By Nick Hedley
NGS Super, the Australian retirement fund for
teachers in non-government organizations, is well on its way to achieving a
carbon-neutral investment portfolio by the end of this decade – a full 20 years
ahead of the industry standard. And it expects no negative impact on returns.
“We could have closed our eyes and announced a 2050 target –
the investment team and I would be long gone and we’d have no responsibility
for achieving that or carving out a path,” NGS Super’s chief investment
officer, Ben Squires, tells Markets Group.
“We wanted to set some hard and ambitious targets, so we set
a 2030 target and worked back from there.”
As part of those plans, the fund recently announced that it
had sold its holdings of oil and gas exploration and production companies,
including Woodside in Australia and U.S.-based ConocoPhillips.
Its first fossil fuel screens were put in place in 2016,
when the fund decided it would no longer invest in companies that get more than
30% of their revenue from thermal coal activities, including mining and coal-based
power production.
These exclusions are not only about taking action on climate
change, Squires says. They are there to manage risk and protect members’
long-term investment returns.
NGS Super, which has AU$13 billion (US$9.1 billion) in funds
under management, has been building up its research capabilities in recent
years after concluding that asset managers were not adequately pricing in the
risks associated with climate change and the move away from fossil fuels.
Part of that research has been aimed at understanding the
fund’s baseline carbon emissions position. That is a difficult task given that
there is limited data on unlisted investments and on scope 3 emissions – those
linked to suppliers and the products a company sells, such as gas.
“We then determined a feasible glide path,” Squires says. “We
knew we could reduce scope 1 and 2 emissions without having any real impact on our
portfolios, so we decided we could easily get to a 35% reduction in emissions by
2025, versus 2020 levels.”
After setting that interim target, the next step was to
consider scope 3 emission reductions, with oil and gas companies being an
obvious starting point.
“We modelled out each investment under different climate
change scenarios, to measure value destruction.
“With the exception of the business-as-usual scenario, where
no additional climate action is taken, in every other scenario there was a
material destruction of wealth in these companies. So, divesting from oil and
gas companies was a very simple decision based on their future prospects.”
The roughly US$131 million in proceeds were redistributed to
other holdings within the fund’s equities portfolio, and Squires sees plenty of
opportunities in the unlisted space.
It recently participated in the acquisition of a gas-fired
peaking power plant in California, which will be converted to a hydrogen or biogas
facility.
“No one wants a 20-year contract with a gas provider, so
these assets are cheap, and there’s a huge opportunity there to create
significant amounts of value.”
NGS Super has also partnered with managers such as
Copenhagen Infrastructure Partners to increase its exposure to solar and wind
energy projects. In private equity, it has identified several strong European
and Australian managers of “cleantech” portfolios.
Engagement versus divestment
Squires says engaging with oil and gas exploration and
production companies would not have made sense at this stage, given that not
much can be done about their scope 3 emissions. And the risk that they will end
up with “stranded assets” is escalating as the clean energy transition gains
momentum.
However, NGS Super could reconsider these investments in
time – if these companies overhaul their business models.
On the other hand, Squires says it makes sense to engage,
rather than divest, with groups that operate in the electricity generation and
heavy industry sectors, including concrete and aluminium suppliers.
Institutional investors should be pushing these groups to
prepare solid transition plans and invest more heavily in clean energy and
research and development, he says.
NGS Super will increasingly engage with companies that are
vulnerable in the energy transition, and with its partners in the asset
management industry “to see how they’re using their influence.”
Squires says the transition will only accelerate as governments
start to take the climate crisis more seriously.
Alongside the new Australian government’s firmer climate
targets, the European Union’s stronger green energy targets, and China’s
massive renewables program, he says the Inflation Reduction Act in the U.S.
will significantly enhance policy certainty – partly by extending the tax
incentives for green energy projects by at least a decade.
This will encourage institutional investors to invest
further into the transition. “Taking a leap of faith is not something that
institutional investors like to do, so having a clear policy direction will
certainly help… The momentum is now getting to a self-sustaining point.”
Squires urges other pension funds to lift their climate
ambitions and actively engage the companies they invest in.
Their members will likely support those efforts, he says.
“We’ve had a lot of positive feedback.”
A “small number” of members are skeptical, although most
understand the reasoning, including that the rapid move towards carbon
neutrality will reduce risk, Squires says.
“We actually think other funds with exposure to fossil fuel
assets are more at risk than us. Being a first mover was important for us.”
What a carbon-neutral portfolio will look like
Considering that not all companies NGS Super invests in
today will reach net zero by 2030, Squires says the fund will retain
investments in companies with “some level of scope 1 and 2 emissions” at the
end of the decade – provided they are “genuinely transitioning” to the
low-carbon economy, pose no transition risk, and are yielding acceptable
risk-adjusted returns.
“In 2030, we envisage that we will have investments that have
low or justifiable scope 1 and 2 emissions, are carbon-neutral, or are
carbon-positive – offsetting other investments within the portfolio.”
NGS Super would prefer not to use carbon offsets to achieve
its goals but will measure the offsets generated from investments in renewable
energy and carbon sequestration.
“If we decide to use carbon offsets, we will share this
information in our reporting to members.”