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Japan Pension Funds and ESG Investing

November 21, 2017

Environmental, social, and corporate governance (ESG) investing is rapidly gaining momentum as a global movement, especially in the U.S., Europe, and Asia. ESG investing factors are used to measure the sustainability and ethical impact of investing in a company or business.

For stakeholders, these factors are playing a larger role in the selection of investments. Many funds now incorporate ESG analysis into their investment strategies and organizational policies. Recent shifts in policy by Japan pension funds may be influential in this growing field. 

ESG Investing Factors Still Not a Priority for Many Japanese Firms

There is growing evidence that companies with stronger ESG credentials may be more profitable and trade at higher premiums than rivals. For instance, companies with strong, clearly defined ESG practices deliver higher returns in a 5-10 year investment period. The reasoning is that more responsible funds may be less likely to experience unforeseen losses, and may be able to outperform benchmarks. 

Even with the increased interest in ethical investing, a Reuters poll found that a majority of Japanese companies are not interested in inclusion in stock indexes guided by ESG investing principles. This is true even as firms face pressure to revamp their management standards following a string of corporate scandals in Japan. 

Despite overall increased global awareness of corporate responsibility matters, the Reuters corporate survey showed that:

  • Only 56 percent of the 247 Japanese companies polled were aware of ESG indexes
  • Only 6 percent stated that their organization was included in such an index
  • 72 percent of companies reported that they were not included in an ESG index
  • 22 percent weren’t aware of their status
  • 58 percent of the entire survey sample said that they had no interest in joining an ESG index

These numbers may change in light of recent policy shifts by institutional investors in Japan.

GPIF Raises ESG Allocation 

Japan’s Government Pension Investment Fund (GPIF) decided to raise its ESG allocation from 3 percent of its stock holdings to 10 percent (a total of $29 billion). The fund is the largest pension fund in the world; it currently manages $1.3 trillion. GPIF began soliciting proposals for environmental indexes in late October.

In many cases, ESG indexes track companies through a point subtraction method. Industries that are prone to more carbon emissions may receive a lower point score, or may be excluded from the index entirely. In contrast, GPIF seeks indexes that add points for environmental or social considerations when tracking select stocks. GPIF has already begun using a new ESG index created by FTSE Russell. 

The pension fund’s shift towards increased ESG investing may help to prompt other corporate and public pension funds in the region to allocate more in such stocks as well. Mark Makepeace, chief executive for FTSE Russell, said “GPIF is very influential not just in Japan but across the region and internationally.”

World Bank-GPIF Joint ESG Research Project

The World Bank Group announced that it will be partnering with GPIF to research the application of ESG investing criteria to fixed-income investments and other types of assets. 

The World Bank and the GPIF stated that bonds would be the initial focus of the joint study. The goal would be to analyze a broad range of ESG investment criteria, such as:

  • Benchmarks
  • Guidelines
  • Rating methodologies
  • Disclosure frameworks
  • Reporting templates
  • Risk analysis

ESG investing factors have already been taken into account in other asset segments such as equity investment. The joint research would promote a better understanding of how ESG factors affect bond investments, which would provide valuable insights for global sustainable investing. 

The joint research efforts are expected to continue into March 2018; results of the research will be announced publicly sometime after March. 

Japan Pension Funds and Infrastructure Investing

GPIF also plans to allocate as much as 5 percent of its capital into alternative assets such as private equity, real estate, and infrastructure. Specifically, the focus on infrastructure will be a key part of GPIF’s strategy, according to the fund’s president, Norihiro Takahashi. Takahashi also stated that the focus would be on core infrastructure in developed countries, noting keen competition for infrastructure assets in areas like Australia. 

The increase in infrastructure allocations is in line with broader trends being utilized by sovereign wealth funds and other large institutional investors. For instance, Turkey transferred bank and phone company holdings into a newly created sovereign wealth fund, which was created to finance large infrastructure projects. 

Updates to Japan’s Stewardship Code

Japan’s Stewardship Code was created to assist institutional investors in fulfilling their fiduciary responsibilities and to “promote sustainable growth of companies through investment and dialogue.” Recent updates to the Code, which is voluntary, include:

  • Stewardship Policies: Asset owners in Japan must now include reference to stewardship obligations in asset manager selection, appointments, and contracts
  • Conflicts of Interest: There is a call for more detailed policies, which should include methods for conflict mitigation. The need for independent oversight of voting decisions was also emphasized
  • Monitoring: Efforts should be made to continue standardizing the currently fragmented nature of governance reporting in Japan
  • Engagement: Organizations should pay attention to the increasing influence of index funds over voting and engagement

Overall, the Code encourages institutional shareholders to be more active in their role as business owners. Competence at the leadership level of the firm will help ensure that proper stewardship is integrated throughout the organization. 

The policy and strategy decisions of Japan pension funds may have strong impacts on the surrounding region and throughout the world. While ethical investment principles and guidelines are still being developed, these factors are already shaping the way that large institutional investors operate. 

ESG investing principles can be complex and can involve a wide range of issues across different jurisdictions. If you have any questions or concerns regarding the laws that regulate institutional investment, contact us today at Kessler Topaz. We are active in the global discussion of how ESG investing impacts institutional portfolios, and we are committed to creating workable engagement strategies. Offered at no cost to our clients, our monitoring service, Securities Tracker, can help promptly identify potential claims and events that could affect assets.