Marco Becht, Solvay Brussels School of Economics and Management, European Corporate Governance Institute (ECGI), Centre for Economic Policy Research (CEPR); Julian R Franks, London Business School, ECGI; Hideaki Miyajima, Waseda University, Research Institute of Economy, Trade and Industry; Kazunori Suzuki, Waseda University, ECGI



Since 2017 the Japanese Government Pension Investment Fund (GPIF) has followed a new approach to enhance the ESG performance of Japanese-listed entities. Our new study seeks to document this experiment from the world’s largest asset owner. We found that its portfolio companies have seen significant improvements in their ESG scores in the last six years.

GPIF employs a dual approach. First, it rewards companies that achieve above-average ESG scores with additional investment by including them in best-in-class ESG indexes. The fund also threatens laggards with potential exclusion. This type of indexing has been pioneered by several other asset managers / owners, including Amundi, the Swedish AP4 pension fund and the French Pension Reserve Fund (FFR). AP4 characterised its decision as a success, despite an increase in tracking error from the benchmark, a concept some have argued should be reconsidered if asset managers want to hit their net-zero targets.

Second, GPIF compensates its largest passive manager, Asset Management One, (hereafter referred to as AM One) to actively engage with companies to enhance their ESG performance. It also compensates Fidelity, an active manager, and two more passive managers as of 2021, but this study only analyses the results from AM One’s engagement.

Asset management fees are considered too low to pay for meaningful engagement with companies in a large, diversified portfolio, even when the asset manager uses a targeted approach. GPIF addresses this concern by paying their asset managers a separate fee for engaging portfolio companies.

Not all ESG scores are the same

AM One’s engagement strategy with portfolio firms does not have a direct tie to ESG scores or the composition of ESG indexes. However, we found that companies targeted for engagement improved their FTSE scores, compared with our control group, while MSCI scores remained mostly static. The differential impact may be explained by variations in the ESG scoring methodologies employed by the two ESG indexes.

For instance, while FTSE rewards disclosure, MSCI does not. More subtly, MSCI dynamically adjusts materiality weightings that capture a company’s risk exposure to each underlying E, S and G theme; in contrast, FTSE’s weightings change relatively little over time. The MSCI approach results in a paradox: successful engagements lead to an increase in scores, but a decrease in the theme’s materiality. As a result, the weighted score (score x materiality) remains largely unchanged. Therefore, despite a successful engagement, the net impact on the weighted score can be minimal. We conclude that FTSE-weighted scores are more suitable for measuring engagement success.

We also found that being included in, and excluded from, the indexes resulted in positive and negative abnormal returns, respectively. (Abnormal returns reflect the excess returns above or below that which would have been expected if the inclusion / exclusion had not taken place.) Companies frequently report their inclusion in the FTSE Blossom Japan Index Series (an index of companies demonstrating strong ESG practices), indicating a reputational benefit from being listed in the index. Companies do not announce exclusions. The press releases always mention that the indexes had been adopted by GPIF.

Other asset managers likely to engage more

GPIF exerts its stewardship through approximately 20 external asset managers. Although only two asset managers at the start of the experiment were paid a fee for engaging on ESG, it is likely that other asset managers initiated or expanded their ESG engagements to attract more funds from GPIF or to protect their existing position. It has become well known that GPIF had been looking to enhance its ESG engagement, in line with its PRI commitments, as it has been a PRI signatory since 2015.

Japanese companies’ ESG scores see big improvements

We expected that all Japanese companies, including those in the control group, were incentivised to improve their scores, given the increased probability of engagement from other asset managers and the incentives of being included in ESG leader indexes. To control for these effects, we compared changes in Japan’s overall FTSE ESG scores with those of 26 other countries. We found that since the introduction of the two ESG leader indexes in 2017, Japan’s large and mid-cap company ESG scores increased significantly compared with other countries, including France, Germany, the UK and the US. These results show that Japan, having previously been a laggard in reported ESG scores, has largely caught up with these other countries in the last six years.

Our study proposes a refinement to GPIF’s approach: asset managers could adopt a streamlined scoring method and align engagement objectives with metrics that govern index inclusion and exclusion. Such ‘engagement-compatible’ scores could underpin portfolio decisions that prioritise targeted engagement, particularly concerning pressing risks like climate change. This approach also aligns well with related index strategies, such as net-zero aligned indexes that divest from top carbon emitters or companies lacking credible transition strategies.

GPIF’s initiative provides a case study of the effects of an asset owner compensating asset managers for engaging with listed firms to reduce ESG-related risks. If ESG risks are overlooked, particularly ‘E’, that could notably diminish the universal owner’s portfolio value. Executed correctly, these endeavours can yield long-term returns for fund beneficiaries and concurrently benefit society.

The results of the study suggest that remunerated engagement in combination with index inclusion / exclusion can significantly enhance ESG performance.

The full paper, ’Does Paying Passive Managers to Engage Improve ESG Performance?, is the winner of the PRI Award for Outstanding Research 2023. It was presented at the 2023 Academic Network Conference at PRI in Person, Tokyo. Watch here

The PRI’s academic blog aims to bring investors insights from the latest academic research on responsible investment. It is written by academic guest contributors. Blog authors write in their individual capacity – posts do not necessarily represent a PRI view.