New Zealand Super has radically slashed the holdings in its passive equities portfolio as it re-aligns the portfolio with a Paris-aligned benchmark. It’s part of the fund’s shift to a sustainable finance focus which includes improving the fund’s already-good ESG profile and a more long-term future focus on impact investing.

The decision on what benchmark to use is important for asst owners, and never more so than when they seek to achieve a net zero or sustainable finance target. New Zealand Super recently decided to change the benchmark of its large passive equities portfolio to a Paris-aligned benchmark as it seeks to improve the ESG profile of its investments.

It’s part of a move to sustainable finance by the fund which follows 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.

Rishab Sethi, the fund’s manager of external investments, describes how the last review in 2019 by Willis Towers Watson included a fulsome review of RI practices but recommended that the fund needed to think a bit deeper about what RI looked like over the decade and how the fund wanted to set itself up for that.

“Others may have leapfrogged us in terms of global best practice,” he lamented.

The most recent review initially looked at what other institutional investors were doing, what constituted best practice and how NZ Super’s existing activities and RI frameworks stacked up against that.

The upshot of that was a fairly significant pivot to ‘sustainable finance’.

“We always integrated ESG into investment decisions,” Sethi told Top1000funds.com in an interview. “We would keep doing that while fulfilling our financial purpose but we also wanted to think about the consequences of our decision on society and the environment as well. Not just the risks of it, but the consequences.”

The naval gazing also resulted in the NZ$56 billion fund being firm in its commitment to be part of the solution.

“In effect the system as a whole may be considered to be not very sustainable so what could we do to make the financial system as a whole more sustainable? Recognising we are a small fund at the end of the world,” Sethi says.

Choosing a benchmark

New Zealand Super took a big step back in 2016 to shift its policy benchmark to a climate benchmark (See New Zealand Super adds climate alpha) on the premise that climate risk was not suitably compensated.

“We wanted to rid the portfolio of the uncompensated risks,” Sethi says. “But there is more to sustainability than just climate, so we were doing a disservice by not having a bigger picture approach to sustainability.”

The result was twofold. A big picture approach to impact, which will result in a significant shift in the way the fund invests, and will take three to five years to rollout.

The second more near-term change was improving the ESG profile of investments.

“We asked can we continue to achieve our financial objectives but improve the ESG content of our portfolio and make the portfolio better or stronger?”

While the intention is to cover the entire portfolio, the most obvious starting point was the biggest piece of the portfolio, the NZ$25 billion passive equities portfolio.

“The hardest decision that we had to make was: do we change the benchmark or do we change the actual portfolio and leave the benchmark unchanged?” Sethi explains.

“The board chose to own it and to change the benchmark itself.”

The result was a move from a custom version of the MSCI All Country to the MSCI World Climate Paris Aligned index and the MSCI Emerging Markets Climate Paris Aligned index.

In the process about 7,000 securities were culled from the portfolio, reducing the passive equities to about 1,000 names.

Sethi , who took on the role of running the process and thinking around improving the ESG content of the equities portfolio, says one of the biggest lines of enquiry following these changes was whether the portfolio would be diversified enough.

“We had to gain comfort that we are diversified enough. The benchmarks serve as our reference portfolio which have certain principles including diversification, low cost, simple etc.”

As part of the process the fund reviewed 25 indexes across four different providers considering three broad themes.

“We looked at whether the new index matched up to the financial characteristics we are leaving behind. Also what do the sustainability characteristics look like and do we have a measurable improvement? Is it readily implementable, are there outstanding derivative contracts we can use, will banks give us quotes on these at low costs?” Sethi says, adding that 12 months ago the MSCI

Paris-aligned index that was selected was in a good position on all of these criteria.

One of the fund’s goals as part of the sustainable finance re-think is to change the system as a whole, and in order to do that it wants to be a leader and bring other investors along for the ride.

“We are hoping by choosing an off-the shelf product it could provid greater liquidity and help make it a market standard.”

Active is harder

While the passive equities significantly shrunk in the process, the actual equities portfolio has about 3,000 portfolio companies.
“We still have a bunch of active strategies – in value, low-volatility, quality and multi-strategy portfolios – which re-introduce some names to the portfolio. Some of those names may have been in the passive equities and so culled but now may survive in the active part of the portfolio.”
Sethi says the team is undertaking a piece of work to think about active strategies and what is needed to make that portfolio sustainable.
“Research on our active portfolio is under way, it is hard,” Sethi concedes. “When canvassing for value stocks, quality, momentum etc when combing the world for those, if you start restricting your world you won’t find the factor alpha you are looking for. You do need to start with a broad universe. I would be surprised if we are able to say in a year that an actual portfolio of 1,000 names is sufficient to represent passive and active.”
While Sethi says within the passive portfolio the main management decision is the choice of the benchmark, there is also a question of replication and for New Zealand Super that is normally done by third parties such as Northern Trust, State Street and UBS. It also uses derivatives in house.
All factor equities portfolios are managed externally by AQR, Northern Trust and Robeco and they are doing work on how to incorporate sustainability factors into the typical factor portfolios.
For example Sethi says AQR is doing research to introduce sustainability in a classic mean-variance optimisation framework.
“Given that model looks to maximise return for a given level of risk, it’s asking can you maximise returns and sustainability for that given level of risk, tackling it as a portfolio construction issue.”
The fund uses a lot of Bridgewater’s research on this topic as well.
“One of the questions we get is are you doing it this in the pursuit of alpha? For us the answer is categorically no. We don’t know if there is excess return to be gained from sustainability investments, but we believe it won’t detract from returns.”
From passive and then active equities the fund will look at its fixed income and private market portfolios.
“The overall aim is to be sustainable across the entire portfolio. That might not be the same thing as being Paris-aligned across the entire portfolio. For us that is not an objective but a solution that is helping us become more sustainable.”
The fund does have a net zero 2050 goal, so everything is evaluated in that context.

Norges Bank Investment Management, NBIM, investment manager for Norway’s NKK 12.72 trillion ($1.28 trillion) Government Pension Fund Global, has unveiled its latest investment strategy for the period 2023 to 2025 outlining a contrarian approach that will capitalise on periods of volatility plus boosted, internal technology expertise in its quest to become the best, large investment fund in the world.

“We have made a detailed plan which outlines how we intend to become the leading large investment fund in the world. We look forward to implementing this plan over the next three years”, said CEO Nicolai Tangen, speaking at the launch of the strategy.

Performance

NBIM will increasing use active management to exploit periods when it believes “variations in asset prices are excessive.” Such positions will apply across the fund’s equities, fixed income and real assets exposures. “Our active risk-taking will vary as market conditions change,” the report says.

NBIM manages assets close to a benchmark index comprising 70 per cent equities and 30 per cent fixed income.

However, the asset manager believes some investment opportunities merit diversifying beyond the reference index, particularly in unlisted assets. “All our investment processes have active elements,” it states. “This improves our ability to achieve the highest possible return and to be a responsible owner. Our long horizon enables us to act differently from other investors in difficult and illiquid markets. We believe that the most profitable investment opportunities arise in volatile markets.”

NBIM uses a range of investment strategies grouped into three main categories: market exposure, securities selection, and fund allocation applied across equity, fixed income, and real asset management.

Contrarianism will be a key part of strategy going forward. “We will seek to buy when others want to sell and sell when others want to buy,” says the report, adding NBIM will support portfolio managers who “dare to be contrarian and avoid herd behaviour.” The asset manager will also develop its investment simulator to analyse investment decisions, systematically learning from mistakes, and providing portfolio managers with feedback so that they can make better decisions in the future.

The largest element of the equity allocation is managed internally in the market exposure strategy. NBIM invests broadly in the companies in the benchmark but seeks to avoid mechanical benchmark replication with its high trading costs. NBIM also enhances return by following a diversified set of index refinement strategies, such as corporate action and capital market strategies. Going forward, the fund plans closer collaboration between traders and internal portfolio managers and says it plans to further automate trading processes.

Forensic analysis

In the fundamental strategy, NBIM pledges to expand “forensic accounting and behavioural analysis to reduce exposure to companies” it expects to underperform. It will take slightly larger stakes when it has reason to believe companies will outperform and will also use external managers in segments and markets where it believes they will enhance returns – or mitigate losses. NBIM will also pursue opportunities to invest in companies before they list, pre-IPO. “This would give us access to companies earlier in the company life cycle and potentially enhance returns.”

Fixed income

The main purposes of the fixed income portfolio is to dampen fund volatility, provide liquidity, and harvest risk premia in the bond market, says the report. As in equities, NBIM will invest in selected segments outside the 30 per cent allocation to diversify the portfolio and harvest risk premia. It will invest in corporate bonds based on company research, utilising its company knowledge across equities and fixed income.

Between 2016 and 2020 the relative performance for internal fixed-income management was 45 billion kroner ($5.1 billion), the most successful period for the allocation in the history of the fund. The allocation is run by a team of 25 portfolio managers, 10 analysts and 15 traders across different time zones invested across geographies, currencies, sectors and types of issuers.

Real estate

In real estate, NBIM will target an allocation of between 3–7 percent of the fund. The portfolio, which consists of listed and unlisted real estate, will actively exploit periods of disruption in the market. NBIM will target more development projects in the coming years and will adapt investments to meet increased demand for energy efficiency and flexibility in buildings. “To access the most attractive assets at acceptable risk, we will invest alongside best-in-class investment partners with a proven development track record,” it says.

Technology

Elsewhere the strategy outlines the investor’s pledge to develop tailored trading solutions. “We will buy adaptable and well-proven solutions externally when appropriate,” it says. “We will use our immense set of market and non-market data to support machine learning with the aim of strengthening our investment processes.”

Rather than use consultants, NBIM plans to hire and develop its own people, developing an internal, expert, technology culture in the coming years. “A close relationship between technology and the rest of the organisation ensures that technology developments are tailored to our needs,” it says.

ESG

NBIM integrates responsible investment and ownership at three levels. It works at the market level to elevate global standards for all companies; it works at the portfolio level to monitor ESG information and integrate this into the management of the fund and it works at the company level to promote good governance and sustainable business practices. “We will be a transparent and result-oriented owner. We will continue to develop our activities in collaboration with companies, peers, academia, and other stakeholders,” the report concludes.

 

 

CPP Investment’s current forecasts for contributions and compound investment earnings have it reaching the C$1 trillion mark by about 2030 (and $C3 trillion by 2050).

Chief investment strategist Geoff Rubin told the Investment Magazine Fiduciary Investors Symposium in Melbourne in November that the fund is already planning for that eventuality and actively designing the best structure and strategy to support it.

Rubin said CPP’s growth to date had been relatively straightforward, in the sense that it was endowed with C$200 billion and set out to build the investment capabilities and supporting functions it needed to transition those funds from passive management to active management.

But it’s now at the size, and expecting to achieve the kind of scale in the near future, that requires its various activities to be more joined-up, better coordinated and more focused.

Rubin said CPP has identified four clear areas where it can gain an edge over its competitors: being larger and more liquid, being smarter, being better connected, and being better run.

He said these four “sources of edge” would create a foundation for an organisation that has a simple set of strategic objectives encompassing a single purpose, clarity on its competitive edge, strong relative value capabilities and a set of cultural norms and expectations. Plus effective delegated accountabilities, optimised engagement with partners, methods for measuring success and ways to drive improvement, a set of common capabilities, and a highly optimised decision-making.

“This is some work we started to do to try to identify all possible sources of edge we as an organisation might draw upon,” Rubin said.

“This is not to say we [currently] possess these edges or possess them everywhere. I don’t think any institution possesses them all. But where can we start thinking about very clear demonstrable sources of edge that we can track, that we can measure, that we can push ourselves to perpetually sharpen – in particular, can [we] draw upon combinations that few other investors can?

“If we want to achieve that objective delivering the most return it’s very clear we need to be sharp and picking our spots as to where we apply these sources of edge.”

Rubin said a clear edge for CPP was to exploit its scale to gain an “incredible vantage point over global capital markets”.

“We have these capabilities, we’re invested everywhere, we see a huge swath of the investable capital markets across the world,” he said.

“That should allow us to identify where incremental risk-adjusted return prospects are greater or lesser, and then try to flow capital and other resources to those areas of greater interest, and away from others. No one in the world does that well, because it is really, really tricky, but we’re going to try to build out some of those systems.”

Rubin said CPP’s claim it could gain an edge by being smarter than the opposition was put forward tongue-in-cheek.

“To be honest, this is one that we kind of put up cheekily, because it certainly feels like a bunch of hubris to say you can be smarter than the competition in the space in which we compete,” he said.

“I don’t know that’s likely individually; maybe it’s likely at an organisational level. Maybe we can build smart organisations that draw connections among individuals and can invest in a way that really demonstrates unique insights. But gosh, this was really tough.”

Rubin said it was clear, however, that CPP could be better connected than many of its competitors.

“This is a good one for us,” he said. “We have, by virtue of developing our organisation in the way that we have, great connections with partners, with counterparts around the world. I think this could be a real source of edge advantage.”

Being better run than the competition presents a genuine challenge, Rubin said.

“Can we actually create a clearer, a better empowered, a better developed organisation that allows us to invest in ways that will deliver outsized returns relative to competitors in these markets in which we invest?” he said.

Rubin said the work CPP is currently undertaking is designed to help it identify how it can be “very, very clear and deliberate to ensure that everywhere we’re investing is being done so with some advantage”.

“This is effectively what we have determined we need to be as an organisation in order to effectively invest a trillion dollars and continue aspiring to deliver the most investment return we can, at our targeted level of risk for that very clear objective,” he said.

Next year, Railpen, investment manager for the £35 billion UK railways pension schemes, will focus engagement and AGM voting on affecting corporate change around cyber security, climate transition, biodiversity, workplace treatment and mental health. The asset manager will also enhance its voting and engagement positions on dual class share structures (which give company founders more votes per share) fair pay, the treatment of gig economy workers and modern slavery.

Railpen’s decision to integrate mental health into its voting policy follows research which found that only 13 per cent of UK listed companies’ annual reports discussed mental wellbeing in relation to health and safety or risk assessment, despite the clear materiality of mental health to a company’s ability to attract and retain employees.

An engaged, motivated, and supported workforce is vital for sustainable financial performance, and Railpen expects portfolio companies to engage meaningfully with their workforce and demonstrate a healthy corporate culture, said the asset manager in a statement.

Rather than outsourcing stewardship, engagement at Railpen is in the hands of its own internal team to better align stewardship with its ESG objectives, particularly its ambitious net zero targets. It’s a level of control that is particularly important when it comes to timing engagement and knowing when to escalate.

“This year we have explicitly flagged our expectation that portfolio companies look after their entire workforce, including both directly and indirectly employed workers, and effectively communicate to shareholders the steps they are taking to do so,” says Caroline Escott, senior investment manager at Railpen.

“Our previous research with the CIPD, PLSA and High Pay Centre found that many of even the largest UK companies fail to appropriately discuss their support for indirectly employed workers. This is an issue for many firms, but especially for those in the ‘gig economy’ where it is particularly important for investors to be able to gauge the rights granted and level of support provided to workers.”

The latest voting policy reflects Railpen’s ongoing corporate governance themes of board composition and effectiveness, remuneration and alignment of incentives and shareholder rights, and risk and disclosure.

Pre-declaration

In another step, Railpen will consider pre-declaring voting intentions on specific resolutions. The idea being to send an important signal to the company and the market. “Railpen values open dialogue with companies and therefore will continue to notify companies of voting intentions in advance to support effective engagement, where they are priority holdings,” it said.

A key 2023 priority is ensuring that net zero pledges are turned into real action. Next year’s voting policy also sets out Railpen’s belief that a good transition plan should set out a company’s decisions on decarbonisation and adaptation in a comparable way with clear quantification of interim targets and milestones.

Corporate transition plans should also focus on material actions, activities and accountability mechanisms, account for biodiversity loss, natural capital impact and social impact as key externalities, clearly link targets, financial planning, and capital allocation and, where offsets are used, adhere to best practice principles.

Railpen will also urge portfolio companies to consider how they can better appraise and account for nature-related risk and redirect capital allocation decisions towards nature-positive outcomes. They will consider voting in support of resolutions which encourage companies to address drivers of biodiversity loss.

Although mindful of the ongoing challenges in accessing the best possible data, reporting and analysis of these types of risk is evolving and to support its assessment of companies’ transition plans, Railpen will use its proprietary framework and the UK Transition Plan Taskforce (TPT) best practice guidance.

Cybersecurity

Railpen will also urge companies to do more to counter rising cybersecurity risk. Building on its longstanding engagement with at-risk companies on cybersecurity (both directly and as part of the UK Cybersecurity Coalition) in 2023 Railpen will ask companies to explicitly disclose the governance and oversight structures in place to identify and manage cyber risks, as well as provide timely reporting of any breaches and the measures taken in response.

Where these risks are not deemed to be appropriately managed, the pension fund will vote against audit and other committees, and consider voting against reports.

“The world is constantly adapting, and we need to ensure that we are ahead of major sustainability and governance challenges so we can effectively engage with portfolio companies on behalf of the members of the railways pension schemes. Laying out a clear, defined voting policy allows us to highlight our expectations of performance on key ESG risks in a way that is accessible to our portfolio companies, our external managers, and our beneficiaries,” said Michael Marshall, Raiplen’s head of sustainable ownership.

“In the 2023 AGM season, we will continue to exercise our votes on those resolutions where we believe our vote will have the most impact. We take our role in enhancing the long-term investment returns of our beneficiaries extremely seriously, and doing so in a way that benefits the world around us and the needs of our members now and in the future,” he concludes.

 

 

The credibility of transition plans is under scrutiny because while sustainable investing is booming real world impact is going in the wrong direction. In response investors need to innovate on the nature of investment mandates says Colin le Duc, a founding partner of Generation Investment Management.

Innovating on the nature of investment mandates is the next stage of sustainable investing, said a founding partner of London-based sustainable investment pioneer Generation Investment Management, as rising carbon emissions – despite booming sustainable investing – lead to growing criticism of the ESG universe and its real-world outcomes.

Climate-led or impact investing is the next stage where investors take climate objectives as their “north star” and optimise risk, return and impact, said Generation founding partner Colin le Duc, speaking on the Top1000funds.com podcast.

This is distinct from the old view of sustainable investing which aims to deliver long-term financial returns in a sustainable way, le Duc said. Impact investing enables investors to tackle difficult issues more directly, rather than merely picking the “low-hanging fruit with…investment mandates [that] work today.”

“So, you know, not just investing in de-risked renewables in North America, for example, or not just buying the Tesla stock or whatever it might be,” le Duc said. “You actually need to focus on the hard-to-abate sectors.”

Carbon emissions continue to rise, he said, noting emissions will increase 2-3 per cent this year and are projected to rise up to 10 per cent by the end of this decade, at a time when they need to go down by 50 per cent.

Podcast host Amanda White, director of institutional content at Conexus Financial, pointed out only 10 per cent of capital flowing into climate is going to the solutions for the highest emitting, hard-to-abate sectors that create more than half of global emissions. 

Le Duc welcomed criticism of ESG as part of the “maturation of the sustainable investing and the ESG investing idea and space” and a pushback against greenwashing.

And he praised the “radical transparency” brought by Al Gore-backed initiative Climate TRACE, which moves away from voluntary reporting and tracks the biggest sources of greenhouse emissions for a more accurate– albeit uglier–view of progress on carbon reduction.

Climate TRACE had delivered news that is “very, very bad on actual levels of emissions, which are much, much higher than has historically been reported,” le Duc said.

“Real world impact is going the wrong way, even though sustainable investing is booming,” le Duc said. “So there’s a mismatch there, which I think is starting to play out in all of this greenwashing, and the pushback, and the confusion around what ESG and sustainable investing is.”

But while more reliable data is critical to understand the systemic risk the financial system is running with its carbon dumping, he warned that “perfection can be the enemy of the good,” and that “if we wait for perfection on reporting, every day we’re missing the 1.5-degree window.”

Systems need to be put in place concurrently with fixing the problem, he said, and “being directionally correct is actually better than waiting for perfection on data clarity.”

Unlike harder-to-define measurements such as human health or poverty, climate at least has a well-understood and broadly accepted metric to measure it, which is a ton of CO2, le Duc said.

The United Nations Climate Change Conference, known as the Conference of the Parties or COP, “probably needs a bit of a reboot…but it is the best we’ve got in terms of a global forum to talk about a global issue,” le Duc said, and it would be “extremely dangerous to dismantle it because…there’s no other forum like it.”

Collaboration is critical when facing a systemic challenge like climate change, le Duc said, and initiatives like the Glasgow Financial Alliance for Net Zero (GFANZ) encourage corporates to “put their neck on the line and say: ‘This is what we believe in, in terms of the climate transition.’”

Questions remain about whether these entities will stick to their commitments, he said, particularly in light of the wide-ranging challenges 2022 has brought to global markets, and there are signs some parties are “backtracking” or “push things a little bit to the right.”

With extremely high short-term energy prices, investors are weighing up whether they should “leave money on the table to stick to climate commitments,” he said.

“I think there’s a real focus on credibility of transition plans right now,” le Duc said.

 

Good quality, holistic research is more important than ever when assessing emerging markets investments with a sustainability lens, argues a portfolio manager at Newton Investment Management.
With volatility a strong theme of markets and economies over 2022, some investors have de-risked their portfolios and lost their stomach for riskier emerging markets investments. But a portfolio manager at Newton Investment Management argues emerging markets still offer value if you know how to find it.

Alex Khosla, portfolio manager in the emerging markets and Asia equities team at Newton Investment Management, said emerging markets cover a heterogeneous group of countries where four in every five people live today, accounting for about half of global GDP despite being serviced by about 10 per cent of equity allocations in the world.

There are also compelling reasons for sustainability-focussed investors to be in emerging markets, Khosla said. “Two-thirds of the world’s investment needs for a sustainable future, according to the UN, need to happen in developing countries,” he said.

Speaking with Conexus Financial managing editor Julia Newbould on podcast series Market Narratives, Khosla said Newton begins its search for emerging markets investments by looking at companies and asking three questions: What need is the company addressing? Is the company providing a new or innovative solution to that problem? Can you feel alignment, integrity and competence among the people running it?

 

Newton looks broadly at the industry and its relevance to the country and the region, asking questions like whether the company is investing capital in a way that will lower pricing to consumers, provide a particularly innovative solution or reach a new group.

This could include looking at whether offerings such as food or medicine or travel are a particularly pressing need in the targeted markets. Is the country facing problems with financial under-penetration? Are there negative externalities a venture, such as water intensity or biodiversity risks, and do they outweigh the benefits of the project? Is the company leading or lagging its industry in addressing these problems?

Newton also has well-resourced teams looking more broadly at things like geopolitical risks and their potential impact on different asset classes, leading the group to avoid or be particularly wary about investments in some countries or regions.

“Where you have weak institutions, that can result in things like kleptocracy and things like war, they’re often not great environments for businesses that are looking to try and sustainably solve and address needs in a society,” Khosla said.

Looking at management purpose involves analysing the alignment, integrity and competence of the people at the company, which helps ensure the company stays focussed on sustainable growth.

“Assessing management purpose is very hard, and it’s very qualitative but we do think it’s critical,” Khosla said. “We also think it’s why it’s important to have a team of investors that are trained across a wide degree of skill sets because some of these more qualitative things are difficult for investors trained to build spreadsheets.”

As an example of differentiating companies based on management, Khosla pointed to the solar industry which is increasingly important for renewable energy, and also increasingly crowded. But among the myriad companies in this space, it is a smaller number that are truly committed to innovating to reduce the cost curve, he said.

“Some companies are just there to empire build, and some companies are more interested in scale for scale’s sake, rather than really identifying where they can improve the industry’s cost profile by doing specific things around innovation,” Khosla said.

There are also examples of emerging markets companies “where the owners or the management of that company really found themselves in that industry because of some sort of patronage or some sort of link to a government that wasn’t because of their competence, it was because of other things,” Khosla said. “And we tend to believe that in the very long run those businesses are more likely to be found out.”

Differentiating between companies can be harder in some emerging markets, with limited data or limited voting posing difficulties for sustainability in particular. But these obstacles aren’t insurmountable, Khosla said.

“We do think there’s enough data now to–as long as you work hard and you keep plugging away–to start really trying to track company progress on whether they’re delivering…those sustainability goals.”

Active engagement on sustainability issues can also help drive emerging markets companies in a positive direction, he said, and also gives the investor the chance to analyse the management’s response.