climate change | Pension360

Britain Secretary of Energy: Investing in Fossil Fuels Big Risk for Pension Funds

Last week the advisory board of one of the largest asset owners in the world, the $857.1 billion Norway Pension Fund Global, concluded that divesting from fossil fuels would be an unwise financial decision that would reduce returns.

But Edward Davey, Britain’s Secretary of State for Energy and Climate Change, said Monday he thinks fossil fuel companies could become the sub-prime assets of the future.

He called on Britain’s pension funds to examine the risk associated with oil, gas and coal investments.

From the Telegraph:

Investing in fossil fuels is becoming increasingly risky because global action to tackle climate change will curb demand, forcing companies to leave unprofitable reserves in the ground, Ed Davey, the energy secretary, has warned.

Financial authorities must examine the risks posed by coal, oil and gas companies to prevent pension funds investing in what could become “the sub-prime assets of the future”, Mr Davey said.

The comments are Mr Davey’s first intervention into the debate over the “carbon bubble”, the theory that the world’s existing fossil fuel reserves are overvalued because the majority must be left unburned in the ground if extremes of global warming are to be avoided.

Mr Davey told the Telegraph: “One has got to worry about the investments for pensioners.

“If pension funds are investing in companies or banks that have on their balance sheets huge amounts of assets in fossil fuels, and those assets don’t give the return that people expect – because of changes in technology where low-carbon becomes cheaper or because of the world having to take action against carbon emissions – one has got to protect those pensioners and those investments.”

Pension Advisory Board: Divesting From Fossil Fuels Will Harm Future Returns

There have been calls from many corners in recent months and years for pension funds and other institutional investors to begin divesting from fossil fuel-based investments.

But not many institutional investors have heeded that call, choosing instead to use their sway as major shareholders to work with companies.

One of the largest asset holders in the world is taking a similar approach. The board of the $857.1 billion Norway Pension Fund Global has told the fund that divesting from fossil fuels would be an unwise financial decision that would reduce returns.

CalSTRS Stepped Up “Green” Bond-Buying By 300 Percent In 2014

CalSTRS released its Green Initiative Task Force report on Wednesday. The report highlights the pension fund’s “environmental-themed investments” and risk-management efforts related to climate change.

The report reveals that it increased its purchases of “green bonds” by 300 percent in 2014. Investopedia defines a “green bond”:

These bonds are created to encourage sustainability and the development of brownfield sites. The tax-exempt status makes purchasing a green bond a more attractive investment when compared to a comparable taxable bond. To qualify for green bond status the development must take the form of any of the following:

1) At least 75% of the building is registered for LEED certification;

2) The development project will receive at least $5 million from the municipality or State; and

3) The building is at least one million square feet in size, or 20 acres in size.

From a CalSTRS press release:

California State Teachers’ Retirement System’s (CalSTRS) eighth annual Green Initiative Task Force report shows an almost 300 percent increase in green bond purchases within the Fixed Income portfolio. This year, the Teachers’ Retirement Board identified sustainable investing as a key, strategic priority, which is reflected in the report and other initiatives.

The growth in green bonds aligns with a commitment that CalSTRS Chief Executive Officer Jack Ehnes made during his participation in the 2014 Climate Summit where he announced that CalSTRS will more than double the fund’s clean energy and technology investments of $1.4 billion to $3.7 billion over the next five years. The move is in response to United Nations Secretary-General Ban Ki-moon’s call for bold action to build resilience to the impacts of climate change.

“Targeting the clean energy and technology sector provides a good investment opportunity while positioning CalSTRS for a low-carbon future,” noted Ehnes. “But more importantly, we hope our actions will help catalyze incentives for comprehensive climate change policies that ultimately lead up to a global agreement in Paris in 2015.”

CalSTRS sees a growing number of investment opportunities in low-carbon solutions, especially as renewable technology costs come down and regional clean energy policies take hold.
“Our growth of green-related investments is a good example of successful engagement on environmental and climate risk issues,” said CalSTRS Chief Investment Officer Christopher J. Ailman. “Looking forward, we hope to bring more attention to the role large institutional investor’s play in financing green bonds, clean energy and climate change initiatives.”

The entire Green Initiative Task Force report can be read here.

Photo by penagate via Flickr CC

NYC Comptroller Explains Boardroom Accountability Project in Open Letter

New York City Comptroller Scott Stringer is pushing corporations to give their biggest investors – often pension funds – more power over corporate boardrooms.

Stringer says pension funds can use their leverage as large shareholders to rein in excessive executive compensation and make corporate boards more diverse.

From a piece written by Stringer in Wednesday’s Daily News:

In partnership with the city’s pension funds, recently launched the Boardroom Accountability Project, a national initiative designed to improve the long-term performance of American companies by giving shareowners the right to nominate directors using the corporate ballot — also known as proxy access.

Proxy access promises to transform corporate elections from rubber-stamp affairs, where one slate of candidates is listed on an official ballot determined entirely by current officeholders, to true tests of merit and independence.

Bringing accountability to the boardroom will have real benefits for the retirement security of millions of Americans, including the 700,000 municipal workers , retirees and their beneficiaries who rely on city pension funds.

A recent report by the CFA Institute, the world’s largest association of investment professionals, concluded that on a marketwide basis, bringing more democracy to the boardroom could increase U.S. market capitalization by up to $140 billion.

We have focused our initial list of 75 companies being targeted around three core issues: those with excessive CEO pay, those with little or no gender or racial diversity on their board, and many of our most carbon-intensive energy companies. They include Urban Outfitters, ExxonMobil, Abercrombie & Fitch and Netflix.

Excessive CEO pay is a problem in itself and can create perverse incentives for management to focus on short-term profits at the expense of long-term value creation. It is also often a sign of a captive board that puts the interests of management ahead of the interests of shareholders.

And while most agree that more diverse boards make better decisions, the pace of change is glacial. In 2006, women made up 11% of S&P 1500 board seats. By last year, that number had barely budged (to 15%), and also as of last year, 56% of S&P 100 companies had no women or minority-group members in their highest-paid senior executive positions.

That’s bad for business, investors and our economy, and we will use our leverage to change it.

Lastly, we know that transitioning the world’s energy production to low-carbon sources is essential if we are to stem the most extreme effects of climate change. But the CEOs of the world’s major energy companies have little incentive to make investments that may reduce earnings today to protect their companies’ long-term prosperity.

In corporate America, the buck stops with the board. As a result, the right of shareowners to nominate and elect truly independent directors that reflect a diversity of viewpoints is critical to ensuring that the interests of long-term shareowners triumph over the pressure for short-term gains that all too often drives decisions at our largest corporations.

Read the whole piece here.

CalPERS, New York Pensions Lead Push To Give Largest Shareholders More Control Over Corporate Boardrooms

Pension funds are often among a corporation’s largest shareholders, a position that gives them unique ability to influence corporate decision-making and governance.

But a handful of the nation’s largest public pension funds are leading a push for more oversight over corporate governance – namely, the ability to hire and fire a company’s director.

From the New York Times:

Weary of what they see as a dysfunctional dynamic, a band of institutional shareholders is mounting the first push ever at 75 United States companies to allow investors to hire and fire directors directly. The plan is intended to bring greater accountability to corporate boardrooms and eliminate some of the “clubby” aspects for which they have been criticized.

Leading the drive is Scott M. Stringer, the New York City comptroller and a Democrat, who oversees five municipal public pension funds with $160 billion in assets — much of it invested in the kinds of companies his effort will target. His office will submit a proposal at each of the 75 companies, asking the company to adopt a bylaw allowing shareholders who have owned at least 3 percent of its stock for three years or more to nominate directors for election to the board.

Among the 75 companies targeted by Mr. Stringer are eBay, Exxon Mobil, Monster Beverage and Priceline. None of the companies commented on the comptroller’s shareholder proposal.

[…]

“The bottom line is, friends still put friends on boards,” Mr. Stringer said in an interview Wednesday. “My job as a long-term investor is to make sure that these companies truly represent the interest of share owners.”

The effort by the New York City pension funds will focus on companies that have been unwilling to change practices in three areas: board diversity, climate change and executive compensation. Companies with no women as directors or those with little or no ethnic diversity were identified, along with companies whose shareholders had recently expressed dissatisfaction with executive pay practices but had done nothing to address them. On climate change, more than a third of the companies identified by the shareholder group are in the energy industry.

The proposals will be put to shareholder votes at the companies’ annual meetings in the coming months. While the companies would not be required to adopt the bylaw even if a majority of shareholders voted for it, advocates say the boards would be more likely to go along with the idea if it won strong support from shareholders.

Scott Stringer is leading the charge, but he has other powerful pension funds on board, including CalPERS. From the NY Times:

Working with Mr. Stringer’s office to drum up support are officials at the California Public Employees’ Retirement System, the nation’s largest public pension fund. Calpers said it would hire a proxy solicitor to discuss the proposal with other institutional shareholders. “We view this as a five-year project and will be back again and again as needed,” said Anne Simpson, senior portfolio manager and governance director at Calpers. “But making the commitment and getting an alliance formed on this issue is so important.”

Public pension overseers in other states, including Connecticut, Illinois and North Carolina, are also supporting the effort.

Pension360 covered last week how CalSTRS, CalPERS and New York’s largest pension systems were upset over governance changes at Bank of America.

An Optimist’s View of Long-Termism In Institutional Investing

Investments & Pensions Europe released a survey today indicating that three of every four pension funds consider themselves long term investors. But they disagreed on the specifics of long-termism.

In light of the survey, here’s an article by Theresa Whitmarsh, Executive Director of the Washington State Investment Board, discussing how pension funds can move away from short-termism and improve the dialogue surrounding true long-term investing.

The article was published in the Fall 2014 issue of the Rotman International Journal of Pension Management.

Whitmarsh writes:

While solutions to short-termism proposed for institutional investors vary, they coalesce around three themes: first, disintermediation through direct ownership of private assets; second, concentrated holdings of publicly traded securities with commensurate influence over corporate behavior; and, third, collaboration with other investors to influence market behavior. All three models are being tested and successfully implemented, but not at scale.

There are several sound reasons for this. Disintermediation is not always practical for a globally diversified portfolio. Skilled intermediaries who possess asset class, style, sector, and geography expertise will always be in demand (and, unfortunately, even unskilled ones will remain in demand). And holding a concentrated portfolio of public companies runs counter to what we know about active investing: it is very difficult for an active investor to outperform broad market indexes, and index investing remains an efficient and cost-effective way for institutional investors to put large amounts of money to work. Finally, as mentioned earlier, market and governance reform has fallen short of our goals as investors, despite strong governance-focused collaborations. Intermediaries outnumber us, outspend us on lobbying, and are more financially motivated than us to maintain the short-termist status quo.

So while the benefits of long-termism can be many – harvesting an illiquidity risk premium, providing ballast to the capital markets, and encouraging corporations to invest in innovations that sustain their enterprises and society over time – neither investors nor corporations have a particularly strong record.

However, I am becoming more optimistic that a movement for long-termism is afoot, one that is pulling in corporations and intermediaries and that has the potential to get enough traction to change behavior. This movement comes from deep within the corporate sector and is increasingly supported by important market players. It goes by various names – sustainable capitalism, fiduciary capitalism, inclusive capitalism, conscience capitalism – but no matter the moniker, the goal of all these undertakings is to encourage a brand of capitalism that prices in externalities, broadly benefits society, and ultimately sustains the planet. An initiative co-sponsored by the Canada Pension Plan Investment Board and McKinsey, Focusing Capital on the Long Term,1 involves broad participation from investors, money managers, corporations, and finance academics and will be producing several recommendations on how to take these concepts from idea to practice.

Whitmarsh on the three catalysts that she believes will spur long-term investing:

I see three catalysts for the increasing dialog on the benefits of long-termism – the first two self-serving of the market, though not without benefit to society, and the third essential to our survival as a species.

The first catalyst is the need to restore trust in the capitalist system. Trust was one of the main casualties of the Great Recession, according to Christine Lagarde, Managing Director of the International Monetary Fund, who spoke at the Conference on Inclusive Capitalism in London on May 27, 2014.2 Lagarde noted that in a recent poll conducted by the Edelman Trust Barometer, less than one-fifth of those surveyed said they believe that business or government leaders will tell the truth about important issues. This should be a wake-up call, she told her audience; trust is the lifeblood of the modern business economy. The way to restore trust, according to Lagarde, is to ensure that growth is more inclusive, favoring the many, not just the few. She shared a startling statistic: the richest 85 people in the world hold more wealth than the poorest 3.5 billion.

This leads us to the second catalyst: increasing recognition of the negative effect of rising income inequality, in both developed and emerging markets, on the pace of growth. The most unlikely signal that this issue has gone mainstream came in early August, when Standard & Poor’s (2014) published a report that correlates the rise of income inequality in the United States with dampening GDP growth.

The last catalyst is the threat of carbon-emission-induced climate change. Market economies do not price in externalities well, but carbon emissions have to count as potentially the most costly externality ever encountered. (To my mind, only nuclear weapons production comes close.) Even the most self-serving capitalist wants a world in which to keep making money.

Perhaps, with capitalism in crisis, trust in the finance sector at an all-time low, and growing concerns about what we are doing to our planet, we just may – as a society, and collectively as investors – be willing to act.

We have reason to be optimistic that we will act, according to economist Larry Summers. Speaking at the same event as Lagarde, he noted, “This idea that capitalism is about to fail is one we have seen before, and yet it has been a triumph of the capitalist system that it has proven remarkably resilient; that it has given rise to what might be called self- denying prophecies, prophesies of doom that lead to adjustments that lead to repair.”

The entire piece can be read here.

Photo by Santiago Medem via Flickr CC

Video: CalPERS CIO Talks Hedge Fund Exit, Market Risk of Climate Change and Corporate Tax Avoidance

http://youtu.be/jRDuJt_jJqQ?list=UUWHcVDsYvL_xcRjarkRlqoQ

The above video features an interview with CalPERS chief investment officer Ted Eliopoulos. Topics include CalPERS’ hedge fund exit, the fund’s stance on corporate tax avoidance, and how climate change has impacted the fund’s portfolio.

Ai-CIO.com summarizes a few key points from the interview. On hedge funds:

“One of our prime considerations in reviewing the program is whether we believe we could scale the program to a much more significant part of the overall portfolio,” he said. “Our analysis, after very careful review, was that mainly because of the complexity of the hedge fund portfolio and the cost we weren’t comfortable scaling the program to a much greater size than it currently held.”

On corporate tax inversion:

Eliopoulos emphasised that, in general, tax was something to be addressed by relevant governments as a policy issue, but expressed concern about corporate inversions.
“We think the best approach is for the US government to address this type of a loophole in the context of overall corporate tax reform, and we’ve urged the government to get at it,” he said.

CalSTRS: Financial Risk of Climate Change “Very Real” For Institutional Investors

CalSTRS has been one of the most active (and vocal) pension funds in the world this year when it comes to exploring the financial risk of climate change.

The fund announced last month it was joining forces with Mercer and a handful of other pension funds to study the market impact of climate change.

Now, CalSTRS has commented on a new report showing the “profound lack of preparedness” for climate change among the nation’s insurance companies.

The pension fund calls for institutional investors to be “more mindful of market exposures to environmental risks.”

From a CalSTRS release:

The Insurer Climate Risk Disclosure Survey Report & Scorecard: 2014 Findings & Recommendations was released today by Ceres, a nonprofit sustainability organization mobilizing business and investor leadership on climate change and other sustainability challenges, ranks property & casualty, health, and life & annuity insurers that represent about 87 percent of the total U.S. insurance market. Ceres found strong leadership on the issue in fewer than a dozen companies nationwide.

“Environmental, social and governance risks and issues such as climate change are very real for CalSTRS. This new report enables large institutional investors to be more mindful of market exposure to environmental risks through our insurance investments,” said CalSTRS Chief Executive Officer Jack Ehnes. “More importantly, the report gives us better perspective on how well, or not, insurance companies are responding to climate change risk.”

The report states, “… insurers are on the veritable ‘front line’ of climate change risks, and there is compelling evidence that those risks are growing. Rising sea levels and more pronounced extreme weather events will mean increasingly damaging storm surges and flooding. Hurricane Sandy alone resulted in over $29 billion in insured losses.”

“Meaningful change in the recognition of climate risk to the investment portfolio will come from an alignment of interests, and who better to take leadership this effort than the insurance industry,” added Ehnes. “The foundation of the insurance model is based on risk analysis, so ignoring the risk of climate changes seems most imprudent. Clearly, more action on the part of the insurance sector is needed.”

Last month, CalSTRS announced plans to double down on its clean energy investments.

Swedish Pension Divests From 20 Fossil Fuel Companies

One of Sweden’s largest pension funds has announced it plans to divest from $116 million worth of fossil fuel-related holdings.

In an effort to ward off the “financial risk” of climate change, Sweden’s AP2 will cut 20 gas, oil and coal companies from its portfolio. From Chief Investment Officer:

[AP2] is cutting 12 coal companies and eight oil and gas production firms, with a total market value of SEK 840 million, or roughly 0.3% of the portfolio.

“Our starting point for this analysis has been to determine the financial risks associated with the energy sector,” said Eva Halvarsson, CEO of AP2. “By not investing in a number of companies, we are reducing our exposure to risk constituted by fossil fuel based energy. This decision will help to protect the fund’s long-term return on investment.”

In a statement released today, AP2 said its team had reviewed all holdings in fossil fuel companies and assessed the financial risk posed to each one by climate change.

The fund said the coal companies it would sell “face considerable climate-related financial risk, due to the negative environmental and health impacts of coal”. AP2 also cited competition from gas and renewable energy sources as affecting demand for coal.

AP2 also identified “serious climate-related financial risks” for a number of oil producers, particularly involving “high-cost projects” such as extracting oil from oil sands. AP2 said it believed it was “highly likely that these projects may either be stranded or unprofitable”.

The Swedish fund is the latest institutional investor to reduce or completely scrap their investments in fossil fuel producers. Stanford University’s $18.7 billion endowment said in May that it would sell out of fossil fuel-related companies, while the $860 million Rockefeller Brothers fund in September announced its intention to divest from coal and oil. A group of US charities representing $1.8 billion in assets also took similar steps at the start of this year.

AP2 manages $36.7 billion of assets.

Photo by Penagate via Flickr CC

How Should Investors Manage Climate Change Risk?

CalPERS is measuring the carbon footprint of its portfolio. CalSTRS is helping to fund a study on the market impact of climate change.

For the first time, institutional investors are beginning to wonder: How will climate change impact the value of our investments?

Howard Covington of Cambridge University and Raj Thamotheram of the Network for Sustainable Financial Markets tackled that question in a recent paper, titled How Should Investors Manage Climate Change Risk, in the most recent issue of the Rotman International Journal of Pension Management. From the paper:

The consequences of high warming, if we collectively go along this path, will emerge in the second half of this century; they are therefore remote in investment terms….Capital markets anticipate the future rather well, which suggests that investment values may respond strongly over this time scale as views on the most likely path begin to crystallize. Technologies for producing and storing electrical energy from renewable fuel sources, for energy-efficient housing and offices, and for reducing or capturing and disposing of greenhouse gas emissions from industrial processes are moving along rapidly. In important areas, costs are falling quickly. Given appropriate and moderate policy nudges and continuing economic and social stability, it is overwhelmingly likely that the global economy will substantially decarbonize during this century.

If…an emissions peak in the 2020s becomes a plausible prospect, investment values for fossil fuels, electrical utilities, and renewable energy (among others) will react strongly. The value of many fossil fuel investment projects will turn negative as assets lose their economic value and become stranded; companies and countries will face significant write-downs, with clear consequences for financial asset prices.

As the authors note, we don’t know exactly how the earth will eventually react to greenhouse gasses. Different responses will have different implications for the global economy. From the paper:

If we are unlucky, and the climate’s response comes out at the upper end of the range while emissions go on climbing, the likelihood of the global economy’s potentially heading toward rolling collapse will significantly increase. A run of extreme weather events in the 2020s, particularly events that lead to sharp increases in prices for staple crops or inundate prominent cities, might then focus the attention of the capital markets on the consequences. A broad adjustment of asset values might then follow as investors try to assess in detail the likely winners and losers from the prospect of an increasingly turbulent global social, economic, and political future.

We are not suggesting that this kind of outcome is unavoidable, or even that it is the most likely. We are merely noting that the chance of events’ unfolding in this way over the next 10 to 15 years is significant, that it will rise sharply in the absence of a robust climate deal next year, and that long-term investors need to factor this into their investment analysis and strategy.

If these scenarios correctly capture the likely outcomes, then we have reached a turning point for the global economy. For the past 150 years, the exploitation of fossil fuels has generated enormous value for investors, both directly and by enabling global industrialization and growth; but it is now rational to anticipate that continued and increasing emissions from fossil fuel use might, over several decades, lead to the destruction of investment value on a global scale. Moreover, capital markets may adjust to this possibility on a relatively short time scale.

So how should institutional investors respond?

Broadly speaking, there are three main ways that investors can help. The first is to raise the cost of capital for companies or projects that will increase greenhouse emissions. The second is to lower the cost of capital for companies or projects that will reduce greenhouse emissions. The third is to use their influence to encourage legislators and regulators to take action to accelerate the transition from a high- to a low-emissions economy.

Formally adopting a policy of divesting from the fossil fuel sector can be helpful with the first of these, provided that the reasons for doing so are made public, so that other investors are encouraged to consider their own positions. Alternatively, active investors might take significant shareholdings in fossil fuel companies, so as to exert a material strategic influence to prevent investments that encourage long-term value destruction.

Supporting investments in renewable energy sources and related sectors is particularly effective where the potential exists to disrupt traditional industries. Tesla Motors is a case in point, since the potential for rapid growth of electric vehicles could transform the auto industry. Through the related development of high-performance, low-cost battery packs, it may also transform both the domestic use of solar power and the electrical utility business.

There is little time left for legislators to agree on the terms for orderly cooperative action to reduce emissions. Investors concerned about long-term value should act now to encourage the adoption of mechanisms to ensure an early peak and rapid decline in greenhouse missions. By the end of 2015, the chance for this kind of action will have largely passed.

The above excerpts represent only a portion of the insights the paper has to offer. The rest of the article can be read here [subscription required].

Photo by Penagate via Flickr CC

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