The global macro-economic future remains precarious amongst huge uncertainties according to the head of the capital markets department at the IMF, Tobias Adrian, who warns of fragilities including the disconnection between the real economy and financial markets, and growing debt, as potential interruption to future growth.

Global growth is projected at 5.2 per cent in 2021 according to the IMF with wide negative output gaps and elevated unemployment rates this year and in 2021. According to the recently release world economic outlook from the IMF, A long and difficult ascent, after the rebound in 2021, global growth is expected to gradually slow to about 3.5 per cent into the medium term.

According to the most recent report, global growth is projected at -4.4 per cent in 2020 which is a less severe contraction than was forecast in its June world economic outlook. Importantly in its October outlook, the IMF says the pandemic will reverse the progress made since the 1990s in reducing global poverty and will increase inequality.

Speaking at the launch of the global financial stability report this week, Adrian who is financial counsellor and director of the monetary and capital markets department at the IMF, said policy makers have made bold unprecedented action to safe guard the financial system.

“For the moment near-term financial stability risks have been restrained thanks to extraordinary monetary policy and massive fiscal support,” he said. “That dramatic action has stabilised global financial markets, boosted investor sentiment and maintained the flow of credit. Critically the size of policy support has helped prevent the destructive micro financial feedback loops that were so prevalent in the financial crisis in 2008.”

However, Adrian says that some pre-existing vulnerabilities are now intensifying representing potential headwinds to the recovery.

“Risks to growth are still tilted to the downside and the probability that global growth will fall below zero in 2021 is close to 5 per cent. This tail risks suggests the economic future remains precarious amidst huge uncertainties.”

He says there is a risk that recent policy actions may have unintended consequences beyond policy makers stated objectives.

In particular he points to the persistent gap in financial markets where rising stock market valuations and the weak performance of the real economy are disconnected.

“This gap is hopefully going to narrow as the economy regains steam. But if the recovery is delayed, if it takes longer than expected to get the virus under control then investor optimism may wane,” he said. “Policy makers face a tradeoff in decision making between support needed today and implications of rising vulnerabilities for growth in the medium term.”

Adrian also pointed to the higher and increasing levels of debt in some sectors pushing solvency risk into the future.

“Renewed liquidity pressures could easily morph into insolvencies especially if the recovery is delayed. The resilience of the banking sector is likely to be tested. Our analysis shows that some banking systems may suffer significant capital shortfalls, and a large number of firms and households won’t be able to repay their loans,” he said. “We also have concerns about the non-bank financial sector institutions which now play a growing role in credit markets in advanced economies including its riskier segments.”

He said the increased links between corporations, banks and non-bank financial institutions imply that at some point fragilities could spread through the entire financial system.

“After the pandemic is under control a robust financial sector reform agenda should focus on rebuilding bank capital buffers, strengthening the regulatory framework for non-bank financial institutions and stepping up prudential supervision to contain excessive risk taking in a lower for longer interest rate environment.”

Adrian called for policy makers to carefully sequence their response to build a bridge to a sustainable recovery. He said as economies reopen, monetary policy should remain accommodative to sustain the recovery and liquidity support should be maintained.

“A robust framework for debt restructuring will be critical to reduce debt overhangs to resolve non-viable firms,” he said.

Importantly Adrian called for the immediate policy agenda to be mindful of one over-arching objective: the transformation of today’s carbon intensive economic model and a transition to a greener, cleaner and more stable economy.

CFA Institute recently released the report Climate Change Analysis in the Investment Process to help investors gain the knowledge needed, and understand the resources available, to better incorporate climate change analysis in the investment process. The report includes a survey of global CFA Institute members and showed that 75 per cent of C-level executives surveyed believe that climate change is an important issue. However, only 40 per cent of all survey respondents (a larger sample size) say that their firms currently incorporate climate change analysis into the investment process. This gap between aspiration and the current level of practice on climate change integration at global financial firms speaks to the need for more resources to train today’s analyst and portfolio managers in climate change related analysis.

Climate change will have a substantial economic impact on earth in the coming decades, and the longer it takes to mobilise action around mitigating climate change, the larger the bill will become.

A recent Morgan Stanley report estimates that $50 trillion dollars will have to be invested in order to reach net zero carbon emissions goals by 2050. In a 2019 speech, Sarah Breeden, then the Bank of England’s executive director of International Banks Supervision, stated that if no action is taken to mitigate climate change, losses could be between $4 trillion and $20 trillion.

These substantial economic and investment costs that will be shouldered by global society can be aided by the financial community doing what it does best – efficiently allocating capital. At this point however, there are large gaps in climate data. Financial professionals need complete, comparable and accurate data on climate change from companies in order to do the job of efficiently allocating capital when it comes to the issue of climate change.

Unfortunately, the tools needed to incorporate climate change into the investment process are either lacking or are not well known by many financial professionals. In the survey mentioned above, of financial professionals who say they do not incorporate climate analysis into the investment process, 57 per cent say that this is due to a lack of proper climate related investment and analysis tools.

However, this is changing. With standards like the Sustainability Accounting Standards Board (SASB) focusing on material climate issues and the Task Force on Climate-related Financial Disclosures (TCFD) providing a framework for engagement around climate issues, more tools are being made available. The IFRS currently has a consultation paper out on sustainability reporting because it realises the importance of getting sustainability accounting right, so that externalities such as climate change receive the proper accounting treatment.

From accountants and auditors to portfolio managers and analysts, financial professionals have an important role to play in addressing climate change. This will take increased investment in education and training, as well as concerted engagement with companies and policymakers to ensure that what gets measured, gets managed.

CFA Institute has detailed the following steps that financial professionals, issuers and policymakers can undertake to help financial professionals include climate related analysis in the investment process.

  • A price on carbon: To underpin robust and reliable carbon pricing, CFA Institute calls on policymakers to ensure that regulatory frameworks for carbon markets are designed to deliver transparency, liquidity, ease of access for global market participants, and similar standards across jurisdictions.
  • Carbon price expectations included in analyst reports: CFA Institute recommends that investment professionals account for carbon prices and their expectations thereof in climate risk analysis.
  • Increased transparency and disclosure on climate metrics: CFA Institute recognises the coalescing of the investment industry around the SASB and TCFD standards for climate-related disclosures, which are the most relevant and succinct climate-related disclosure standards that address the materiality of climate-related risks.
  • Engagement with companies on physical and transition risks of climate change: CFA Institute suggests that investors should engage with issuers to ensure that climate data, scenario analysis, and related disclosures are sufficiently thorough to support robust climate risk analysis in the investment process.
  • Education within the investment management profession: Investors need to continue to educate themselves about climate change to provide the climate-related analyses clients require.
  • Policymaker involvement: Investors need to continue to urge policymakers to craft regulations to ensure that investors have the tools they need to do the work of finance.

Matt Orsagh is senior director, capital markets policy at CFA Institute

Watered-down shareholder participation at AGMs, due to virtual meetings during the pandemic, is sounding alarm bells at APG, the largest pension fund in Europe, where collaboration with other asset owners and organisations is the beating heart of its ESG strategy and a central tenet to its stewardship response to the pandemic.

Virtual annual meetings may be the pandemic norm, but Dutch asset manager APG is concerned about the consequences of lost face-to-face engagement and the ability of investors to collaborate to put pressure on companies to change.

“In our view, AGMs as they are now can only be an interim solution,” said Claudia Kruse, managing director, global responsible investment and governance, APG, Europe’s biggest pension fund in an interview with Top1000funds.com.

The majority of AGMs that APG has attended since the shut down due to the pandemic are one-way webcams, simply speeches that don’t involve two-way dialogue. Nor is the advance voting process as effective according to Kruse.

“We’ve participated in 10 webcast AGMs and sometimes put forward questions as part of a collective engagement, but of course the votes are cast in advance,” she said.

In other cases, questions are not put forward as part of collective engagement, and interaction between the board and retail investors is also lost. Possible solutions include hybrid models where investors can participate virtually in conjunction with a smaller physical meeting, said Kruse.

However, she said success here requires innovation and commitment by companies and boards and has revealed a disparity between different regions.

“In Asia, AGMs largely went ahead. In other countries we have seen more postponement or webcasts,” she said.

Her comments echo growing investor concerns that online AGMs, as well as postponed meetings and meetings being held behind closed doors, are stymying shareholders’ ability to participate as company owners. Only 36 per cent of questions posed to companies by shareholders at virtual AGMs in the US in 2020 were addressed at the event, according to Miriam Schwartz-Ziv, a lecturer at the School of Business Administration at the Hebrew University of Jerusalem in a recent study. It’s an issue on the PRI’s agenda where the stewardship team is advising signatories on how to navigate virtual AGMs and make sure their voices are heard.

“We are working with investors on guidance to navigate the virtual AGM season,” said the PRI’s Fiona Reynolds.

It’s no surprise watered-down shareholder participation is sounding alarm bells at APG. Collaboration with other asset owners and organisations is the beating heart of the asset manager’s ESG strategy and a central tenet to its stewardship response to the pandemic. APG has signed the PRI’s investor statement on the COVID response and under the Human Capital Management Coalition (an organisation comprising 28 global investors with a collective $4 trillion under management) engages on labour rights thrown into the spotlight by the virus, most recently with Amazon.

Looking ahead she sees opportunities for collaboration with DFIs like the European Investment Bank, the World Bank and the Nordic Investment Bank structuring investable COVID recovery loans.

“There is a real opportunity for investors to work with DFIs to design instruments we as investors can invest in and allocate capital to where it is needed for a sustainable recovery,” she said.

Elsewhere, APG’s collective asset owner engagement with the world’s worst polluters through Climate Action 100+ has encouraged companies like Shell to change, while membership of the Institutional Investors Group on Climate Change’s (IIGCC) Portfolio Alignment Initiative currently brings together 70 investors to help design and model asset allocations to fit Paris alignment by 2030. Closer to home, APG is leading the investor contribution to the Netherland’s National Climate Agreement, working to achieve measurable 2030 targets amongst all Dutch financial institutions.

Most recently APG is seeing the fruits of a partnership with Japan’s GPIF, PGGM and Norway’s Norges Bank on the Carbon Real Estate Monitor (CREM) and the exploration of decarbonisation pathways for global real estate come to fruition.

As APG continues its route to a climate neutral portfolio by 2050 and Paris alignment by 2030 the focus is on scenario analysis and strict targets, says Kruse. Recent pledges include a target to cut the listed equity portfolio’s carbon footprint by 40 per cent by 2025, phase out exposure to coal and tar sands and built a $15 billion allocation to in SDG 7 (clean energy) by 2025.

To meet the challenge, APG is planning sweeping new hires across responsible investment, she concluded. ”

We plan to hire an additional 100 people of which 70 will be in portfolio management including responsible investment. We are keeping our focus on long term.”

Pension funds need a generation of investment professionals that are willing to be brave and less conservative than their predecessors if they are to move to the systems level perspectives on investment that is required for better returns and societal outcomes, according to the co-head of the Thinking Ahead Institute, Marisa Hall.

ESG 3.0 will require systems level thinking on investment, and intentionality to work on the system, rather than just ESG portfolio integration, she said in a Conexus Institute Exploring Big Ideas webinar.

The Thinking Ahead Institute encourages both bottom up and top down thinking to solve systemic problems and let “a thousand flowers bloom”. Its aim is to mobilise capital for a sustainable future and it sees merit in seeing the investment industry and its connected parts as a system

“We are working on ESG 3.0 around the need for systems level investing and systems perspectives on investment. As an investor you can work directly on the system which leads into better and stronger investment results,” Hall says. “What we are talking about is instead of having ESG in the portfolio we are calling for greater intentionality to work on the system, and then get additionality and value creation within your portfolio.”

She says to effect change leading pension funds are executing through multiple touch points including capital allocation and strategic tilting, engagement, bottom-up security selection and top-down systems level engagement such as influencing industry groups, looking at mandate design, longer-term time horizons, governance and organisational design.

“Pension funds need a holistic approach and a mindset that focuses on intentionality to change the system,” she says. “They need to do more than just delivering pensions for members. Delivering what’s best for your members and the sole purpose test is linked to doing good for society and the environment and maintaining that social licence to operate. How do you achieve that? You need a generation of investment professionals willing to be brave and less conservative.”

Hall says another “big idea” the Thinking Ahead Institute is exploring is the concept of value creation, and translating the measurement of ESG to what it really means to create value for different stakeholders.

“We have been working on this concept of value creation. What is value and who are you creating value for? One of key concepts is that by creating value for a particular group of stakeholders you may be destroying it for another group. Profit for shareholders and externalities an example of that,” she says. “This is what we talk about the concept of 3D investing – risk, return and impact. Every investment decision we make has an impact on society it’s just in the past we haven’t put a weighting on that. We are not just talking about impact investing but the impact of investing, of our everyday decisions.”

She says when asset owners, managers and corporates talk about creating value for clients there needs to be a fuller description of what that means, and that starts with defining the time horizon.

“For example, if you are looking at a benchmark over a year then some of that value has a risk of being reversed. We need to be more transparent about this.”

She called on investors to look at ways to translate granular ESG measurements into value creation for stakeholders, and is an advocate of integrated reporting.

“It’s the concept of double materiality, firms needing to look at how they report on financial metrics and how they create long term enterprise value creation for investors, and balancing that with the impact on people and planet. Beliefs are really important in that.”

She encouraged pension funds to think about their time horizon and the fact that sustainability and long-term value creation potentially requires tradeoffs between current and future members.

“Your role as an asset owner is to understand those tradeoffs and balance intergenerational risks and needs, and that is tied into your role as a fiduciary and also your own career risks.”

In this Fiduciary Investors Series podcast, Amanda White speaks with John Claisse, the chief executive of Albourne Partners. Albourne, which is a leading consultant focused on alternative investments, has been advocating for better practice within the alternatives industry for many years and the discussion covers fee discovery and transparency; new initiatives around diversity and inclusion; and how alternative investment managers can incorporate ESG.

About John Claisse
John Claisse joined Albourne in July 1996, relocated from London to San Francisco in July 2013 and became Albourne Group CEO in August 2015. He is an equity partner and member of Albourne’s executive committee and also chairs the firm’s corporate planning council, which comprises Albourne’s function and region heads. Claisse helped develop the firm’s proprietary risk analytics and was formerly the senior analyst for quantitative equity strategies and multi-strategy hedge funds. He remains a portfolio analyst working with several public and corporate plans, large endowments and foundations. He holds a first class Mathematics Degree and a PhD from Sussex University.
Albourne is an independent advisory firm focused on hedge funds, private equity, real assets, real estate and dynamic beta. Founded in 1994, Albourne has over 250 clients with over $550 billion invested directly in alternative investments.

About Amanda White
Amanda White is responsible for the content across all Conexus Financial’s institutional media and events. In addition to being the editor of Top1000funds.com, she is responsible for directing the global bi-annual Fiduciary Investors Symposium which challenges global investors on investment best practice and aims to place the responsibilities of investors in wider societal, and political contexts.  She holds a Bachelor of Economics and a Masters of Art in Journalism and has been an investment journalist for more than 25 years. She is currently a fellow in the Finance Leaders Fellowship at the Aspen Institute. The two-year program seeks to develop the next generation of responsible, community-spirited leaders in the global finance industry.

What is the Fiduciary Investors series?
The much-loved events, the Fiduciary Investors Symposiums, act as an advocate for fiduciary capitalism and the power of asset owners to change the nature of the investment industry, including addressing principal/agent and fee problems, stabilising financial markets, and directing capital for the betterment of society and the environment. Like the event series, the podcast series, tackles the challenges long-term investors face in an environment of disruption,  and asks investors to think differently about how they make decisions and allocate capital.

New Zealand Super’s low-carbon reference portfolio has outperformed the original reference portfolio, adding NZ$800 million to the fund and providing evidence of ESG alpha.

The low-carbon reference portfolio, that until now has had targets of reducing emissions intensity by 20 per cent and its exposure to potential emissions from fossil fuel reserves by 40 per cent, has added about 60 basis points per annum to performance since it was brought in.

New Zealand Super incorporated the low carbon approach into its reference portfolio in 2016, making it a benchmark rather than an active decision, essentially creating a greater hurdle for adding value.

“The 60 bps difference between the low carbon benchmark and the old reference portfolio is consistent with our thesis that the market is not pricing climate risk properly,” Matt Whineray, the fund’s chief executive, said in an interview. “So not only has this approach reduced what we considered to be an insufficiently rewarded risk, it has also added return.”

Whineray does clarify that the relatively short time period is a caveat in looking at performance, but he points out that if it was a negative return the performance would be highlighted and the time frame overlooked.

“If it had been the other way and it was a negative 60 bps everyone would have ignored the time frame. It is comforting that this is consistent with our thesis.”

In 2017 the fund first made significant moves to make the portfolio resilient to climate risks, with 40 per cent of the fund at that time – the global passive equity portfolio – moving to low-carbon.

The transition involved moving NZ$950 million away from companies with high exposure to carbon emissions and reserves into lower-risk companies.

In equities the fund also use derivatives for exclusion. The portfolio completion team, under Mark Fennell, created a short swap consistent with the carbon benchmark.

“That’s been important too. I can tell from performance reporting we are outperforming the benchmark,” he said.

This year the fund overall underperformed the reference portfolio, due mostly to the underperformance of some of the strategies such as value and global macro, but it added value through those carbon exclusions.

The fund uses a carbon measurement methodology created in consultation with MSCI, and each year ranks all stocks by reserves, ownership and emissions intensity, filtering them according to the target criteria.

Having met the 2020 targets, new ambitious limits have been set and the fund now aims to reduce the emissions intensity of the portfolio by 40 per cent and fossil fuel reserves by 80 per cent by 2025.

As the targets get bigger the diversification of the portfolio gets lower but Whineray is not too concerned with that, citing a tracking error difference of about 50 basis points.

“They are not massively different portfolios because carbon exposures are quite concentrated in certain industries as you’d expect and the weightings of those sectors has been declining,” he said.

The fund’s climate strategy is built on the theory that climate risk is mispriced, but the board holds the executive team to account on the possibility that at some point the market will price it in.

“The market is getting better, but one of the reasons we said this is difficult for markets is because there are a bunch of different risks – transition, physical, consumer behaviour, liability – and a bunch of different paths to get to, is it two, three or four degrees?” Whineary said. “As governments put in new measures, corporates get better at disclosures [and] the market gets a bit better. But there is still uncertainty about how to get to wherever we are going. We are still comfortable that the mispricing exists.”

The fund has made a number of moves to make it resilient to climate risk and to make the most of opportunities in the mispricing.

The climate strategy is made up of four parts:

  • Reduce exposure to fossil fuel reserves and carbon emissions
  • Incorporate climate change into analysis and decision making
  • Manage climate risks by being an active owner through voting and engagement
  • Actively seek new investment opportunities for example in renewable energy.

The reduction strategy has been reflected mostly in the passive listed equities portfolio but also in factor mandates and other active mandates. Unlisted assets will be the next focus.

The investment teams have been working to include climate risk in the valuation frameworks so there is a more structured way of thinking of how to price the risk across investments. And the fund has been actively engaging across a number of different programs including Climate Action 100+.

Whineray says the fund has invested in renewable energy projects but is actively looking for more opportunities.

“The board has given us a nudge to say we’d like to see more of that and it’s something we need to pick up.”

The fund’s climate report was produced in line with the TFCD framework and coincides with the New Zealand government’s recent announcement that financial sector, publicly listed companies and Crown financial institutions, like New Zealand Super, will be required to report on climate risks based on the TCFD framework.

New Zealand Super has been recognised this year in the PRI’s Leaders Group 2020, which showcases leadership of 36 of its 3,500 signatories. The fund was recognised for its climate reporting.