NZ, Sweden state funds flag ESG challenges

New Zealand Super faces obstacles to implementing a climate-focused investment policy. The former head of Swedish state pension AP4 explains how it addressed such issues.
NZ, Sweden state funds flag ESG challenges

Certain state investors and pension funds in Asia are grappling with the challenges of implementing environmental, social and governance policy in their portfolios. These include assessing fund houses' approach to ESG, managing emissions-related risks and addressing government concerns about the impact of ESG factors on returns.

There are things they can learn from European funds, it emerged at the annual sovereign wealth funds conference held last week in Auckland.

New Zealand Superannuation Fund is one of the institutions setting the pace in Asia Pacific, having announced last month that it had adopted a new climate-focused investment policy.

Chief investment officer Matt Whineray said at the forum that NZ Super's overriding objective was to increase the resilience of its portfolio to climate change risks.

“It may become more of an ethical driver in time, but our chief concern is that these are risks embedded in our portfolio that we consider undue,” he noted. “We want to reduce our exposure to those companies that are most exposed to this risk.”

But it's not so easy, added Whineray (pictured right), because when it comes to emissions, for example, there is no single accepted metric to measure or manage their risk to portfolios.

He said NZ Super was just starting out with its new climate-focused policy and that over time data would improve and related benchmarks would change.

Moreover, the new climate policy will affect how the fund picks asset managers, he noted, but that comes with its own challenges: “How do you get managers to think about a risk we don’t think is properly priced when it’s probably well beyond the horizon that they care about?”

Whineray added: “It’s going to make us an annoyingly engaged LP in relation to our private investments and in relation to our public market mandates. We are going to want to know how managers are thinking about this risk; how they are pricing it and what their measures for mitigating it are.”

A Swedish example

The experience of more mature funds in Europe is showing them how effective such policies can be, and how they overcame barriers to putting them in place.

One such institution is AP4, one of the four state pension funds in Sweden, with $40 billion under management. Four years ago, it implemented a dedicated ESG strategy across its global equity portfolio.

Mats Andersson, the fund's former chief executive (pictured below left), said it had aimed to tackle climate change and mitigate the risks posed by pollution and rising sea levels. But putting the strategy required overcoming barriers from the top, he told the conference.

“You have to prove there is no conflict between returns and sustainability,” he noted. “But over the past five years we have delivered 10% per annum, and we have done that at a cost of 10 basis points, which I think is quite an achievement, even though my parliament complains it is still a ridiculously high cost."

Funds need to put sustainability on the agenda, he said, “because long term it is impossible to be successful as a pension fund or as a company unless you have done that”.

AP4 has a return target of 4.5% after fees with a 65% allocation to global equities and 35% to government bonds with duration of around seven years and a currency exposure of 30%. Historically it has a tactical mandate, which aims to beat the benchmark by 40-50bp.

Four years ago the fund’s governing board gave the managers a mandate to extend the investment horizon from three to 15 years. “This made a huge difference, because the opportunities are enormous if you can prolong your mandate,” said Andersson. Since then, AP4 has been able to deliver an annual excess return of 500bp.

Assessing carbon footprints

But Andersson noted that other pension funds around the world often “did not have a clue about the risk posed by their exposure to climate change”.

AP4 takes the view that if companies are looking after their carbon footprint, they are probably looking after the rest of the business in the same responsible manner.

The fund’s solution is to assess the carbon footprint of companies listed on the US benchmark stock index, the S&P500. By excluding the 150 with the biggest carbon footprint the fund achieved “more or less” the same underlying returns as if it had owned the entire 500, said Andersson. “But the interesting thing is we lowered the carbon footprint by 50%.”

Similar moves by other sovereign wealth funds would help build momentum on this front. Such entities are key to addressing risks of climate change, said Rowan Douglas, CEO of the capital, science and policy practice at Willis Towers Watson, also speaking at the Auckland event.

However Asia-Pacific's largest institutions have been slow to adopt global ESG standards. Of the 1,600 companies that have signed up to the UN’s Principles of Responsible Investment, only 38 are from the region.

Still, some Asia-based funds – including Japan’s Government Pension Investment Fund, Australia’s Future Fund and Korea Investment Corporation, as well as NZ Super – are evolving their ESG approach.

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