NZ Super revamps factor portfolios, continues impact journey

New Zealand Super has revamped its multi-factor equities portfolios, working with its three external managers to integrate sustainability. Amanda White spoke to head of external investments, Del Hart, about the fine balance of meeting sustainability goals and finding factor alpha, and the next phase of the fund’s sustainability strategy: measuring investments for impact. 

New Zealand Super’s active global equities is managed by three managers in various concentrations of multi-factor portfolios across value, low volatility, momentum, and quality. 

As part of the fund’s bid to integrate sustainability across its whole portfolio, it recently engaged with Northern Trust, AQR and Robeco, which manage the portfolios, on how to best integrate its sustainability objectives without compromising the integrity of the factor exposures. 

“The multi-factor mandates make up 19 per cent of the portfolio so if we couldn’t do something with that, it was a gap in the portfolio in terms of sustainability goals,” NZ Super head of external investments and partnerships Del Hart tells Top1000funds.com in an interview. 

“If we restricted it too much we wouldn’t find the scope for factor alpha we were looking for, but we found we couldn’t simply give the factor managers the Paris-aligned benchmark we used for the passive portfolio as their universe for stock selection.” [See NZ Super culls equities, focuses on impact] 

The balancing act meant ensuring the managers had a large enough investable universe and weren’t restricted in their approach to creating the alpha expected from the portfolios, whilst still meeting certain ESG outcomes. 

The NZ Super team did a lot of research and spoke to peers as well as a range of fund managers, both incumbent and others, to canvass the financial effects of integrating ESG into multifactor equities. 

“There was a range of views, but the prevalent view was the impact was uncertain,” Hart says. “If we can incorporate ESG considerations without compromising the exposure then there is no reason to believe it will reduce returns. Our goal is not to generate alpha from the ESG integration but to have justifiable confidence it won’t detract from returns.” 

Three changes to the factor strategies ensued. The investable universe was moved away from the MSCI ACWI IMI to the MSCI World index, effectively removing small caps and reducing the number of stocks from 4,500, to 1,500. 

“That’s the level we think there won’t be a negative performance impact. It was still possible at that level to achieve a strong exposure to our desired factors,” Hart says.  

From that universe, managers were given freedom to choose their exposures to manage the portfolios but their benchmark was changed to the MSCI World Climate Paris-Aligned index, which is the same as used for the reference portfolio and passive global equities.  

“So they need to manage to the ESG characteristics of that index but can do it in a way they choose for generating the returns,” Hart says. 

Managers can design a portfolio that gives the ESG desired outcomes, as per the benchmark, but doesn’t require them to meet specific targets in terms of ESG metrics. 

“It gives them flexibility. And the important thing is we will use MSCI ESG metrics to report their performance and require them to explain any consistent underperformance, that’s our way of checking in a consistent way that our three managers are adopting an appropriate solution to achieve the goal,” Hart says. 

The fund is now working with the managers to implement the new changes which may include some amending their investment management agreements. 

With ESG considerations further integrated across equities, the fund will turn its attention to the fixed income portfolio. 

Impact measurement 

It’s all part of a move by the fund to sustainable finance which followed a two-year review of its responsible investment position, with ‘sustainable finance’ referring to the consideration of the impact of investments on society and environment, as well as thinking about the ESG risks on investments. 

There are few large asset owners globally which measure the impact of their investments, but it is attracting growing attention. New Zealand Super will do an initial portfolio assessment due by the end of September.

In developing an appropriate framework, the first part of the process was to define impact, and the framework for qualification, measurement and management. 

New Zealand Super’s definition of impact is: Investments made with intent to deliver measurable positive social and/or environmental impacts, and the fund’s required financial return. Importantly it has the four factors of intent, measurability, impact and returns. 

And questions it asks to assess investments around impact include: Does the investment meet the return hurdle; have positive social or environmental impacts been identified as a core component; can those impacts be measured; and are there any significant adverse impacts associated with the investments? 

Hart says developments in the past few years including the growing use of taxonomies has given the fund confidence they can invest in scale, measure impact and meet the financial return goal. 

“A few years ago we were interested in impact but our mandate to meet returns and with our fund growing we couldn’t get sufficient comfort in scale in a meaningful way,” she says. 

“We couldn’t invest in size and be able to measure what we were getting out of that. 

“There has been an evolution happening in the industry that has helped us get comfort that we can find managers that have that intent, and we needed those manager to report ideally on a comparable basis.” 

The fund has developed an impact investment framework with a five-step process covering qualification, measurement, reporting, analysis and management. 

The fund’s preference was to adopt, and if needed adapt, an off-the-shelf solution, given the progress and convergence of existing frameworks, and it decided on the IMP 5 dimensions of impact as the most appropriate approach.  

“In terms of measurement we wanted to have a consistent approach so we are using the five dimensions of impact for working through our existing portfolio and to invest in new sustainability solutions. We are at the stage where we are putting the new framework through any relevant new investment that we do, and taking time to go through the existing portfolio for which investments qualify for impact.” 

Importantly the fund will continue to apply its standard sustainable investment framework to all investments, including those that don’t qualify as Impact investments.

“It doesn’t mean we won’t invest in something but we are making sure we are giving thought to if an investment creates impact or not and having the lens and giving sufficient consideration to impact investing.” 

Hart says the impact measurement is a work in progress with the first step to get really clear on what the fund was trying to achieve and ensuring a consistent methodology, criteria and expectations in measuring impact. 

“The external managers’ team, the internal team and our direct team all need a consistent approach,” she says, adding the fund has engaged some of its managers, including Generation Investment Management which it appointed only this year, and are leveraging some of their expertise. 

“We have leveraged our network to help us form our solution and that has helped us,” she says. “We are on the cusp of having a lot more clarity and visibility.” 

Other tools are also being created for the investment team, including a dashboard, to provide visibility to the team internally and to help educate them. 

The predominant themes that are being measured are positive environmental impacts, with Hart acknowledging the social aspects are much harder to measure. 

“The next stage is to think more about where the opportunities are, where we can focus our effort to get impact and map that against the SDGs,” she says. “We will get more sophisticated.”