New Zealand's NZ$31 billion ($22 billion) sovereign wealth fund has announced it will follow new environmental investment rules, which are designed to reduce its carbon footprint and create a more sustainable portfolio.

Adrian Orr, chairman of the New Zealand Superannuation Fund, said the exclusionary investment strategy represented a fundamental shift for the fund, which is seeking to cut its exposure to energy companies deemed vulnerable to rules changes around carbon emissions.

"In coming years the global energy system will transition away from fossil fuels. Reducing the fund's exposure to these risks and to the physical impact of climate change is good for the portfolio,” he told AsianInvestor.

The fund intends to be proactive and has set up its own methodology for managing and measuring this new policy.

“Climate change, and the coming transition to a low-carbon energy system, also present investment opportunities for long-term investors that we intend to capture,” said Orr.

Guarding the climate

The new environmental investment strategy will be applied across the fund's entire portfolio. Additionally, NZ Super Fund's trustees, the Guardians of NZ Superannuation, will incorporate climate change considerations into investment analyses and decisions, for example into valuation models, risk allocation and manager selection.

“We will continue to manage climate risks by being an active owner, including prioritising climate change engagements, developing our voting policy and directing our investment managers to vote according to our instructions on climate change resolutions," said Orr.

"Importantly, we will intensify our efforts to actively seek new investment opportunities in the areas of alternative energy, energy efficiency and transformational infrastructure."

The Guardians has studied climate change strategies from European pension funds, including Denmark’s AP4 and PGGM from the Netherlands.

The trustee organisation said it would report publicly on the levels of reduction in the fund's carbon footprint, for both carbon emissions and fossil fuel reserves, from 2017.

Strategic shift

The investment strategy shift means that companies in the business of climate change solutions stand to benefit – in particular, companies that provide alternatives to fossil fuel-based energy and infrastructure.

Orr said NZ Super Fund isn’t setting a specific target for reducing its carbon footprint because of the fragmented nature of measuring the risks. Instead, the fund has decided to build its own low-carbon methodology to target the divestment of high-risk companies. It believes doing so will allow it to focus more accurately on carbon risk and introduce measures as these develop over time. 

Active ownership is a key driver of this initiative for NZ Super.

The new environmental investment rules are largely exclusionary in nature. While they do not explicitly prevent NZ Super Fund from investing into fossil fuels or mining, the fund will set hurdle return rates for such investments that are not considered sustainable.

Orr said the decision not to fully divest from all fossil fuel companies was taken because it doesn’t rule out the possibility of engaging with firms in the sector that might be able to transition to cleaner energy production, and have a role to play in moving towards a low carbon economy.

Commenting on this development, Emma Herd, chief executive officer of the Investor Group on Climate Change, said, "Investors have a critical role to play in managing the financial risks of climate change and supporting the transition to a net zero emissions economy.”

James Day, local director of the Climate Disclosure Project added, "We were struck by the breadth of (NZ Super Fund’s) climate commitments, from measuring and reducing carbon exposure across all of their physical equities, through to being an active owner via their voting activity and engagement, which is becoming an increasingly important mechanism for investors to drive the change they need to protect their investments."

The NZ Super Fund returned a pre-tax 1.89% in the year to June 30, 2016, a relatively weak return primarily reflecting negative returns by global equities. Although this was the fund’s worst annual return since 2012, it still out-performed its passive reference portfolio benchmark by 0.52% during the year, due mainly to strong performance by active investments in timber and infrastructure.

Orr admitted that onlookers should brace themselves for lower annual returns from NZ Super Fund going forward  "Overall investment returns are likely to be volatile and on a low trajectory for some time," he noted.