CEO Geraldine Leegwater explains the total portfolio approach to sustainable investment integration at the heart of PGGM Investment Management’s ‘3D investing’ model.
In a football team, the players have a variety of roles and tasks – goalkeepers save, defenders tackle and strikers score. All contribute to the overall objective of winning the game in different ways.
A notable exception was the fondly remembered Dutch national team of the early 1970s, whose ability to stylishly and effectively switch roles was dubbed ‘total football’.
When it comes to achieving the three goals of risk, return and sustainability, Geraldine Leegwater, CEO of PGGM Investment Management, has asked her team to adopt a ‘total portfolio approach’.
But rather than having equal expectations of all sub-portfolios and their components, PGGM’s blueprint – named ‘3D investing’ – allows them to play very different roles in meeting the needs of core client PFZW, responsible for the retirement savings of three million Dutch healthcare and welfare workers.
PGGM’s 3D investing approach, which has been implemented in its equity and credit portfolios, and is now being rolled out across other asset classes, was developed in response to PFZW’s Strategy 2030.
“We’re extremely long-term investors. To realise sustainable investment returns over our 40-year horizon, we need to take into account not only how developments in the financial markets are generating a financial risk premium, but also developments in the real world. Ultimately these will find their ways into the risk premiums as well,” says Leegwater, who has been at the helm of PGGM for five years. She has a long history in pension fund investing, including board member and chair of investment committee roles.
The shift has already grabbed attention for its pivot from passive to active, its slashing of equity holdings and its implications for certain global asset managers – but the headlines miss some of the underlying logic and principles.
Making an impact
As part of the new strategy, PFZW wanted its investments to have a particularly strong impact in two areas: climate and energy transition; and Dutch healthcare and welfare. But rather than seeking to achieve this by targeting contributions from all assets or portfolios, PGGM reasoned that this objective could be best met by instigating two new impact strategies, with a remit to invest in earlier stage firms than the organisation would typically consider.
Although they have different areas of focus, the impact funds are similar in that they look for investments with smaller ticket sizes across asset classes, with an emphasis on firms delivering solutions via innovative technologies, within required returns and risk tolerances.
Alongside this, components of other established portfolios must meet minimum sustainability standards, set by internationally recognised organisations like the Organisation for Economic Co-operation and Development, to ensure they’re not causing unnecessary harms.
“As we don’t look at these topics in isolation, we might take different decisions for different components of the investment portfolio. For example, an interest rate hedging portfolio is there to reduce risk, not generate high returns. Of course, minimum sustainability standards should apply, but we will not generate additional impact with that portfolio,” says Leegwater.
This also means that the components of PGGM’s equity or credit portfolios do not have to contribute in the same way to collective investment goals. Targets for risk, return and sustainability are set and managed at the overall portfolio level, leaving individual holdings to justify their place in different ways.
“When it comes to an individual asset class, certain components might be in the portfolio for their impact or sustainability characteristics, but others might be there to diversify,” she adds.
Equal footing
A key reason that 3D investing is underpinned by a total portfolio management approach is the systemic nature of sustainability themes, which universal owners cannot diversify away from. This applies not just to climate change, but also far-reaching demographic shifts driven by the ageing of populations in both developed and developing markets.
Addressing the opportunities and risks arising from these sustainability-related mega-trends requires managing and steering at the overall portfolio level, rather than trying to apply a climate policy across multiple mandates, each with their own risk and return characteristics and guidelines.
As noted, a fundamental element of PGGM’s response to Strategy 2030 was that sustainability had to be treated on an equal footing with risk and return. This means adding sustainability targets for the overall portfolio to existing required return and risk tolerance metrics.
For this first phase of 3D investing the three sustainability goals are 50% reduction in CO2 emissions from 2019 levels, 30% alignment with UN Sustainability Development Goals (SDGs); and alignment with the Paris Agreement. Leegwater says current policies and metrics can deliver and evidence 100% achievement of these goals by 2030.
For PGGM, SDG alignment is achieved via 30% of the overall portfolio being designated sustainable development investments (SDIs) as defined by the SDI AOP platform that it established in 2016 with a group of fellow asset owners. SDI AOP effectively provides a framework, including a taxonomy, to define and measure the SDG alignment of investments.
New goals might be added, but that depends at least in part on data availability and quality.
In parallel with the sustainability goals, 3D investing has three other co-equal objectives that have far-reaching implications. These include the aforementioned establishment of impact funds in response to key transition themes, but PGGM will also pursue a more active and engagement-led approach to investing, which involves a strengthened focus on shareholder commitments and a shrinking of its number of holdings.
“It’s important that we can explain why we have each holding in our portfolio, in terms of return, risk and sustainability,” says Leegwater.
“It’s no longer possible [for pension funds] to hide behind the benchmark. We should be conscious investors, and we should be able to explain.”
In order to rebuild its portfolio in accordance with these objectives, PGGM has identified three enablers: the investment process itself; the skills and knowledge of the in-house team; and the organisation’s operating ‘backbone’, i.e. the systems, data and other tools that support analysis, reporting and measurement.
Given that PGGM had already developed a highly-regarded responsible investment team, this involved breaking down silos before building anew.
“If you really want to integrate those three dimensions, you need to integrate fully. And that required designing a new investment process,” Leegwater says.
While the responsible investment team was effectively disbanded, 3D investing builds on its legacy.
“Our people had different competencies, across sustainability, investment, and data science for example. With the world rapidly changing around us, we needed to make sure that those competencies were further integrated, and also that the knowledge of each individual is broadened as well,” she explains.
Know what you own
From a practical perspective, one of the most significant changes under 3D investing is PGGM’s shift in emphasis toward a more active and engaged approach to equity holdings, summed up by the term ‘know what you own’.
This has implications internally and externally. In terms of partnerships with third-party asset managers, it has been accompanied by a reallocation of business, with some firms losing out and new firms hired.
PGGM has long worked with external managers to share workload and augment internal capabilities. While much about its selection and monitoring process will be unchanged under the 3D investing strategy, manager selection is set to become even more important as the firm’s requirements become more specific.
“The selection process is still as thorough as ever, but additional criteria have gained importance,” says Leegwater.
“Given that we are in something of a ‘pioneering’ phase where not everything is set in stone, we are more aware of the need to find partners who have similar assumptions and ideas.”
As well as sharing a philosophy, this means working with partners who can augment PGGM’s own capabilities, whether through domain knowledge, data or analysis.
“In order to engage more broadly with the industry, it’s helpful to have partners who are aligned with what we are doing with our portfolio,” Leegwater explains.
“And when it comes to the impact mandate, it’s even a more delicate process to find partners to cooperate with, certainly with respect to direct investments.”
Similarly, ‘know what you own’ has elements of continuity and change for PGGM’s internal teams, with portfolio managers expected to be equally comfortable engaging with companies on matters of risk, return and sustainability.
“Their traditional role has always been to engage with companies, because they are in discussions about their returns and risks. Engagement on sustainability topics should be integrated into the role of being a portfolio manager.”
But for systemic sustainability topics that are managed from a total portfolio perspective, i.e. those that have an effect across most if not all investments, there also is a dedicated engagement team.
“Given we’re no longer just passive, the opportunities for us to engage have increased as well, because they really determine which holdings you include in your portfolio. All in all, our capacity to engage has increased,” explains Leegwater.
An iterative process
PGGM’s commitment to building and managing its portfolio with reference to three equal pillars arguably comes at a challenging time for asset owners seeking to fully integrate sustainability into their investment decision-making.
One aspect of this is the reduced appetite amongst regulators and policymakers for mandatory reporting requirements, which provide investors with consistent and accurate information on sustainability-related risks and impacts.
In a number of jurisdictions, these have been criticised for imposing burdens on domestic firms that could put them at a disadvantage to overseas competitors. At present, the European Parliament is debating its position on the European Commission’s first omnibus package, which could significantly dilute the Corporate Sustainability Reporting Directive.
Leegwater says clear regulatory requirements on company disclosures “make our life much easier”, but admits that identifying standards and metrics is an iterative process.
“As an industry, we’re also still finding out what is material,” she adds. “Ultimately, the goal is to realise the return required for a good pension, and therefore you should focus on what is material in terms of either risks or opportunities towards this return. That is still an area of investigation, not only for us, but for many investors.”
Another aspect of this cooling climate for engaged investors is the growing limits on investors’ ability to scrutinise and engage with companies in their portfolios. A recent Morningstar analysis reported a 22% annual drop in the number of sustainability-related shareholder resolutions filed during the US proxy season following rule changes in favour of issuers.
“We are aware there are some challenges in the current environment,” says Leegwater. “But with the responsibility of generating returns also comes the responsibility to be in contact with the firms in which we invest on topics that – either in the short or longer term will influence the profits they generate – or their license to operate. This is the traditional role of the shareholder and one that we should defend.”
Alongside this task, Leegwater and her team must also complete the job of transitioning other asset classes in PGGM’s portfolio to 3D investing. This involves writing a new investment case for private equity, infrastructure and real estate, reassessing risk, return and sustainability parameters for each asset class.
At the same time, the work on ‘bedding in’ 3D investing into equity and credit portfolios continues, both in terms of staff adapting to new processes and responsibilities, and systems being refined and developed to support consistent measurement of risk, return and sustainability.
Nevertheless, it is not too early to reflect on the milestones achieved on the journey so far. “For the transitioned equity and credit portfolios, we are starting to measure against new guidelines. We can now more concretely measure the total portfolio, along the returns, risks and and the three specific sustainability goals.”
From a change management perspective, Leegwater underlines the importance of maintaining a careful balance between running and changing the factory. Unlike total football, everyone has a different role to play in achieving the overall goal.
“You need to involve the whole organisation,” she says.
“If you have a smaller group who are more completely involved in the new thinking, while other areas are not yet aware of the implications, that can lead to some uncertainty. We have learned that we need to bring all those people together and align them continuously on [the direction] we’re heading to.”
