance energy transition, this is a more generalised approach that would encourage long-term investors to include environmental concerns – and more particularly those related to energy transition – in their investment decisions. The great strength and relevance of the best-in-class approach is that it encourages all economic agents to change their behaviour. But that is also one of its limitations. Because its impact is diffuse, it is less visible than strategies that aim from the outset to have an immediate impact. This is clearly the case for Green Bonds, which aim to allow additional resources to be “channelled” into investments identified as having a positive impact on transition. As is often the case, these two approaches are not mutually exclusive but round each other out. Impact investing, as its name suggests, has a visible impact, and that is precisely what we expect of it. In this regard, Green Bonds play a positive role because they finance – efficiently, ideally – investments in new energies and technological innovations that could lead to genuine energy savings.They are also a means by which the media relay the motivational message that transition can create real added value and substantial employment provided we can transform this challenge into an opportunity. Nevertheless, the more generalised approach remains the most important because it addresses 95% of the economy, whereas “impact” approaches are directed at just 5%. The real challenge we face is to incrementally transform the entire economy on a day-to-day basis into one that takes greater consideration of its impact on mankind and the environment. In this regard, systematic disclosure of the carbon footprint of investments by major institutional investors would also be a means of measuring the impact of efforts to reduce emissions. There is no reason, in respect of the trillion dollars [annually] that CERES has called to be invested in transition, not to include investments by pension funds and other investors, which would demonstrate that their investment policies significantly reduce (2) the carbon footprint of their portfolios relative to that of their benchmarks. As far as ERAFP is concerned, its employees will continue their work to assess to what extent the scheme could introduce further measures from as early as next year.
Philippe Desfosses is CEO at ERAFP, the €16bn Paris-based French Public Service Additional Pension Scheme

1. President Obama said recently, “Well, science is science. And there is no doubt that if we burned all the fossil fuel that’s in the ground right now, that the planet’s going to get too hot and the consequences could be dire.” Under the leadership of three public figures -Hank Paulson, Michael Bloomberg and Tom Steyer – a working group recently published “Risky business”, a report showing the potentially catastrophic consequences of global warming if nothing is done to limit the rise in temperature to less than 2° by 2050. For Hank Paulson “In the run-up to the financial crisis, we incentivized lending. Today we are encouraging the overuse of fossil fuels”. One cannot be clearer than that.
2. i.e. over and above the minimum threshold to be defined in respect of the objective of limiting the average temperature increase to 2° by 2050.