Attention to ESG grew in 2022 along with headwinds

It is tricky to say which was a more volatile issue in 2022 for public pension funds operating under ESG principles — the politics or the markets.

They managed to navigate both, and this year many of them are even ratcheting up their sustainable investing agendas.

Some, like the $61.4 billion Maryland State Retirement and Pension System, Baltimore, took a page from the largest U.S. funds that added ESG specialists for their investment divisions. Although Maryland CIO Andrew Palmer first formed an ESG risk committee in 2017, last year the pension fund added a senior manager of ESG and corporate responsibility to oversee all governance for the system and the investment division, with duties that include monitoring and evaluating ESG impacts on the portfolio among other duties.

While large public pension funds are often leading the ESG charge, of the 23 top 200 defined benefit plans reporting in Pensions & Investments' 2022 survey on the largest retirement plans that use ESG factors, four were corporate DB plans: CommonSpirit Health (also known as Catholic Health Initiatives), Corteva Inc., Ernst & Young and Kaiser Foundation Health Plan Inc.

ESG experts think even more corporate plans are well along in their ESG journey.

"A large number of clients are engaged in the conversation and education around defining sustainable investing as a broad concept, and the ESG issues underlying that," said Chris Thompson, head of North American equity research for Willis Towers Watson PLC in Stamford, Conn. "A smaller subset are in fact doing something."

The Washington State Investment Board, Olympia, exemplified a robust ESG agenda in 2022. CEO Allyson Tucker and Chief Investment Officer Christopher Hanak, both newly installed, wasted no time launching initiatives to address climate change and diversity, equity and inclusion within the $130.8 billion commingled trust fund of defined benefit plan assets.

In 2023, WSIB's climate change blueprint has eight specific initiatives including updating proxy voting policies and training staff and the board. The DEI blueprint has 11 initiatives in 2023, including proxy voting policy updates and understanding what their peers and the companies they hold are doing to make it a core part of organizational culture.

Last year saw asset owners pushing for diversity, equity and inclusion in the portfolio companies they hold, and for more investment with diverse-owned managers. Even in a difficult year, market-wise, the 22 pension funds that reported assets managed by diverse- and women-owned firms had $131.7 billion with those managers as of Sept. 30, up 12.4% from what that group reported a year earlier.

Climate change once again led the ESG list of priorities for large pension funds interested in addressing both the investment risks and opportunities.

As more and more asset owners commit to having net-zero greenhouse gas emissions in their investment portfolios by 2050, some pension funds raised the bar further in 2022.

On Aug. 31, the California State Teachers' Retirement System, West Sacramento, voted to reduce greenhouse gas emissions across its entire investment portfolio by 50% by 2030. CalSTRS started with its largest asset class, a public equity portfolio that equaled $115.7 billion at the time, with roughly one-quarter of that in 2022 targeted to the MSCI ACWI Low Carbon Target index.

That focus on potential rewards of an energy transition will also inform an asset-liability study that CalSTRS launched in the fall. This May, as part of the study, the investment committee will use modeling results of a low-carbon fixed-income index that will inform future bond allocations.

While CalSTRS' overall assets dropped to $288.6 billion as of Sept. 30 from $312.2 billion one year earlier, the pension fund ended the calendar year with $302.1 billion, all of which was invested under ESG principles. The drop was due to market conditions, a spokeswoman said.

That was also the case for the New York State Common Retirement Fund, Albany, with $233.2 billion in assets as of Sept. 30, all of which are invested under ESG principles.

It was a noticeable dip from $267.8 billion one year prior, but it was all due to market decline, said spokesman Matthew Sweeney.

And despite the year's market downturn, assets in New York State Common's sustainable investments and climate solutions program jumped to $18.4 billion from $15.2 billion in 2021.

The formal, multiasset-class program created in July 2022 now includes actively and passively managed public equity strategies, green bonds, clean and green infrastructure funds, private equity and green building real estate funds aimed at increasing the pension fund's allocation to low-carbon investments and technologies.

On climate, New York State Common set 2040 as its target for reaching net-zero portfolio emissions. It uses an ESG scorecard to evaluate existing and prospective external investment managers' capabilities to assess and manage climate risks and opportunities, and committed $2 billion to a climate transition index strategy in December 2021, among other steps toward the 2040 goal.

Thomas P. DiNapoli, the state comptroller and sole trustee of the pension fund, is not shy about engaging with managers and portfolio companies to understand their energy transition strategies, particularly in high-impact sectors like shale oil and gas. In 2022, the 21 companies not meeting the pension fund's minimum standards faced restrictions and divestment.

Mr. DiNapoli also is active in the public policy arena. Last year, he filed a comment letter with the Securities and Exchange Commission supporting mandatory corporate climate disclosure rules. He also calls out corporations for spending on political causes that may conflict with shareholder interests and calls out ones that he sees as contributing to "the increased polarization of our political discourse."

That polarization clearly crystallized in 2022, when politicians in Republican-led states turned their sights on public pension funds that consider ESG factors in their investment decisions. They also went after asset managers such as BlackRock Inc. for pro-ESG stances.

In August, the three politicians comprising the board of Florida State Board of Administration, Tallahassee, sent a clear message by passing a resolution banning the $183.1 billion Florida Retirement System from including ESG considerations in its investment management decisions, and other red states followed suit.

That prompted CalSTRS CIO Christopher J. Ailman to publicly express concern the following month at a media briefing that the growing anti-ESG political movement in the U.S. banning ESG considerations could impede the world's energy transition away from fossil fuels.

It could also prevent pension funds from taking advantage of a huge investment opportunity, Kirsty Jenkinson, investment director of sustainable investment and stewardship strategies at CalSTRS, said at the briefing.