At present, there is a great deal of work being carried out by both national and international parties in a bid to achieve a more sustainable European economy. The EU has undertaken much of this work, with the commission’s High-Level Expert Group on Sustainable Finance (HLEG) being key in developing more sustainable financial markets in the region. Sweden, France and the Netherlands are early adopters of the development, but market stakeholders from various countries have been quick to catch on too.
There is no conflict between achieving higher-than-average returns and investing in a sustainable pension system
In recent years, there has been a significant increase in the number of sustainable investments being carried out. In 2015, the UN’s Principles for Responsible Investment Initiative announced that its signatory base represented $59trn of assets under management, marking a year-on-year increase of 29 percent. We’ve also seen increased interest in the sustainability initiatives and reporting of listed companies. Meanwhile, institutional investors are increasingly investing in green bonds, and impact investments are becoming popular with all investors. The most recent trend concerns social impact bonds; there have been some pioneering activities in the UK, and more regional attempts in Sweden, but that particular financial instrument is yet to mature.
One of the most important insights of recent years is that future pension systems must incorporate sustainability completely in order to procure maximum long-term value creation for beneficiaries. To achieve this, it is necessary to ensure that institutional investors, such as pension funds, fulfil their duty to beneficiaries, a responsibility known as ‘investor duty’. Before this can begin, such duties must be clarified and an active management model must be implemented.
At the beginning of the 20th century, Sweden’s white-collar workforce wanted to create a better future and ensure their financial security in old age through a pension system.
With this goal in mind, plus a strong understanding of what a sustainable pensions system really is, was founded in 1917.
Today, occupational pensions are one of the most important sources of pension benefits for Sweden’s white-collar workers. Consequently, capital from pension accounts form a substantial portion of institutional capital in the country. According to HLEG’s Financing a Sustainable European Economy report, the insurance sector is the largest institutional investor in Europe, accounting for roughly 60 percent of the EU’s GDP. The financial risks taken by pension funds must generate the highest possible returns without ever jeopardising clients. Therefore, investor duty must include sustainability.
Establishing a framework
In the HLEG report, it is stated that investor duty is often misinterpreted, with a common belief being that its sole focus is on maximising short-term returns. HLEG proposes that a single framework of principles should be established to outline what investor duty actually involves. It is equally important that regulatory authorities make clear to all involved in the investment and lending chain that the management of ESG risks is integral to fulfilling fiduciary duty, acting loyally to beneficiaries and operating prudently.
Future pensions are in fact a form of life insurance based on actuarial calculations. Collective belief and scalability is what makes pension capital different from any given savings account. As such, insurance risks need to be managed in a way that ensures insurance commitments can be fulfilled. That said, it is important to reiterate that there is no conflict between achieving higher-than-average returns and investing in a sustainable pension system. However, the investment model needs to be an active one.
At present, more players are advocating for passive management or index investments as a model for long-term asset management. In a conservative financial industry, it’s commendable to raise initiatives on sustainability. However, we need to depart from the idea that all sustainability initiatives should be praised and rewarded. Instead, we need to consider what kind of sustainability work is actually the most beneficial; this can only be done effectively through stock picking.
The asset management model used by Alecta is unique in the sense that it is based on active management of an equity portfolio of about 100 holdings and a corporate bond portfolio with equally few issuers. This means that the company has an in-depth understanding of every company it invests in. In addition, as it focuses its investments on just a few companies, it is able to influence their decisions in a sustainable way. A fund manager with a larger spread of holdings wouldn’t be able to achieve the same level of influence.
Alecta’s model allows an investor to assess the sustainability of a business model and its compliance with ESG criteria. At the same time, it allows an investment that might temporarily reduce the sustainability of the investment portfolio, say by increasing the CO2 footprint, if the company or industry is likely to disrupt unsustainable
business models in the long term.
Contrary to popular belief, active management doesn’t need to be more expensive. In fact, an in-house team dedicated to keeping costs at a minimum can achieve a sustainable portfolio that focuses on low fees and high returns. Today, Alecta is the third most cost-effective pension company in the world, as ranked by the Centre for Evaluation and Monitoring. Alecta manages its customers’ pension capital itself and only engages in active asset management. As such, it isn’t constrained by the need to track an index. What’s more, each investment is the result of thorough internal analysis. Alecta believes that clearing out hundreds of companies from an index is an ineffective and poor use of customer money.
The HLEG report states that the assets of pensions funds should be less prone to short-term financial risks. However, they are potentially more exposed to substantial long-term risks related to the real economy and the environment. It also states that the interplay between governance and sustainability is key to ensuring that those who lead institutions become fluent in sustainability risks and opportunities. While active responsible ownership is now being exercised by a growing number of investors, much more could be done.
Alecta’s vision for a future society is built on an inclusive society with safety and flexibility for all. It contributes to this vision by working for sustainable pensions so that people, the environment and society can thrive in the long term.
Taking shortcuts is never the sustainable option. Passive capital management can achieve excellent returns, but if the institutional capital wants to deliver on its fiduciary core duty, the solution is qualitative hard work – knowing your investments and respecting your beneficiaries – otherwise known as active management.
A prime concept in the establishment of Alecta was that pensions should not be seen as a gift from management – a token of gratitude for long and faithful service. Instead, pensions should be a natural part of an employee’s compensation package. Around the same time that the business was founded, there were some far-sighted industrial owners and managers who understood the benefit of having a flexible solution that allowed employees to keep their pension benefits even after they changed employer. This counteracted the slow employee turnover in the labour market and made it easier for industrial companies to recruit the right talent.
Following Alecta’s inception in 1917, this smart concept spread quickly throughout Sweden. This model, which involves cooperation between the labour markets’ various parties, became a central aspect of Sweden’s economic success throughout the 1900s. Today, 2.3 million Swedish employees are beneficiaries of the pensions that Alecta manages. Through collective agreement, these individuals have a pension solution that provides them with security in the event of ill health and old age. In addition, they can also receive compensation for their family members in the case of death. For these reasons, the occupational pension is the most important source of pension benefits, and the very foundation upon which Alecta operates.