FIS Singapore 2023

Cross-checking data, wringing necks: the ESG journey

Making a portfolio more resilient to climate change, and playing a role in decarbonising the real economy, requires a range of creative solutions to complex problems, along with a good measure of determination, said a panel of leaders driving ESG efforts at GIC, New Zealand Super and APG.

The journey to date has involved laborious translation of scientific analysis into investable insights, cross-checking climate and market models to gain more confidence in imperfect data, investing in solutions-providers at an earlier stage than a large fund would otherwise invest in a new company, and proverbially wringing a few necks, they said, in a panel discussion at Conexus Financial’s Fiduciary Investors Symposium held in Singapore.

Speaking with Amanda White, director of international at Conexus Financial, the panel members were Rachel Teo, head of total portfolio sustainable investing in the economics and investment strategy department and head of sustainability at Singaporean sovereign wealth fund GIC; Yoo-Kyung Park, head of responsible investment & governance Asia Pacific at Dutch pension giant APG, and Anne-Maree O’Connor, head of sustainable investments at pension fund New Zealand Super.

Measuring exposures using available data has been an ongoing challenge, said Teo, but the data has been improving.

Scenario analysis before the arrival of the NGFS Climate Scenarios framework involved going through materials provided by the Intergovernmental Panel on Climate Change and translating scientific analysis into investor insights such as the impact on the macro economy and asset returns, with the help of consultants.

Around 2018, models were new in their development and the team did not know which model to use, so they picked several and triangulated their information. “We had to cross check the work we did with one model with other models to give us some confidence that the impact is either material or in a certain direction,” Teo said.

Looking at how asset class returns were affected in different climate scenarios, “the ranking of broad asset classes didn’t change in the scenarios,” Teo said, “so it suggests for strategic asset allocation, if you’re allocating across broad asset classes, climate change drivers shouldn’t affect that strategic asset allocation.”

But when allocating at a more granular level such as to industries and countries, “there are big winners and big losers within asset classes, and that could affect how you might want to allocate,” Teo said.

For example in the Divergent Net Zero scenario by NGFS, 12% of the equities listed by MSCI will experience an earnings impairment of more than 50% due to extreme carbon pricing, Teo said. Findings like this were what the fund then brought to its investing teams, establishing sustainability and climate chance as material, with an impact on earnings.

Climate change impacts GIC’s portfolio in various ways that are relatively easy to articulate, Teo said. There is a transition risk from related policies, technological progress in clean tech, physical risks from both chronic global warming and also acute risks from extreme weather events.

“Those affect cash flows, affect our investments, disrupt businesses,” Teo said.

A third insight through the fund’s research was market risk related to climate change, based on the belief markets were not adequately pricing in the risks.

“So we have to consider and know when will markets price in climate change related risks, and will it be done smoothly or disruptively,” Teo said. “It will be smooth if you know policymakers are telecasting their intentions ahead of time. But if there are sudden changes…the potential for disruptive pricing could be pretty high, and will there be an over-reaction in markets?”

Large investors like GIC typically invest in the growth stage where companies need large amounts of capital to scale, but when it comes to investments in solutions that decarbonise the real economy, GIC is “willing to now maybe invest a bit earlier in the life cycle of the company,” Teo said, owing to the urgency of decarbonisation.

“We’re really going out looking for companies that have promising technologies with viable business models, and they are small but we’re willing to go in and support them,” Teo said.
“But this means that in GIC we need to have the deep technology core capabilities to assess the technology and the commercialisation rates, and we need also to be able to cover broad sectors and markets.”

Park said there are three components to APG’s efforts to decarbonise its entire portfolio, each with their own set of challenges that often involve tactfully applying pressure to related stakeholders. The fund needs to measure its carbon footprint, which is easier said than done when it involves companies or managers reporting to the fund, sometimes you have to apply pressure and even then it sometimes takes them years.

The next step is to set targets and steer the whole portfolio towards net zero by 2050. “By 2030 we have to already be halfway,” Park said. Attending and influencing shareholder meetings can be challenging, because “In Asia, most of the CEOs, they do not know the carbon [emission] number. If they don’t know the carbon number, how do they cut?” These are the people who “sign the cheques,” she said.

“We try to steer our portfolio, but at the same time, the companies that we invest in, they need to steer themselves and we need to help them by squeezing their neck a little,” she said.

The third part of the strategy is investing in solutions, and helping companies reach their potential in this area, Park said.

New Zealand Super made its first big move in managing climate risk in 2016. The fund set “quite a small carbon intensity target [and was] quite comfortable with making that move because we saw climate risk as unrewarded,” O’Connor said. “So part of our mandate is to maximise returns without undue risk.”

The fund gradually became more aggressive with its carbon targets including significant reduction to fossil fuel reserves, and found it was able to achieve market-tracking and diversification with its passive equities, while reducing its carbon footprint and carbon exposure.

The fund also launched a project called RI Compass where “the board said, imagine it’s 2030, what does our social license to operate look like there? And then look back to now and think about what should you be doing now, what should we be looking at now?”

This project was a more broadly-focussed work on improving the ESG profile of the portfolio, with the fund ultimately choosing an off-the-shelf MSCI Paris-aligned index with around 3500 stocks in the portfolio.

“So that was one big leap forward In terms of improving the ESG profile of our portfolio, retaining that lower risk through having a lower carbon footprint,” O’Connor said. “It doesn’t mean that we don’t still engage on climate change, because there’s still plenty of companies in the portfolio and our next focus, our current focus, is on whether our multi-factor portfolio managers can improve their ESG profile as well.”

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