Fund Solutions

ESG Prompts Top Asset Owners to Re-Think Governance

Adopting total portfolio approach has improved investment dynamism, according to Thinking Ahead Institute.

To manage the growing complexities tied to ESG-related targets, asset owners are increasingly looking to modernise their governance structures, according to Marisa Hall, Co-Head of the Thinking Ahead Institute.

Pension boards are going to face “multiple and complex challenges in the future”, Hall said. These include managing sustainability risks, navigating a low-return world and handling increasing organisational and investment complexity.

In particular, rising ESG expectations has led to more complex goals, such as achieving net-zero targets and factoring double materiality into their governance, risk management and reporting processes.

“These challenges are stretching the governance of many pension fund boards,” she noted, forcing them to rethink the architecture of their current models, as well as their portfolios and investment strategies and how these are enabled by culture and technology capabilities.

The Thinking Ahead Institute’s annual research on the world’s largest pension funds, which was published earlier this month, observed the increasing trend among pension schemes to review their governance models. Within the top 20 were Denmark’s ATP, Ontario Teachers and the California State Teachers’ Retirement System (CalSTRS).

Sustainability demands greater maturity  

Seven assessed funds said the importance of sustainable and responsible investment was better supported by ensuring best practice within their corporate governance models.

Hall outlined three distinct maturity models typically adopted by asset owners: basic (v1), well-resourced (v2) and advanced (v3). These are differentiated by the “specialisation and depth of the governance model and sophistication and breadth of the investment model”, she added.

In the past, most asset owners relied on a v1 basic model, meaning that the board had ownership of the fund’s investment policy via strategic asset allocation and using external investment managers. However, as asset owners develop more complex sustainability-related goals, “there is a premium on increasing capability to manage in a more sophisticated model”, said Hall.

For v2, the board shares ownership of the fund’s investment policy with an internal team, or an equivalent outsourced chief investment officer (OCIO), which also separately controls the investment strategy implementation.

However, large asset owners are increasingly attempting to introduce the v3 governance model. This is where the internal team or OCIO takes responsibility for the investment policy and implementation, while the fund board controls the risk appetite strategy in a total portfolio approach (TPA) arrangement. The latter works by clearly specifying investment goals and then putting capital towards the best opportunities, rather than filling asset class buckets.

Canadian pension plans have also built a global reputation based on a foundation of strong governance, Hall added.

In April, Canadian financial services firm CIBC Mellon published a survey of 50 Canadian pension funds, noting that funds are leveraging these more advanced governance models, co-investing and engaging both in-house expertise and third-party experts to deliver out-sized results for stakeholders.

“Asset owners will find sustainability with real-world impact extremely hard to manage without attaining the v3 maturity. While the transition through the maturity profiles across the industry remains slow, it is picking up speed given increases in attention given to sustainability considerations,” said Hall.

Not investing in silos 

Asset owners are reworking their governance models and adopting TPA to make their investment process more dynamic, Hall said.

The top 20 pension funds assessed by the Thinking Ahead Institute boasted an average AUM increase of 14.6% in 2020, compared to 11.5% for the top 300 funds. Further, the compound annual growth rate (CAGR) for the top 20 funds over the last five years is higher than the top 300 funds, growing by 8.9% and 7.9% respectively.

TPA is allowing for a shift away from equities. Jo Holden, Global Head of Investment Research for investment consultancy Mercer, previously told ESG Investor that responsible investors are increasingly opting to invest in a wider array of assets, such as alternatives.

Last year, WTW published a global study analysing the current and future asset allocation practices of leading asset owners, focusing on understanding TPA strategies.

A number of funds, such as ATP, The Singaporean Sovereign Welath Fund (GIC) and the New Zealand Superannuation fund, identified themselves with this approach, said Hall, noting that they cited advantages in dynamism, decision-framing and decision-making.

“We continue to see slow but steady adoption of this approach as organisations try to better connect the total portfolio with the fund goals,” she told ESG Investor.

The Thinking Ahead Institute was established by Willis Towers Watson in 2015 and is a global not-for-profit investment research and innovation member group made up of engaged institutional asset owners and service providers.

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