The New Zealand Superannuation Fund (NZS) will venture further off-benchmark for its passive global equity holdings following a just-announced climate change policy.
According to a NZS spokesperson, the ‘bespoke’ passive offshore shares portfolio would take the first hit as the $31.6 billion fund implemented its wide-sweeping climate change investment strategy revealed last week.
While the climate change approach would be applied across all NZS investments in a “four-part strategy” – covering carbon footprint reduction, analysis, engagement and new investment opportunities – the spokesperson said the process would begin “where we can reduce climate risk as easily and quickly as possible”.
“Most of the fund’s carbon exposure sits within its global equity portfolio and so one of our first steps will be to target high risk companies in this portfolio for divestment,” the spokesperson said. “This will mean using quantitative rules to reduce holdings to zero in some cases, and potentially underweighting in others – so the portfolio will look different, and will be refined over time.”
Justine Sefton, a climate change specialist who helped develop the NZS strategy in a two-year consulting stint with the fund, said the move implies a major shift “from mainstream benchmarks”.
Sefton said the decision was “based on the NZS belief that climate change presents material risks – and upside opportunities – to long-term investors and that the market is not fully pricing these into asset valuations ”.
She said it was understandable that the fund was building the climate change portfolio construction methodology in-house given the complexity of the issue and the “limitation and tracking-error constraints of first generation off-the-shelf low-carbon index products”.
“The current suite of low-carbon index products are also benchmarked against their market-cap weighted parents, begging the question whether the opposite should be true in a market that is aligned with a 2°C pathway and carbon asset risk is priced in,” Sefton said. “In other words, should low-carbon be the benchmark from which deviation is tracked?”
Nonetheless, she said the NZS move sent a strong signal to companies, investors and regulators about raising the game on climate change related governance and disclosure.
The latest NZS performance report shows the fund had about 67 per cent invested in global shares, mostly managed to passive mandates by BlackRock, Northern Trust and State Street. However, the NZS already deviates from a pure cap-weighted index international equities play with a series of exclusions – including munitions manufacturers and tobacco firms – in place.
In August this year the NZS handed Northern Trust $1.2 billion to invest in ‘smart beta’ global shares strategies targeting value and momentum factors. The fund would also scope out “the benefits of concentrating on fewer stocks at lower cost” for its portfolio this year, the NZS 2016 annual report says.
The NZS spokesperson said the climate change approach would be “quite different” from how the fund manages it responsible investment screens where, for example, tobacco or cluster munitions firms, were completely scrubbed from the portfolio.
“In this case, we don’t mind having some exposure to companies that are high risk,” the spokesperson said. “Our focus is on reducing our overall exposure to carbon emissions and fossil fuel reserves as efficiently as possible.”
About 5 per cent of the NZS investments are exposed to fossil fuel reserves.
Aside from cutting, or reducing, exposure to climate change-linked stocks in the global passive portfolios, the fund would use a range of “different tools” with other investments.
“For example, with our illiquid private assets our managers are more likely to work with companies to reduce their energy use, and reducing carbon emissions from property will need to focus on green design and tenants,” the NZS spokesperson said. “We will continue to use engagement and we will work on assessing climate risk appropriately when we analyse investments.”
Last week, the NZS also criticised the NZX ‘Corporate governance code’ in its latest submission on the draft proposal.
In the submission cover letter, Matt Whineray, NZS chief investment officer, says the fund “was disappointed our submission to the earlier consultation has largely been ignored in the ‘comply or explain’ recommendations to the revised Code”.
Whineray says the proposed NZX code relies too heavily on “commentary” rather than hard-line ‘comply or explain’ rules.
“… the NZX is in a unique position to drive improvements in our market through these [comply or explain] provisions, rather than through the commentary; Commentary can be easily ignored,” he says.
The NZS submission calls for the NZX to adopt the higher corporate governance standards used in many offshore jurisdictions.
“It is encouraging to see NZX improve the Code in the areas of diversity, risk and remuneration,” Whineray says. “We strongly advise more attention to shareholder rights, reporting, Board quality and composition, environment, social and governance (ESG) reporting and stakeholder relationship management.”
The NZ Corporate Governance Forum, a collective of local institutional investors including the NZS, echoed similar concerns in its, separate, submission on the NZX code.
Submissions closed on October 14 following publication of the NZX draft proposals on August 31. According to the NZX, the final corporate governance rules should be implemented in the first quarter of next year.