Introduction
To support investors in extending or adapting existing policies, programs or practices to the system-level, TIIP developed seven hypothetical scenarios. These scenarios illustrate the nature of these transitions through such things as the re-thinking of purpose, the expansion of their risk management techniques, and the use of tools designed explicitly for system-level influence.
To illustrate these transitions, we chose three different systemic challenges:
- Climate change
- Income inequality
- Availability of sustainability data
Each scenario focuses on an investor from a different silo of the investment world:
- Pensions
- Diversified financials
- Foundations
- Family offices
- Insurance
- Private equity
Each scenario describes the investor and their current status relative to conventional or sustainable investment; the catalytic moment that prompts a decision to change; the challenges in moving forward specific to their institution; their preparation for overcoming those obstacles; the actions they take to do so; and long-term management considerations necessary once that transition to system-level investment has been made.
The purpose of these scenarios is to illustrate seven of the fundamental types of transitions that will arise no matter the type of system challenge or investor. The scenarios assume investors starting from an initial minimal commitment to ESG integration and then portray obstacles that typically stand in the way of a transition to integration of an explicitly systemic approach and steps typically useful in that transition. They are stories about turning points in the journey to fulfilling the full promise of investment: to benefit society as well as the individual. Our hope is that these scenarios help investors today as they address the twists and turns on the road to realizing that potential.
How a Pension Fund Transitions to the System-level
Case Overview: Pension Fund Takes a System-Level Approach to Climate Change
A large public pension fund uses the issues of climate change to make the case for systemlevel investing strategies to transition its social, financial, and environmental risk management practices from a portfolio level to management at a system level.
Key Takeaways
- The pension fund, due to its size, determined it could not diversify away its climate change risks. It needed to actively mitigate the risks of climate change to be effective stewards of its fund.
- The fund concluded that it must take all feasible steps to minimize the long-term risk of climate change itself, rather than simply manage risks for individual portfolios or asset classes.
- All Trustees and investment staff were not convinced of the need for a system-level approach because they had already integrated ESG considerations. A core group of Trustees worked with the CIO to conduct a study of the material, systematic—that is, non-diversifiable—risks that climate change posed for the Fund.
- The study identified climate change as a market risk tied to the economy as a whole, and hence systemic.
- With the study complete, the core group of Trustees recommended the following actions, which were adopted by the full board:
- Modifying the Fund’s Investment Beliefs Statement, proxy voting policies, and engagement with portfolio companies to reflect a system-oriented approach;
- Joining with peers to urge public policy initiatives to minimize global warming and to prepare for foreseeable disruptions;
- Taking a leadership role in collaborative organizations among peers to amplify the Fund’s influence; and
- Sharing data and best practices with peers to build a common understanding of the most effective next steps.
Case Detail
The large public pension fund ABC with $150 billion in assets under management has for some time directed its internal and external managers to integrate climate change risks into their security selection when financially material – with, for example, fossil-fuel extraction firms, those dependent on fossil fuels as an energy source, and those whose primary products are substantial greenhouse gas emitters.
Three ABC Trustees were surprised when its internal managers across all industries and asset classes reported that climate risks are material. They immediately understood the implication of this development: the Fund cannot diversify away its climate change risks; there is no place to hide. They therefore concluded that ABC must take all feasible steps to minimize the long-term risk of climate change itself, rather than simply manage risks for individual portfolios or asset classes.
The trio faced a substantial challenge, however: despite these findings, their fellow Trustees, as well as their in-house investment staff were not convinced of the need to change their current practice. Indeed, having integrated ESG considerations into security valuation for their specific industries, they considered their job done.
Recognizing the need for data to convince these key stakeholders that their vested interests in the current approach was misguided, they began a campaign to change this perception. They first met with ABC’s Chief Investment Officer (CIO), whom they considered a key point of leverage within the organization. They requested the CIO to commission a top-notch third-party firm to assess the material, systematic—that is, non-diversifiable—risks that climate change posed for the Fund. They also asked that the study recommend steps to contend with any such risks.
Although the study took 18 months at considerable expense, these Trustees believed it a crucial step in aligning interests. The study in fact showed that about 50 percent of the Fund’s climate-related risks were not diversifiable and could not be avoided through security selection, asset allocation, or hedging options. In effect, it identified climate change as a market risk tied to the economy as a whole, and hence systemic.
These Trustees reviewed the study and its recommendations with the CIO, making a case for implementation of its recommendations. Among others, these included: modifying the Fund’s Investment Beliefs Statement, proxy voting policies, and engagement with portfolio companies to reflect a system-oriented approach; joining with peers to urge public policy initiatives to minimize global warming and to prepare for foreseeable disruptions; taking a leadership role in collaborative organizations among peers to amplify the Fund’s influence; and sharing data and best practices with peers to build a common understanding of most effective next steps.
Having obtained support from the CIO, the trio then presented the report to the full Board. An extended nine-month discussion overcame internal dissension and the Board agreed to adopt the study’s recommendations. It imposed one condition, however: any impacts on portfolio performance and the costs of implementation should be assessed biannually to assure that they do not conflict with those anticipated. The program was phased in over two years, with the first assessment scheduled after two years of full implementation.
Further Reading
Steve Lydenberg, Robert Dannhauser, and William Burckart, “Graduating from ESG to Systems: Scenarios for Investors,” Money Management Institute and The Investment Integration Project, October 2020.
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