Sustainable Finance: RI momentum gathers pace

Matt Whineray. Photo / Supplied

The momentum for responsible investment has built steadily over the past decade and this year's Covid-19 pandemic has only served to increase the pace.

The pandemic has brought home to business and policy-makers the importance of getting a better balance between economics, the environment and urgent social needs. It has highlighted, in particular, the importance of the "S" of the acronym ESG (environmental, social and governance). It has also underscored the ability of governments to bring in radical measures if business, industry and finance are not sufficiently proactive.

The NZ Super Fund was set up with a social purpose — to help save for the increasing future cost of universal superannuation — and it was an early mover in Responsible Investment (RI). RI is understood internationally to involve incorporating ESG matters in investment management. It has become the predominant framework for what was known as "ethical investment" at the time our founding legislation was passed in the early 2000s.

Since then the responsible investment landscape has evolved and expanded to cover an array of ideas and concepts, including stewardship, fiduciary responsibility, sustainability and natural capital. One of the challenges for investors, as we consider what comes next on RI, is that there is a plethora of standards and guidelines; and, while ESG tools, data, information and methodologies are improving, there are complexities with how to apply these to the interconnections between finance, companies, customers, supply chains and other stakeholders.

We began our RI journey by viewing ESG through the lens of risk and ethical guidelines. Since then the consideration of ESG risk has been substantially embedded in the investment industry. The global risk environment is escalating attention on climate change and sustainable development goals. There is a shift from focusing on a blunt tool to remove ESG risk from a portfolio to a more nuanced approach of considering the risk and opportunities facing a company and now also considering the impact from the investment on the environment or society. There is a growing trend which sees a demand for, and ultimately towards, investing in environmental and social solutions. At the same time, sustainable finance initiatives such as New Zealand's Sustainable Finance Forum are looking at a system-wide response and provide a vision for how New Zealand's financial system might evolve over the next decade — one that calls on all participants to play a significant part.

The NZ Super Fund's Responsible Investment framework, developed in 2007, responds to the requirement in our mandate that, we must invest the fund on a prudent, commercial basis and, in doing so, must manage and administer it in a manner consistent with:

● best-practice portfolio management; and
● maximising return without undue risk to the fund as a whole; and
● avoiding prejudice to New Zealand's reputation as a responsible member of the world community.

The framework is closely aligned to the UN-backed Principles for Responsible Investment (PRI), which set the global standard for best practice (we were a founding signatory). Further, we include RI in our investment beliefs: Environmental, social and governance considerations, including climate change, are fundamental to long-term risk and return.

ESG considerations are integrated across the various aspects of the Guardians' investment activities, from investment selection and due diligence to ownership activities such as exercising voting rights and engaging with companies to improve ESG policies and practices.

As an investor, we highlight the importance of companies taking a long-term perspective on performance, including ESG in their strategies and risk management processes, and considering their social licence and purpose.

Our New Zealand listed and private equity managers have responded well to this challenge.

Sustainable finance is following a similar path — recognising the role investors and banks and insurers can play.

We developed a climate change strategy in 2016 with the goal of making the fund more resilient to climate-related risk. Climate-related risk is complex and multi-faceted when it comes to investment portfolios, with uncertain impacts on different sectors and countries and uncertainty over when these effects might play out — we don't know what the ultimate destination is, or which pathway will take us there, and the pathway really matters to portfolio outcomes. The strategy, which now applies to our entire investment portfolio, has four legs: reduce, analyse, engage and search. In 2017 we committed to reduce the fund's carbon emissions intensity and carbon reserves by at least 20 per cent and 40 per cent respectively, compared with the original reference portfolio. We met, indeed exceeded, these targets this year and have now set new targets for 2025, with expectations of a 40 per cent reduction in carbon intensity and an 80 per cent reduction in reserves. This year we issued our first Taskforce for Climate-Related Financial Disclosures (TCFD) report, providing detailed disclosure about how we manage climate risk.

The NZ Super Fund has consistently received an A or A+ from the PRI in its annual RI assessment, and an AA rating for RI integration and ownership in a five-yearly independent review by global investment experts Willis Towers Watson last year. Looking ahead, PRI has flagged that its assessment framework will have a stronger focus on stewardship, social issues and the United Nations' Sustainable Development Goals (SDGs).

Moving on from a risk management approach to understanding the impact of investments beyond their financial and economic outcomes is a complex and nuanced area. Understanding impact involves detailed analysis of individual companies, interconnected investment structures, and consideration of up-stream and down-stream effects.

The NZ Super Fund holds shares in approximately 6,500 listed companies globally, with two-thirds of the Fund invested in a passive market-tracking portfolio that replicates the mix of listed equities on stock markets around the world. As with the majority of investors, we use passive investment as an essential and cost-effective way to achieve the investment returns we require. We monitor this universe and focus on issues and companies with the most material ESG risks. Measuring the positive or negative impact of 6,500 stocks will become easier over time with an increase in available data, including automated data analysis. Measuring impact, positive and negative, is a much more fledgling exercise than identifying risks.

Though we have a commitment to engagement as the best way of getting companies to improve performance, we exclude companies from the portfolio — primarily based on product exclusions such as tobacco but also sometimes for their business practices.

Our RI approach has been in place for more than 10 years now, and international best practice is evolving rapidly, so we have a review under way. The review, due for completion in 2021, is about making sure that our approach is fit for the future. It will look at questions such as: how to utilise new tools to improve ESG performance and investment returns, how to increase investments into assets with social and environmental benefits that also meet our financial objectives, and what our future social licence looks like as stakeholder expectations evolve. The goal is to build on our experience so that we have a pragmatic and modern approach that is ready to meet future developments in this fast-changing field.

● Matt Whineray is CEO of the NZ Superannuation Fund.