Background

The New Zealand Superannuation Fund—NZSF was created from scratch in 2001. It started investing in 2003. The fund is a way for New Zealand to save now in order to make future pension costs more affordable. From the beginning, the fund has focused on global best practices in order to learn from them. The size of the fund, in March 2018, was NZ$38 billion² (US$25 billion). Although it is a government vehicle to save future tax, it is managed by a fully independent Crown entity with clear separation between the New Zealand Government and the fund. This means that the fund can make independent, long-horizon investment decisions. The fund has a true long-term character: its size will not peak before 2080. Since its creation, the performance of the fund is well ahead of its benchmarks. One of these benchmarks is a passive Reference Portfolio consisting of 80% equities and 20% fixed income. The board delegates responsibility for all investment decision-making to the investments team, except for the choice of the Reference Portfolio. The board makes decisions about the composition of the Reference Portfolio. The fund has to operate in a way that it will not damage New Zealand's reputation as a responsible member of the world community.

The challenge

A big question for the fund over the past few years has been whether it should integrate climate change into the investments of the fund and, if so, how. By doing this in a deep, fundamental way that fits into its beliefs, the fund has succeeded in creating an approach that is fully consistent with its long-term nature and its financial mission.

The process

The integration of climate change into the process was not an overnight exercise. The climate change investment strategy has been a long time in the making. It took the fund back to fundamentals, by asking itself where the risks posed by climate change would fit into the investment beliefs, and its mandate as an investor. It also had to consider how best to approach the strategy; whether to incorporate it into their passive Reference Portfolio and benchmark, or to configure it as an active investment decision.

As the investments team was of the view that climate change created risks and opportunities for the fund, it was apparent that the actual portfolio (making active investment decisions) would be changed as a result. However, the team was also of the view that climate change was such a significant, long-term risk, that it would be wrong to set a Reference Portfolio that would not reflect this risk, given that it acts as a benchmark and default allocation for the fund. As the passive equities portfolio also contained by far the largest concentration of risk, it was a natural first to change the reference portfolio in that respect. In the equity portfolio it is also possible to make large changes at a low cost.

In order to change the Reference Portfolio there needed to be alignment at the board level because doing so, in a sense, made the board directly responsible for the return impact.

From the board's perspective, it took time to become comfortable with making what was a material and very long-term decision. Part of the difficulty was the uncertainty, because the risk was so long-term that the fund was putting together a strategy and starting to implement it without knowing all of the answers. To allay this uncertainty, the investment management organization spent time getting the board up to speed and comfortable with the significance of arriving at a decision to act. In total, the investment team presented to the board five times, from concept to final implementation.

In creating this common understanding the fund used a decision tree. It shows the beliefs regarding climate risks and how to deal with them, and the consequences for the investment approach. The decision tree had statements such as: “You believe that climate change poses a risk to investors” and “You believe that markets properly price the risk.” This approach also helped guide the conversation internally and with the board.

Eventually, the fund arrived at an explicit goal: to make the portfolio more resilient to climate-related risks. It agreed on a set of targets for the strategy: to reduce the carbon emissions intensity, which is tons of carbon emissions per dollars of sales, by 20%, and to reduce the carbon reserves held in the portfolio by 40%, both by 2020. Importantly, the fund thinks about this at the whole of portfolio level, meaning it does not have carbon budgets at an individual asset class level.

The outcome

The strategy to make the portfolio more resilient to climate-related risks has four work-streams:

• Reduce. Reduce exposure to reserves and emissions.
• Analyze. Incorporate climate change into the investment hurdles and investment decision-making process.
• Engage. Integrate climate change into the considerations, both in the voting and engagement policy. Engage with companies, particularly disclosing the impact of climate change on them.
• Search. Search for attractive investment opportunities as we transition to a low-carbon world.

The fund started implementing the reduce work-stream straight away. In June 2017, it shifted to a lower carbon passive equities portfolio, reallocating approximately $670 million away from companies with high exposure to carbon emissions and reserves into lower risk companies.

It did this while continuing to search for answers on how to best implement the remaining three components of its strategy. The climate change strategy will evolve over time as the fund uncovers more information about the pace of global warming, policy change and market pricing reactions, and as the data and tools available to measure and manage risk improve.

Lessons for Achieving Investment Excellence

• It takes serious time and collective effort to build an approach to climate change that is consistent with the mission and beliefs of the fund.
• The board should be totally aligned with the climate change strategy and the way it is integrated into the reference portfolio and the investment chain.
• Even when there is uncertainty around the long-term development of big forces such as climate change, it is possible to formulate a strategy which is owned by the board and informs and guides the investment decision-making process of the fund. By creating explicit goals, the progress of the strategy can be monitored well.