Investors are not getting paid for taking on carbon risk according to New Zealand Super, prompting the fund to move its global passive equities portfolio to low carbon. The next step for the fund, as it implements its climate strategy, will be to work out how it will account for carbon risk in unlisted investments and some active exposures including factor mandates.
The NZ$14 billion ($10.2 billion) global passive equities portfolio, which accounts for 40 per cent of the fund, made up 75 per cent of the fund’s carbon emissions and so was an obvious place to start with transitioning the entire portfolio to low carbon.
The fund has reallocated about $695 million away from companies with high exposure to carbon emissions and reserves, into lower-risk companies.
The carbon exposures were highly concentrated in a relatively small number of companies and fell into three sectors – utilities, materials and energy. They accounted for about 83 per cent of the carbon emissions in the portfolio and 16 per cent of the equities portfolio.
By making these changes the fund’s carbon emissions intensity is 19.6 per cent lower and its exposure to carbon reserves 21.5 per cent lower. New Zealand Super expects to reduce the carbon emission intensity of the fund by at least 20 per cent and the carbon reserves of the fund by at least 40 per cent by 2020.
Using a carbon measurement methodology created in consultation with MSCI, the fund divested away from stocks with high carbon emissions and carbon reserves.
MSCI examines the carbon metrics of 8500 companies for scope one and scope two. Scope one is emissions generated directly by the company and scope two are those emissions purchased into the organisation, often through energy usage.
New Zealand Super’s global passive equities portfolio is managed by State Street Global Advisors, BlackRock and Northern Trust which implemented the changes.
The chief investment officer of the $26 billion fund, Matt Whineray, said the weight of evidence shows the market is under-pricing carbon risk, partly given the very long horizon of the fund.
“It’s a risk investors are not getting paid for,” he says.
The belief is that the risks associated with climate change are material and the new low carbon portfolio will increase the resilience of the fund.
The fund used the reference portfolio equity exposure – a combination of the world investable market index, emerging markets investable market index and the S&P/NX50 index – as the starting point for developing an exclusion list. Stocks in the top quartile as measured by MSCI ESG research were not excluded.
Stocks were then ranked by their reserve intensity and eliminated until the desired reserve reduction was met. Then the remaining stocks were ranked by carbon emission intensity and progressively eliminated until the right carbon emission intensity reduction was obtained. Then the remaining stocks within the indices were linearly up-weighted to preserve the proportionality between the three equity indices.
The reference portfolio reserve target was set at a 70 per cent reduction and the carbon emission intensity target was set at a 50 per cent reduction. The new reference portfolio retains 93 per cent of the original market capitalisation.
Separately the fund also excludes stocks on the basis of cluster munitions, anti-personnel mines, nuclear explosive devices, nuclear base operators and tobacco. About 137 companies are currently excluded.
The fund used Bloomberg’s global active equity risk model to calculate the active risk for the equity component of the reference portfolio after the new exclusions lists were applied. At the total reference portfolio level, this is estimated to be about 0.7 per cent of active risk.
New Zealand Super doesn’t typically take conventional active risk in stockpicking, but its active risk is in its allocation away from the reference portfolio into, for example, forests and farms, and also in tactical asset allocation tilts.
New Zealand Super defined its four-part climate strategy in October 2016; it includes carbon footprint reduction, analysis, engagement and seeking new opportunities.
The acronym for the climate process is RAES – reduce, analyse, engage, search (ironically, this was authored by Dave Rae who has since left the fund).
The fund analyses how to incorporate climate risk into the investment hurdle rates, the risk allocation and manager selection process. It is searching for opportunities such as renewables, alternative energy, green bonds and green property.
Whineray says the next step will be for the fund to apply the same carbon measurement to its active equities mandates.
The fund has a number of New Zealand equities active mandates, one active manager in emerging markets and factor mandates with AQR and Northern Trust.
The fund is also looking to understand its climate exposures across the unlisted asset classes.
“We need to get a sense of the footprint, which is hard to do in unlisted because there is less data,” Whineray says. “Then there’s the discussion of what we can do to mitigate or change these exposures. We kicked off with listed equities because it’s where the biggest exposure is and it’s the easiest.”