AkademikerPension: Responsible investment in sovereign bonds

AkademikerPension is owned by its scheme members. We are obliged to act in accordance with their wish that our investment activities are conducted responsibly. We also believe that responsible investment practices lead to better returns, thereby contributing to our primary duty of safeguarding our members’ pension savings.

Why we incorporate human rights into our sovereign bond investments

Integrating sustainability factors into investment practices is an important element of securing high, risk-adjusted returns in a responsible manner. This includes managing environmental and social issues, with human rights at the heart, as crystallised by the UN Guiding Principles on Business and Human Rights.

Like other institutional investors, our portfolio invests in a diversified range of asset classes and has a global reach. How we integrate responsible investment practices must therefore encompass broad, fundamental principles, but also be adaptable to the particular asset class, sector, market, company, sustainability issue, etc. The background, principles and processes of our approach are outlined in our policy on responsible investment, which consists of a general overview and separate chapters on different asset classes, including sovereign bonds.

Generally, we prioritise engagement and active ownership as the main lever for avoiding adverse sustainability impacts and contributing to positive developments through investments. However, engagement is normally less feasible with sovereign states than with companies, given the limited scope for influence. We occasionally decide to raise concerns, either directly or publicly, when a state has been failing to fulfil a critical responsibility, but exclusions remain the most important lever for us to avoid investing in states which are consistently failing to fulfil their duty to protect human rights.

How we incorporate human rights into our sovereign bond investments

We conduct quarterly screenings of sovereign states’ sustainability profiles. These assessments are guided by data from independent, external service providers, drawing on reports from the UN, the World Bank and other institutions. They cover the country’s management of governance, environmental and social issues. The social pillar of the assessment encompasses a wide range of human rights-related issues, including formal and actual protection of labour rights, civil/political rights and social/economic rights. If countries do not meet a minimum threshold (based on a score by an external service provider), they are placed on an internal focus list for further analysis, drawing on a variety of additional information sources such as Freedom House, Transparency International and Human Rights Watch. We then consider whether they ought to be excluded for persistent violation of our policy on responsible investment, or whether there are prospects for improvement.

Our committee for responsible investment takes the next step to assess and monitor the severity of the situation as well as the potential for positive development. The committee is also responsible for assessing the investment implications of excluding a particular state from our investment universe and makes the final decision of whether to exclude.

By 2020, it had become clear that our ongoing focus on the sustainability of sovereign bonds and the increasing number of exclusions were conflicting with the use of a standard benchmark. Certain countries deemed in clear breach of our policy on responsible investment were shielded from exclusion solely due to risk and portfolio management concerns. This led us to make an important adjustment in 2020 by introducing a new, customised benchmark for sovereign bonds which operates without the excluded states but retains an acceptable level of diversification.

The benchmark reflects the composition of the remaining part of the emerging market debt universe. The portfolio is actively managed against the index and our asset managers can deviate from the index within certain limits. However, they are not allowed to invest in excluded sovereigns. It is our external managers’ responsibility to comply with the restrictions but we supervise the portfolio as well, as part of the ongoing risk management. The customised benchmark provides greater room for manoeuvre and means that risk and portfolio considerations are less likely to impede the exclusion of a sovereign without proper scrutiny.

In January 2021, the committee for responsible investment chose to exclude nine more countries. Four countries were excluded due to human rights concerns: Azerbaijan, Belarus, Cuba and Djibouti. The remaining five countries were excluded for a wider range of issues. We excluded 45 countries as of June 2021.

The process for excluding sovereign bonds cannot avoid certain fundamental dilemmas. Firstly, as mentioned, there is the primary duty to safeguard our members’ pension savings through risk management and diversification, and to exclude all countries which violate human rights would, in our assessment, restrict diversification to an unacceptable degree. Secondly, while we exclude countries with the most egregious violations of human rights, many countries with serious human rights issues are emerging markets in need of capital to develop their economies. In navigating these challenges, we seek to be as transparent as possible by publicising all our holdings in the asset class on our website and reporting at least annually on the main exceptions and dilemmas regarding sovereigns in our portfolio. Currently these exceptions include Egypt and the UAE. This emphasis on transparency follows from our interpretation of the UN Guiding Principles on Business and Human Rights, and in our view has served to promote trust in our work.

We track the performance of the customised benchmark versus the former benchmark, which reflects the entire market and has no exclusions, and we have not identified significant performance deviations to date. We maintain an ongoing dialogue with our asset managers to make sure that we are aware of all implications that the restrictions may have. As part of this, we discuss the individual as well as the aggregated volume of the exclusions and whether this has any adverse effects on the risk- and portfolio management.