A new Mercer study has identified an almost US$6.3 trillion annual “transformational investment” hole across six major global systemic trends.
According to the Mercer report, produced on behalf of the World Economic Forum (WEF), “universal shareholders” such as sovereign wealth funds are well-placed to fill the transformational-investing void – earning higher returns and saving the planet to boot.
The study, authored by US-based Mercer investment consultant Richard Silvan while on almost year-long secondment to the WEF, rates the six most-urgent world systemic issues as: climate change; water security; geopolitical stability; technology; demographics; and, entrenched low interest rates.
“The amount of capital required to effect change across the global trends is daunting,” the paper says. Numerous examples from the past 20 years (e.g. recycling infrastructure, solar power, vehicle electrification) illustrate how government support and regulations combined with private investments can transform society. We believe that unlocking the potential of transformational investments and addressing global systemic trends will require further securitization, structuring and product development.”
For addressing climate change alone the report says investors would need to pitch in an extra US$2.4 trillion each year with technology (US$1.7 trillion) and demographic changes (US$1.5 trillion) presenting similar outsize opportunities.
“Multiple potential outcomes are possible for each risk, ranging from the benign to the catastrophic. Universal shareholders have strong incentives to find transformational investments to respond to these risks,” the study says. “Effective transformational investments can support a smoother transition of society, economies and markets towards favourable outcomes, while generating attractive risk-adjusted investment returns for investors.”
As well as outlining the transformational investment thesis, the Mercer report highlights successful case studies from six “early adopter” global institutional asset owners including the $45 billion NZ Superannuation Fund (NZS) and the A$70 billion Australian Sunsuper.
“For early adopters of transformational investment, seeing other asset owners follow isn’t just an instance of the adage that imitation is the greatest form of flattery; following in this way provides liquidity, helps drive the cost of investment down through scale and helps produce the positive externalities that helped motivate the early adopters to pursue the investment in the first place – or mitigate the negative externalities,” the paper says. “In short, transformational investment is one of the areas of economic activity in which collaboration helps produce better results.”
NZS, for example, has led the way in addressing climate change under a four-pronged strategy dubbed reduce, analyse, engage and search, the Mercer study says.
In a report published to coincide with the WEF study mid June, the NZS says it has already significantly outperformed portfolio decarbonisation targets set in 2017.
“Given we have met and exceeded our targets, we will next review our targets and assess if and where in the portfolio further carbon reductions can be made,” the NZS paper says.
“… Our reduction strategy does not necessarily mean we will reduce our exposure to all carbon-intensive assets. For example, we may from time to time invest in carbon-intensive assets, where the opportunities are both sufficiently compelling and consistent with our mandate. Our goal is to materially reduce the whole-of-portfolio carbon footprint over time.”
The Mercer/WEF report also praises NZS for backing an Auckland light-rail project, describing it as a “transformational project demonstrating a carbon-efficient improvement [strategy]”.
Last week the NZ government shelved the Auckland light rail plans after coalition partner, the Winston Peters-led NZ First, withdrew support for the project.
In a statement NZ Infra – the joint venture between NZS and
CDPQ Infra, a subsidiary of Canadian pension scheme Caisse de dépôt et placement du Québec – said the light rail cancellation was a “significant disappointment”.
Matt Whineray, NZS chief, said in the release: “We remain committed to seeking opportunities for the NZ Super Fund to invest in New Zealand, including in large-scale infrastructure, and look forward to utilising the knowledge and expertise we have developed on other projects.”
Despite missing one opportunity to demonstrate its large-scale “transformation investment” chops, last NZS reported some success in more granular operational activities.
The fund has “added considerable value” by in-sourcing certain ‘portfolio completion’ services, a new NZS white paper says.
Portfolio completion, which refers to how the fund moves actual assets around its passive ‘reference portfolio’ settings, “is anchored to the investment fact that managing fees and costs, and ensuring efficient implementation, can prevent unnecessary cost to the Fund over time”, the report says.
Decisions around activities such as passive exposure methods, currency and liquidity all fall under the portfolio completion banner.
“Over the past five financial years represented in the table below, in dollar terms, we estimate the value added as approximately NZ$700 million,” the paper says. “Of the various work streams involved in completing the portfolio, foreign exchange management is the biggest contributor to value add…”
However, the portfolio completion annual bonus has varied from 0.03 per cent to 0.61 per cent of NZS reference portfolio outperformance for the five years ending June 30, 2019.
“To place these figures in context, we expect to outperform the Reference Portfolio by 1% per year across all of our value-adding strategies (including Portfolio Completion), over the long-term, based on the level of risk we take,” the NZS report says.