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May 04, 2012
Sustainable Investment by Pension Funds Total Less than One Percent of Assets
    by Robert Kropp

Despite the necessity of a low-carbon economy and the opportunities for investment in the transition, efforts by governments and institutional investors remain inadequate. Second of a two-part series.

Recently published studies from Ceres and E IRIS demonstrate that corporate sustainability efforts are inconsistent at best, and are not enough to help guide business and society in the transition to the low-carbon economy essential to a near future of resource scarcity.

With the possible exception of governments, pension funds, with portfolios large and varied enough to designate them as universal owners, seem especially well-positioned to pressure corporations to increase their sustainability efforts. And with 250 asset owners among the more than 1,000 signatories to the United Nations' Principles for Responsible Investment (PRI)—20 of which are located in the US—there appears to be considerable commitment among pension funds to the aspirations of environmental, social, and corporate governance (ESG) considerations and corporate engagement.

A working paper published last fall by the Organization for Economic Co-operation and Development (OECD) notes that with a total of some $28 trillion in assets, the involvement of pension funds is essential to a successful transition to a low-carbon and climate resilient global economy.

Such a transition, OECD reports, "over the next 20 years to 2030 will require significant investment and consequently private sources of capital on a much larger scale than previously." According to some estimates, as much as 85% of funding for the transition will have to come from private investment. However, the report continues, "pension funds' asset allocation to such green investments remains low."

"Governments have a role to play in ensuring that attractive opportunities and instruments are available to pension funds and institutional investors," according to the report. However, regulatory inaction, perhaps most prominent in the US, is not the only impediment to the uptake of sustainable investing by pension funds; the funds themselves share responsibility for the slow pace of the transition: "Other barriers to investment include a lack of appropriate investment vehicles and market liquidity, scale issues, regulatory disincentives and lack of knowledge, track record and expertise among pension funds about these investments and their associated risks."

"Pension funds' asset allocation to such green investments (particularly sustainable energy sources and clean technology) remains low (less than 1%)," OECD reports.

The ranges of investment needed for the transition is considerable, as OECD points out in the report. Six financing needs gathered from a variety of sources indicate that such investments could exceed $10 trillion per year. Such a level of financing cannot come from public sources, especially at a time when government spending is constrained. Yet, with the proper allocation of public funding that is available, the potential for private investment is considerable.

However, "Such investments will only be made if investors are able to earn adequate risk-adjusted returns and if appropriate market structures are in place to access this capital," the report warns. "There must be transparent, long-term and certain regulations governing carbon emissions, renewable energy and energy efficiency."

"Incentives can only come from government in the form of guarantees, tax incentives and with the help of innovative institutions like the proposed green infrastructure and investment banks," the report continues.

Yet governments can pressure pension funds to invest in more sustainable ways as well. "Pension funds can also be encouraged (or even required) to consider environmental, and social and governance (ESG) issues in their investment analysis," the report concludes.

A second report, published in April by the International Trade Union Confederation (ITUC), demonstrates the benefits of investment in a green economy, not only for sustainable development but for job creation as well.

According to the report, "Economic research by the Millennium Institute forecast that investments of 2% of GDP in the green economy over each of the next 5 years in 12 countries could create up to 48 million new jobs."

In the US alone, investment of two percent of Gross Domestic Product (GDP)—amounting to about $300 billion per year—could, over a five-year period, create as many as 21 million jobs in a green economy, or 14% of total employment. The construction and transport industry sectors would experience the greatest number of added jobs.

However, the report continues, "Current business models in many countries, based on competition over the lowest social and environmental standards, are not creating jobs, nor are they protecting our planet."

While the commitment of governments to allocating two percent of GDP to green investments would not in itself suffice to finance the transition to a low-carbon economy, doing so would surely send a positive signal to institutional investors. But as OECD noted in its report, a lack of appropriate investment vehicles has been one impediment to more widespread private investment.

A step toward making such vehicles available in the US was announced last week by the International Finance Corp (IFC). The first IFC green bond targeting US investors is expected to raise $500 million to promote innovative energy-efficiency and renewable-energy projects in emerging markets.

The lead arranger for the issue is JPMorgan. Institutional investors that have signed on thus far include BlackRock, TIAA-CREF, and the California State Teachers' Retirement System (CalSTRS).


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