NZ Super has concluded a thorough review of its responsible investment framework and has decided there is room for improvement. We speak with the fund’s CIO, Stephen Gilmore, about the changes.
New Zealand Super has decided to embrace sustainable finance after a wide-ranging review of its responsible investment strategy.
Whereas the fund’s environmental, social and corporate governance (ESG) process looks at how ESG risks might affect its investments, sustainable finance is an outward-looking approach and assesses how the fund’s investments might impact the environment and society.
The fund says that when it comes to best practice much has changed in recent years and the finance sector is becoming an important part of the global effort to transition towards a low-carbon and sustainable economy.
There is now a greater expectation on institutional investors to report on how they are addressing sustainability in their investment strategy.
“From a practical perspective, we need to think not just about the impact that the external environment has on our portfolio, but also about the impact that our investing has on the external environment more generally, whether that be the environmental or social,” Stephen Gilmore, Chief Investment Officer of NZ Super, says in an interview with [i3] Insights.
In addition to the shift to sustainable finance, the review also looked at the integration of ESG and investments that contribute positively to the environment and society.
We have for a long time wanted to have a greater exposure to impact investments, but we haven't really achieved very much there so that's become more of a focus for us and we've made some more investments in that area
“We basically broke down our project into three parts, where we were looking at what we thought best practice was and where it was going. We also thought and continue to think about how we can improve the ESG performance of our portfolio, and then we’ve been focusing more on positive investment,” Gilmore says.
“We have for a long time wanted to have a greater exposure to impact investments, but we haven’t really achieved very much there so that’s become more of a focus for us and we’ve made some more investments in that area.
“We’ve obviously made investments in renewables and we’re making more. We’re also looking at climate tech and I think that this universe [of potential positive investments] is growing.”
Last month, NZ Super invested US$100 million in the Fifth Wall Climate Technology Fund, an early-stage fund managed by venture capital firm Fifth Wall, which seeks to invest in new technologies to decarbonise the global real estate industry.
In October, the fund committed up to €125 million (NZ$208 million) to the Copenhagen Infrastructure Partners Energy Transition Fund, which is focused on developing industrial-scale sustainable energy infrastructure.
In the year ahead, NZ Super will develop a plan to increase positive investment activity and address barriers to investment and, ultimately, scaling up the positive investments in its portfolio.
ESG in the Risk Budget
NZ Super has long been well-regarded for its approach to ESG and it was recently named as one of the 30 most responsible asset allocators in the world by the Responsible Asset Allocator Initiative.
But an independent review of the fund carried out by Willis Towers Watson (WTW) in 2019 said that while the fund’s responsible investment performance rated highly, the board and management needed to undertake deeper thinking and analysis on developments in responsible investment, and in particular sustainability and long-term portfolio themes, to prepare for the future.
Apart from the move to sustainable finance, the responsible investment review also concluded that this meant improving the integration of ESG into the portfolio, which in practical terms meant making ESG considerations an integral part of its risk management process.
“Right now, we’re going through the process of trying to better integrate ESG considerations into our risk budgeting and that’s something we’ll continue to do over the next half year or so,” Gilmore says.
“It may very well lead to a more concentrated portfolio than we currently have because if you’re just taking an off-the-shelf, market cap index, then you get lots of stocks, including some of them that are smaller and they may not do much at all to help the ESG performance.”
“Right now, we're going through the process of trying to better integrate ESG considerations into our risk budgeting and that's something we'll continue to do over the next half year or so. It may very well lead to a more concentrated portfolio than we currently have
But a more concentrated mandate doesn’t mean the fund expects to reduce the number of external fund managers it uses. In fact, the opposite has been true in recent years.
“We’ve been stepping up our investments in the real asset space, so in both real estate and infrastructure. A lot of that exposure has come via partners and so we’ve actually been increasing the number of managers that we have in the portfolio,” Gilmore says.
“It just may be that some ESG metrics will be used and that leads to a slightly more concentrated exposure.”
NZ Super acknowledges the types of ESG data and their availability have grown very rapidly in recent years, including data on company policies and targets, as well as quantitative metrics about a company’s performance on efficient water use or board diversity.
As the fund begins to implement its revised strategy, the team will drill into the technical detail of the different options to assess their effectiveness and they will attempt to deepen their knowledge of emerging ESG tools, data and metrics.
The fund hasn’t decided yet what the new approach to ESG means for the reference portfolio, a portfolio of simple benchmarks that mimics the strategic asset allocation and which forms the starting point against which to measure performance.
“Improving the ESG performance of the portfolio is consistent with our mandate in terms of best practice portfolio management, so one can make the case that embedding a better ESG performance in the reference portfolio is consistent with that concept,” Gilmore says.
“On the other hand, once you start doing that the reference portfolio will become more and more complicated. So we’ve got to think about the pros and cons of the different approaches.”
Climate change has quickly risen to become a key issue on institutional investors’ agendas. More and more investors have committed to net zero carbon by 2050 and in October 2021, NZ Super joined the ranks of asset owners committed to this target.
But the fund already developed a climate change strategy five years ago and its early move means it has benefited from the current shift to a low-carbon economy.
“We developed a climate change investment strategy back in 2016 and that strategy had four components: we were looking to reduce our exposure to carbon, we were looking to better analyse the impact of climate change on investments, we were also looking to engage with our managers and we were looking to search for investments that might help mitigate climate change,” Gilmore says.
We still think there are many areas of the markets which are not fully pricing in the risks. So when you talk about skew, in some cases that skew can be deliberate
Looking back, reducing the carbon exposure turned out to be the easiest of the four components to achieve, he says.
“We deliberately went out there and decided we didn’t want to have a large exposure to carbon emitters and fossil fuel reserves. That was a deliberate decision because the thinking was that we were taking on unrewarded risk by doing that,” he says.
“It just so happened that reducing that exposure turned out to be quite positive for returns as well.”
Asked whether the strategy to reduce emissions has introduced any unintended tilts to the portfolio, he answers that any skew that has arisen has been intentional.
“We still think there are many areas of the markets which are not fully pricing in the risks. So when you talk about skew, in some cases that skew can be deliberate,” he says.
[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.