PARIS — With the push to mobilize more capital to address the Sustainable Development Goals, the development community has increasingly discussed the need to engage pension funds, and while it is already experimenting with how to do that, there’s still a long way to go.
“There are a lot of NGOs and development agencies that are able to channel funding into deserving sectors. The question is: What kind of finance are you using to do that?”— Admassu Tadesse, president and chief executive, Trade and Development Bank
The discourse around engaging institutional investors isn’t particularly new, but the difference now is that pension funds are evolving, said Admassu Tadesse, president and chief executive of the Trade and Development Bank, a regional development bank in Africa.
Pension funds are focused on their fiduciary responsibility, earning a strong rate of return, and avoiding risk, so development institutions must understand those factors and build models or investment products that fit the criteria they require, he said.
“We went back to the drawing board and reflected on our institutional model and basically started to reverse engineer to say, ‘What would a thoughtful institutional investor want to see in a DFI that would give them comfort and make the value proposition credible?’” Tadesse said.
TDB has several African pension funds as shareholders, but attracting that risk-averse capital isn’t easy, and institutions have to find a certain “holy grail” between development impact and risk-adjusted returns, he said.
“There are a lot of NGOs and development agencies that are able to channel funding into deserving sectors. The question is: What kind of finance are you using to do that? If you're using institutional capital, you better make sure that you are hard-nosed enough to run a professional shop where you can achieve those risk-adjusted returns alongside the development impact,” Tadesse said.
The issue of risk and helping to address or mitigate risk for pension funds was raised several times in discussions at the recent Private Finance for Sustainable Development Conference at the Organization for Economic Co-operation and Development.
One model that is mobilizing pension funds to invest in the SDGs is the Danish SDG Investment Fund, a partnership in Denmark. It was founded in 2018 by a group of six Danish pension funds and Denmark’s DFI, the Investment Fund for Developing Countries, also known as IFU. The six pension funds and the government committed about 4.1 billion kroner ($600 million) to the fund to help meet the SDGs and promote Danish technology and know-how.
The fund is structured so that the private investors get a preference on return, meaning any returns up to 6% go solely to the private investors, with greater returns also going to IFU. Thus far, it has invested in clean energy in Pakistan, education and hospitals in Africa, and solar energy in Ukraine.
“In my perspective, it’s a good model for how to attract private money,” said Anette Eberhard, a managing partner at IIP Denmark, the private equity arm of Danish pension fund PKA. PKA was one of the founders of the Danish SDG Investment Fund and has been making sustainability-related investments since about 2007.
The SDG fund was developed with the idea that DFIs have the expertise and knowledge to make direct investments, which institutional capital does not, but it wasn’t easy to set up; there were concerns about whether the returns would be sufficient and about governance of the fund, said Nicolai Boserup, general counsel and senior vice president of IFU.
The investor committee has representatives from the pension funds who can help determine which projects present acceptable risk and what might be better for the IFU to invest in outside of the fund, according to Boserup. The model can reduce some risks, help pension funds distinguish between real and perceived risk, and make a difference in mobilizing institutional capital, he said at the conference.
While the Danish SDG Investment Fund is unlikely to be scaled enormously, there is “no reason it couldn’t be replicated in most OECD countries that have a domestic pension industry and a DFI they trust and understand,” Boserup said.
The U.S. Agency for International Development has also been trying to engage more pension funds by bringing representatives of American pension funds on trips to Africa and attempting to connect them with African pension funds to explore coinvestment opportunities, said Cameron Khosrowshahi, investment officer at USAID.
“Our challenge with our U.S. community was bringing the perception of risk down,” he said. When the U.S. pension fund representatives meet with their African counterparts and credible asset managers and see the potential for deals, it increases their confidence.
What can change
Despite some existing efforts, there remain challenges in bringing more pension fund investment to low-income countries and convincing funds to invest in line with the SDGs.
But pension funds can be pushed to change the way they invest, for example, by the pensioners whose money they are using, said José Meijer, vice chair of the board of Dutch pension fund ABP.
ABP’s shift to consider environmental, social, and governance factors in its investments was partly brought about by a growing desire from beneficiaries of the pension fund to understand where their money was being invested, as well as pressure from the press and NGOs. Today, ABP has about €58 billion ($63 billion) in what it calls “sustainable development investments” — about 14% of its portfolio, though it is working to increase that figure to 20%, she said.
Meijer encouraged pensioners to push their boards and ask questions, which she said may be tiring for people in roles like hers but does push pension funds to think differently.
Not all pension funds may be as open as ABP or some other European pension funds, but another factor that needs to change in order to get more long-term institutional capital moving toward development investments is a shift in asset managers, Meijer said.
Asset managers are typically hesitant to be more directed by pension funds and take on the added work of building a more sustainability-oriented portfolio, which is often more difficult yet no more lucrative, she said.
Pension funds are also often constrained by regulations that may consider some investments, such as the SDG fund, to be illiquid and have high capital requirements. The OECD should speak to financial regulators and encourage them to reduce capital requirements for certain types of investments, such as when they invest with DFIs or through specific tools, IIP’s Eberhard said.
Better knowledge and collaboration could also help pension funds invest, she added. If DFIs and IFIs improve their cooperation, it will be more attractive for the private sector to come in and invest with them, Eberhard added.
ABP and PGGM, another large Dutch pension fund, are working to create some standardization and shared knowledge through the creation of the SDI Asset Owner Platform, which aims to help asset owners align investments with the SDGs. The platform, which is set to officially launch this month, will have a database that leverages artificial intelligence to help rank and identify companies based on their alignment with the SDGs.
Editor’s note: OECD facilitated Devex's travel for this reporting. However, Devex maintains full editorial control of the content.