The World's Largest Pension Fund is Sinking Money into ESG-Stocks While Stock-Markets are Tanking

The Japanese Government Pension Investment Fund (GPIF) is aggressively redirecting and increasing its investments in ESG-Stocks while stock markets all around the world are tumbling

Stocks worldwide are tumbling. The S&P 500 has lost over 25% this year and the Japanese index, NIKKEI 225 is down over 10%. All this while inflation is eating up currencies all over the world. The Japanese Yen has dropped over 30% to th USD this year.

Even so, the Bank of Japan is continuing its massive equity purchase spree. On top of this, Japanese regulator seeks to push the ESG agenda to the Japanese stock markets.

As Japanese investors, led by the Government Pension Investment Fund (GPIF), increase their focus on environmental, social and governance (ESG) factors, Japanese government bodies are also making a further push to increase the quality of these efforts.

On July 12, Japan’s Financial Services Agency (FSA) sent out a new draft code of conduct for ESG evaluation and data providers. The voluntary code advises investors to pay attention to the objectives and limitations of ESG data.

Among other things, the draft suggests that ESG data providers with Japan-based operations should ensure they have a sufficient number of qualified analysts while giving companies time to examine information for errors.

The proposed code will require data providers to “secure necessary professional human resources'' and “develop capacity building of human resources…even if individual employees do not necessarily have all the necessary expertise.” The ESG market is currently facing a shortage of skilled human resources, the code said.

What does this mean for Japanese stock markets?

GPIF is the world’s largest pension fund and anything it decideds to focus on has an astronomical impact on the Japanese stock market.

As of March 31, 2022, GPIF’s portfolio of Japanese equity was valued at ¥49.5 trillion ($371.8 billion), while the Japanese bond portfolio stood at ¥53.2 trillion.

To promote ESG, GPIF now requires index providers to publicly disclose how they conduct an ESG evaluation and how they construct indexes, as well as to proactively engage with companies.

“As a result, dialogue between index providers and companies is increasing rapidly, which we hope to lead to an improvement in responses to ESG issues and information disclosure by Japanese companies,” GPIF wrote in the report.

The effect of GPIF’s drive to push the ESG agenda has already trickled down among its Japanese peers and managers alike.

According to the results of the 2021 Sustainable Investment Survey conducted by the Japan Sustainable Investment Forum (JSIF), Japan’s sustainable investment balance was ¥514.5 trillion, an increase of 65.8%, or ¥204.0 trillion, compared to the 2020 survey.

The numbers include investments by GPIF, but also other large Japanese asset owners, such as insurers Dai-Ichi Life, Meiji Yasuda Life, and Sumitomo Life as well as the Pension Fund Association for Local Government Officials, better known as Chikyoren.

“ESG initiatives are being actively developed in Japan, and the failure to address these rapid and public-facing initiatives can lead to risk. In addition, like other markets, we are seeing a significant increase in ESG-related investments, from both domestic and international investors,” Clifford Chance wrote in the briefing "Insights into ESG in Japan” in February 2022.

The ratio of sustainable investment assets to total assets under management (AUM) of the respondent institutions increased nearly 10%, from 51.6% in 2020 to 61.5% in 2021.

Isn’t GPIF’s ESG-focus a good thing?

Learning that the Japanese government and the world's largest pension fund is focusing on ervinomentally and socially responsible companies might sound like a good thing at first glance, but sadly it's not.

First of all, ESG-Stocks have come under a lot of scrutinity for becoming overvalued by the market when every investor is trying to jump on the ESG-train at the same time. On top of that, it is unclear that many ESG-companies actually live up to their reputation. In fact, many analysts have a hard time measuring if ESG-stocks are better for the environment and society than “non-ESG” stocks.

What’s also worrisome is that the GPIF is doing this reshuffling of its portfolio at the worst possible time. ESG-stocks have been the biggest losers of the stock-market tumble and many major ESG-companies are facing fraud allegations and even bankruptcy.

Hopefully, the Japanese government and GPIF's invigored focus on ESG-stocks will pay off in the long run, but for now it looks like they have shot themselves in the foot…