In the series “Pension myths debunked” we address misconceptions surrounding the Dutch pension system. One such belief is that sustainable investment by definition comes at the expense of (financial) returns. But is that really true? We asked Brenda Kramer, director of the Sustainable Finance Lab.
In early June 2024, a majority of the House of Representatives approved a motion by VVD MP Thierry Aartsen. The motion stated that “some pension funds advocate an activist investment policy and sometimes allow idealistic principles to trump returns for pensions with sufficient purchasing power for participants. The government is asked “to explore how assessment or supervisory frameworks can be tightened to make the achievement of pensions with sufficient purchasing power central to funds.” But does such an “activist” investment policy actually stand in the way of achieving pensions with sufficient purchasing power?
Treating people well
The short answer is no, says Kramer. “Basically, investors consider companies’ scores on ESG (environment, social and governance, ed.) criteria. How does a company deal with its environment? Does it take into account environmental, social and corporate governance issues? Does it treat its people well, is the work environment safe and healthy? The generic picture that emerges from studies is that companies that pay attention to these kinds of aspects also do better financially. These types of companies tend to have their risk management in good order, which therefore manifests itself in better financial performance.”
Investing in well-managed companies that operate responsibly, with sufficient attention to risk, is actually financially beneficial. When it comes to what Kramer calls “impact companies”, the story is slightly different. These are companies that focus entirely on “improving the world.” Kramer: “With companies like that, it is somewhat less clear whether such a goal also brings a higher financial return. But you can say that, in any case, it is not at the expense of profitability. And there are plenty of companies that do well at both aspects and also perform well financially.”
Moral appeal
In other words, a pension fund can make at least the same return with “good” companies in its investment portfolio as with companies that don’t have a positive impact. However, many Dutch funds also feel a broader social responsibility than just making returns, Kramer says.
“Ultimately, you also want a pension fund that consciously considers the social impact of its investments. For example, a contribution to good healthcare, social housing or child care. We should also not forget that a moral appeal is regularly made to pension funds to this end by politicians. We have now seen Aartsen’s motion calling for financial returns to come first. But how many times in the past ten years has it been suggested, for example, when there was a need for investment in renewable energy or public transport, that pension funds could do something about it?”
Financially responsible
By definition, pension funds invest for the long term. This is another reason why an investment decision seen by some as “activist” can nevertheless be seen as responsible from the standpoint of financial returns as well.
Kramer: “Take the tobacco industry, for example. At one point, many funds got out of that. That really did cost them returns for a few years, but over a longer term of ten-fifteen years it doesn't appear to have had a significant effect on investment portfolio returns. Similarly, you can look at a withdrawal from fossil fuel investments. As a pension fund, you try to take a long-term view of a sector or asset class. How will it develop in the coming years? Sooner or later that market for fossil energy will collapse and as a pension fund you have to have the courage to say: we have a long-term vision and we are pulling out now, because there is a significant risk that in the next ten years these will be stranded assets.”
Get out in time
It’s important to get out in time, Kramer says. “Although, you can only say exactly when that optimal time is after the fact. It could be three years from now, or seven years from now. As a long-term investor, you also handle that assessment differently than as a short-term stock trader, I think.”
Either way, Kramer thinks it is unfortunate that there is a perception that sustainability and good investment returns would be mutually exclusive. “That one should come at the expense of the other is a false contradiction. Of course, a big pension fund can’t only make investments with a very positive effect on the energy transition. The market is simply not big enough for that and, as a fund, you need to have a broader basis of investments for risk diversification. But there is certainly enough to invest the lion’s share of your portfolio in responsibly managed companies that simply manage their risks well. A good portion of a pension fund’s portfolio is also in government bonds, which provides stability.”
Seen and felt
Then, in addition to that broad investment base, a fund can make a very targeted positive impact through investments in specific projects, Kramer says. “For example, I saw that ABP recently invested in the construction of affordable rental housing. In this way, it is cleverly making positive impact with specific projects, which is directly seen - and ultimately perhaps felt - by participants.”