GPIF stewardship report highlights power of engagement

Engagement leads to more companies introducing KPIs; corporate Scope 3 emission reporting often results in companies reporting more emissions than they have and measuring nature-related risks is extremely complex. Just some of the key take homes from Japan’s $1.7 trillion (¥245.98 trillion) Government Pension Investment Fund (GPIF) 2023 ESG Report.

As a universal owner (82.3 per cent of the portfolio is passive) GPIF is exposed to climate and biodiversity risk across the portfolio. Specific ESG strategies include a ¥17.8 trillion allocation tracking ESG indexes and ¥1.6 trillion invested in green bonds. The giant portfolio that is roughly split four ways between foreign and domestic equity and bonds.

Engagement works

The report finds that engagement has led to companies introducing more KPIs to support ESG targets. For example, GPIF found its engagement on climate change and board structure resulted in an increase in decarbonization targets and the number of independent outside directors at companies.

“Analysis revealed that active engagement by asset managers likely made substantial contributions to overall market sustainability, corporate value and investment returns or improved market beta.

We believe both asset owners and asset managers should continue their efforts to achieve more effective engagement activities,” states the report.

Problems with Scope 3

GPIF flags that Scope 3 disclosure will make it more difficult to analyse portfolio emissions over time and states that data vendors and investors tend to overestimate companies’ Scope 3 emissions, often arriving at larger figures for emissions than the companies have.

“It is important for companies to proactively disclose information to ensure that they are properly valued,” GPIF writes.

The report goes on to stress the importance of cost-effective, beneficial disclosures that are not too burdensome.

“We have a high hope for the development of ISSB and SSBJ standards.”

The ISSB standards require companies to disclose material sustainability-related information to help investors make investment decisions based on the single materiality approach.

New climate index

GPIF has moved approximately $20 billion to a new ESG-themed domestic equities index due to concerns over a “large tracking error” with  the former index, MSCI Japan ESG Select Leaders Index which was in place since 2017.

The new index, the MSCI Nihonkabu ESG Select Leaders Index aims “to reduce the risk of tracking error from TOPIX, the policy benchmark, while retaining the basic characteristic of an ESG index including stocks with a high ESG rating.”

As of March 2024, the tracking error of the former index was 2.3 per cent while that of the new index was limited to 1.2 per cent

ESG in alternatives

GPIF has a tiny allocation to alternatives, capped under 5 per cent and currently just 1.4 per cent of total AUM. However, the pension fund insists on ESG integration amongst its alternative managers where a lack of standardization adds complexity. GPIF interviews managers,  requests they answer due diligence questionnaires and uses third-party consultants.

The pension fund references the enduring challenges in measuring emissions in private equity where “only a few” private equity funds report on portfolio companies’ emissions.

GPIF estimates portfolio company emissions using the enterprise value (EV) metric, on that basis “that EV and GHG emissions have a certain degree of positive correlation in the case of listed companies.”

The estimated carbon footprint of the overall private equity allocation was 2.32 million tons in a reflection of the tiny allocation. The carbon footprint of GPIF’s entire equities portfolio was 464.03 million tons. The allocation to private equity industrials had the largest carbon footprint.

GPIF marks a 4 per cent increase in the number of funds in its real estate portfolio which participated in GRESB Real Estate Assessment and says 83 per cent of the funds in the real estate portfolio now use the framework.

Nature dependencies

GPIF documents the challenges of nature reporting and disclosure in accordance with TNFD Framework.

“We feel that measuring nature-related risks is extremely complex and that many unresolved issues remain.”

Using the TNFD, GPIF found  “materials” and “transportation” had the highest nature-related risks in terms of both dependencies and impacts on the domestic equities portfolio, while energy and food, beverage & tobacco were identified for the foreign equities portfolio.

Elsewhere the investor found that research showed that TOPIX companies that have endorsed the TNFD recommendations have better disclosure rates than those that have not.