Several pension funds in Australia and New Zealand appear to be reaping the benefits of reducing the impact of climate change on their portfolios, as opposed to simply offering an environmental, social and governance (ESG) fund option to their members.

New Zealand Superannuation Fund has implemented a low-carbon strategy across its passive equity portfolio. Now 40% of the overall NZ$35 billion ($25 billion) fund is “low-carbon” and it plans to extend the climate policy to its active equity portfolio, said chief investment officer Matt Whineray in a statement yesterday.

The transition involved re-allocating NZ$950 million away from 297 companies with high exposure to carbon emissions and reserves into companies deemed less vulnerable to tighter regulation in this area.

The changes are a key plank in NZ Super’s strategy to address climate change investment risk, announced in October. As at June 30, the fund’s carbon emissions intensity had dropped by 19.6% and its exposure to carbon reserves is 21.5% lower since it implemented the strategy.

Whineray said yesterday that financial markets were under-pricing climate change risk over the fund’s long investment time frame. “The global energy system is transitioning away from fossil fuels,” he noted. “For investors with very long horizons, reducing exposure to carbon emissions and reserves is a low-cost insurance policy.”

"Ahead of the curve"

Roger Urwin, global head of investment content at consultancy Willis Towers Watson, said NZ Super's carbon reduction strategy was “ahead of the climate change curve”.

“All this was achieved because of strong board and leadership alignment,” he noted. “None of that comes easy; that’s why it sets an example that other funds will study.”

There are few other funds in the southern hemisphere operating such an advanced strategy in relation to climate impacts. One is the A$10 billion ($7.8 billion) Local Government Super (LGS) fund in Sydney. The fund's head of sustainability, Bill Hartnett, told AsianInvestor that it viewed climate change as the most significant ESG investment risk for its members.

What separates LGS from other institutional investors is treating ESG investing as a fiduciary responsibility that cuts across the entire fund. Hartnett said LGS was, in October 2014, one of the first funds globally to introduce a negative screen for carbon.

The fund excludes companies that derive more than 33% of their revenues from coal mining, oil tar sands and coal-fired utilities. This is quite a high threshold, said Hartnett, meaning it includes companies that pure-plays in this area. The excluded list initially comprised 57 companies globally, many of which have since gone into bankruptcy and exited the index.

“These [excluded] companies are going to be exposed to transition risk, to increasing legislation, to changing consumer demand around carbon, and it is going to be difficult for them to back-pedal,” noted Hartnett.

"Disruptive technology"

He said the standard ESG indices were unlikely to reflect the impact of the "disruptive technology" that is being developed. LGS prefers using an exclusion list rather than an index, added Hartnett, because this is a dynamic, fast-changing area.

NZ Super has found that carbon exposures are highly concentrated in a relatively small group of companies. “By targeting this group we have been able to significantly reduce the fund’s carbon footprint while retaining the diversification benefits of passive investment,” said Whineray.

What's more, LGS has found that that the diversification benefits of energy stocks are not very significant, said Hartnett. “We’ve still got a highly diversified fund and holdings, and the performance of our international equities has been excellent, so being out of these areas has certainly not hurt the fund, and indeed has helped it.”

Moreover, LGS has some A$950 million invested in renewable energy generation, water and energy efficiency, sustainable agriculture and green property. It also has around $160 million in ‘green bonds’.

Another Australian super fund with a strong focus on climate risks is Sydney-based Australian Ethical. The institution has an ethical charter of 23 principles that seeks to ensure its investments have a positive impact.

Head of ethics Stuart Palmer told AsianInvestor: “Climate change is a key issue. We assess what we think about fossils fuels, renewable energy, nuclear power. Often we’ll find a positive in a company – an energy company for example – which has some form of environmental footprint, so we want to make sure that’s being properly managed.”

Ultimately, that process has led the A$2 billion fund to avoid fossil fuels and nuclear. Palmer said the latter area brings “a heap of additional risks that we are not comfortable with, and which are completely unnecessary given the availability of renewable technologies”.