The New Zealand Superannuation Fund (NZ Super) has explained its decision to shift the benchmark for nearly half of its total $55.7 billion AUM as a matter of cost and time savings.
Between July and September, NZ Super shifted the universe from which it selects $25 billion of passive investments in global equities, to two MSCI market indices that are designed to improve the environmental, social and governance (ESG) profile of the portfolio. The change was intended to reduce investors’ exposure to the risk of climate change and to better align with the 2015 Paris Agreement.
The move also drastically cut down the number of public equities owned by the fund in its passive portfolio. The previous benchmark index covered more than 9,200 securities, while the new investible passive universe would include roughly 1,000 stocks, according to Stephen Gilmore, NZ Super CIO.
“The smaller number of stocks helps focus attention and frees up time internally in terms of person hours,” he said.
He said that, while costs associated with using the index were comparable, the smaller universe from which to select the reference portfolio significantly reduces the amount of time that staff would have to spend on researching stocks for their ESG impact, and would increase the fund’s ability to scrutinise and engage with individual companies. He added that taking an off-the-shelf index with fewer constituents also allowed the fund to communicate more easily about its ESG objectives.
The passive portfolio, which the fund calls its reference portfolio, is currently comprised by 80% equities – of which 75% are global and 5% are domestic – and 20% bonds.
The move follows considerable investment in NZ Super’s internal stock-picking process in recent years in terms of environmental characteristics. “We have spent a lot of time thinking around the customised route with a strong internal influence. But we felt there was a simpler solution,” he said. “It is a guiding principle for us to take solutions off the shelf where we can.”
The shift represented the fund’s wider aim of using external providers in developing its investment process where this was possible.
“The starting point [at the fund] is where possible to draw on the expertise of others. This is one of the key design principles of the reference [passive] portfolio,” he said.
But the move does not signal a change in approach for how the fund works with active managers when it came to ESG, Gilmore said.
He noted that the fund would consider helping a manager develop its internal ESG processes to a level NZ Super would consider satisfactory, prior to awarding them a mandate. This could happen in cases where the fund was keen to invest, where there was a shortage of better-performing ESG managers and where the manager provided a strong investment case.
“The question is: can we use the manager to invest in an area we want to. Then, it would depend on whether we have the resources to work with that manager and whether that manager was truly committed [to improvement],” he said.
According to Gilmore, there is also a wider review into sustainable investing underway at NZ Super.
“We are going through the process of strengthening the framework for our investment process to understand the question of positive [social and environmental] impact and incorporating these considerations into the way that we invest,” he said.
This was reflected in a revised statement of purpose in July, which highlighted “sustainable investment delivering strong returns for all New Zealanders”.
Since 2017, the previous benchmark helped reduce fund-wide emissions intensity by nearly 50%. Today the fund no longer holds any material, long-term exposure to fossil fuel reserves.
NZ Super’s mission, enshrined in national legislation, is to pursue the highest standards in portfolio management. Gilmore said this included a socially responsible dimension. “Best practice is going in the direction of sustainable investing,” said Gilmore.
The two new indexes now employed by NZ Super are the MSCI World Climate Paris Aligned Index, a large and mid-cap index covering 23 of the largest developed markets, and the MSCI Emerging Markets Climate Paris Aligned Index, which covers 24 emerging markets. Last year, these indexes returned, respectively 21.86% and -1.97%. They replace the MSCI All Country World Index Investable Market Index, which returned 18.71% .
Between 2013 and the end of last year MSCI ACWI climate indexes outperformed the MSCI ACWI Index. However, in the first half of 2022, climate indexes underperformed. Poor performance across many such indexes owed in large part to higher oil prices and the outperformance of the energy sector more broadly.