The New Zealand Superannuation Fund (NZS) has released a cache of documents detailing the rationale for its recently-implemented portfolio carbon-cleansing strategy including a previously-unpublished analysis by Mercer.
In its bespoke study prepared for the NZS and 17 other global institutional investors in October 2015, Mercer lists four portfolio ‘risks and opportunities’ facing the NZ sovereign wealth fund.
As well as recommending NZS shift some of its passive equities exposure to a “low-carbon alternative” – which it did this September – Mercer says the $35 billion plus fund should address an overweight energy exposure in its active equity allocation, consider investing more in emerging markets and “niche exposures” such as insurance-linked securities (ILS) or catastrophe bonds.
Mercer also suggests the NZS could appoint a number of “global equity sustainability-oriented thematic managers” to help meet climate change risk reduction goals.
According to Mercer, research shows “… the potentially positive influence that the addition of one or more sustainability-oriented managers could have on the overall sector profile of NZ Super’s equity exposure”.
NZS currently lists 33 external managers, none of which fit under the ‘sustainability-themed’ specialist label. The fund has not appointed any new managers this year with the roster thinned-down from a peak of more than 40 a few years ago.
However, NZS has assumed more investment management duties in-house including taking a stake in an Australian beef farm operation earlier this month.
The report says climate change would have a nuanced effect on agriculture globally, urging NZS to embark on a granular analysis of its exposure to the asset class (along with associated ‘real’ assets such as property, timber and infrastructure).
“[NZS should] Consider reviewing the underlying location exposures, with differing impacts expected for each of the four climate risk factors [technology, resource availability, physical damage, and policy] over various time periods,” Mercer says
The Mercer study notes NZS could further ameliorate portfolio climate changes risks by investing more in ILS, catastrophe bonds and other ‘weather hedging’ instruments.
NZS has catastrophe insurance mandates with two managers – Elementum and Leadenhall, appointed in 2010 and 2013, respectively – but the analysis says the fund should be open to other opportunities.
“… we should also keep in mind there are other ways to invest in the weather, such as through weather derivatives which provide exposure to longer term weather shifts,” Mercer says. “While this segment of the ILS market is presently much smaller even than the catastrophe segment the exposure base is actually much larger. If weather hedging takes off in the investment industry the same way currency or interest rate hedging has then this market would be significant.”
Based on the 2015 actual investment settings Mercer says climate change would carve off between 0.1 per cent and 0.37 per cent each year from NZS returns over the long term while the-then reference portfolio would see annual returns drop by 0.09 per cent to 0.55 per cent during the same time period.
The Mercer paper expanded on its earlier climate change paper while adding specific detail for the 18 contributing institutions, which included Australian fund Cbus, QIC and State Super Financial Services as well as US, UK and European investors.
Elsewhere in the NZS document dump, chief investment officer, Matt Whineray, and head of responsible investment, Anne-Maree O’Connor, reiterate the fund’s preference for engagement over divestment in battling the effects of climate change on its portfolio.
“We also believe that we should use all tools at its disposal,” the NZS paper says. “These include: active ownership; enhancing investment decision-making tools to account for climate change risk; utilising low-carbon indexing; investing opportunistically in alternative energies; and operating transparently to be held accountable to a lower carbon footprint for the Fund as a whole.”
Another paper concludes the NZS should prepare its investment strategy under an assumption climate change would see global temperatures increase by 2 degrees C over the long term “and hedge this with a less ambitious but Co-ordinated action scenario (3DC)”.
“Specifically this requires developing a strategy for:
- applying geographic risk assessments and diversification to manage risks within our rural, timber, property and infrastructure portfolios.
- applying sector risk assessments (including using carbon footprinting) to investment selection and weights across our equity portfolio and active opportunities.
- encouraging companies and sectors to develop their own climate strategies in order to address systemic issues across the portfolio.”