Long-term ESG risks and pension funds

Pension funds and endowments have a distinct advantage over private investors: They have a much, much longer time horizon. In theory, the investment horizon of these investors approaches perpetuity.

But this ultra-long time horizon also means that these institutions have to account for ultra-long-term risks. A private investor may not care about the impact of climate change in the year 2100, but a pension fund or an endowment must. No wonder then that even in the United States, where resistance to ESG investing remains strong the number of pension funds that examine and integrate long-term ESG risks into their investment process has become standard. Zacharias Sautner and Laura Starks surveyed 410 pension funds in the US about their approach to long-term ESG risks. Only 7% of the funds said they had done nothing to incorporate these risks in their portfolios.

Furthermore, the practice of pension funds belies the assumptions of so many critics of ESG investing in the United States. The most common criticism is that ESG investing amounts to optimising a portfolio under additional constraints due to the excluded sectors and companies. I have explained here why that argument simply doesn’t hold any water.

But the survey also shows that only a minority of pension funds use exclusions in their portfolios or divest from an entire sector. Instead, the most common actions taken are analysing the carbon footprint of the portfolio and the risk to be left with stranded assets. Many pension funds also engage with the management of companies they invest in or incorporate ESG risks into their valuation models or their entire investment process. In short, these long-term investors do exactly what research shows they should do: Take a positive, inclusionary approach to ESG because it can uncover risks that may otherwise be overlooked. But they shun exclusionary and reductionist approaches that ESG critics use to criticise the field.

Which measures have US pension funds taken to deal with long-term ESG risks

Source: Sautner and Starks (2021)