Anyone looking to bust the myth that going ‘green’ compromises investment returns need look no further than Alecta. Sweden’s SEK928bn (€88bn) occupational pension provider saw its equities portfolio return 19.8% in 2019 – the same year that it updated its risk models to include the highest carbon pricing assumptions of any investor in the world.
This time last year, CEO Magnus Billing and Chief Risk Officer Daniel Asplund spoke to RI about how they became one of the first asset owners globally to introduce TCFD-aligned climate scenarios into their annual risk analysis. Using a $140 per tonne carbon price, they created 2°C and 3°C transition models to 2040, which they applied to their domestic and global equities, bonds and real estate portfolios.
Last month, they presented their board with a “new and improved” model. So what’s different?
“Well,” says Asplund. “We still use a $140 carbon price, but we’ve come up with two more prices to work with, based on the IPCC’s report: $230 for a 2°C world, and $870 for 1.5°C.”
$870 is the highest carbon price any investor has publicly used for this kind of analysis, and the results are alarming. At $140 per tonne to 2040, Alecta’s global equities portfolio is affected by 21%. At $230 per tonne, it’s 29%. And at $870 per tonne – the average estimated carbon price for preventing global catastrophe – it is down 48%. (According to the results, Alecta's reference index is down only slightly more in each case, but Billing says this is because many constituents go into negative market valuation at a much lower carbon price point, which isn’t captured in the model.)
How to deal with the US’s departure from the Paris Accord will be a "major headache" for responsible investors in 2020, says CEO Magnus Billing
Neither Billing nor Asplund think there will actually be an $870 a tonne price on carbon, or that their equities portfolio will really lose half its value because of climate change, but that doesn’t stop them from taking the analysis seriously.
“This is a stress test done on the basis that company management just sits still and doesn’t make any changes to its business models to cut emissions,” explains Asplund. “But there’s no doubt that, for some companies, these results will become a reality – they will be stranded. And the purpose of this assessment is to develop a discussion with our portfolio management teams about how to identify and deal with those companies.”
Alecta is 100% internally managed, and the latest findings were presented to its portfolio managers last week, as well as being integrated into the existing investment spreadsheets, although Billing insists that all PMs will maintain “a very decentralised mandate when it comes to making investment decisions”, so there will be no rules introduced, beyond Alecta’s existing commitment to be zero carbon by 2050.
No major divestments, then, but an “expectation that the portfolio will change significantly over time as a result of this analysis,” according to Billing. In sectors like automotives – the focus of a dedicated study by Alecta last year – its PMs are already making financial decisions based on climate risk, he adds, but for others “we still have more work to do to help them see new risks and opportunities”.
It would help, he observes, if there were more suitable low-carbon assets to invest in. “It’s not easy to find assets like sustainable infrastructure, and when we do, they’re expensive because everyone’s chasing them.”
When it comes to the climate models themselves, the biggest frustration has been – unsurprisingly, perhaps – the data. Having discussed methodologies with external vendors at the very start of the process, they opted to create a proprietary one, partly due to the lack of third-party options that included Scope 3 emissions. They bought in raw data and established their own model, but even then there were challenges: the unnamed data provider Alecta chose uses estimated data for most of its Scope 3 coverage so Asplund decided to use the self-disclosures made via Bloomberg, too.
Comparing the two sets of figures indicated a real challenge with the estimates. “We found companies with emissions 20-times higher than the estimated data,” he says. “As we don’t expect companies to report higher emissions than necessary, we exchanged the estimated data with the companies’ own figures [where appropriate],” he explains. “We know the problems with Scope 3 – double counting and other issues – but it’s better to try to analyse this data than do nothing, or use data that is much lower than it should be.”
“Having an internal methodology is useful because then we can choose what data to input,” says Asplund. “Using external vendors limits you to their methods and data. It is also an advantage to do the calculations in-house so we understand the effects and can have a better discussion with the PMs.”
He adds that vendors will have to step up if they’re to be valuable to big asset owners like Alecta. “They need to use Scope 3 data, good Scope 3 data, as standard. That’s the only way to seriously understand the impacts and risks of a company. Just look at Alecta: our portfolio looks stable from a Scope 1 and 2 perspective, but introduce Scope 3 and things stop looking so attractive.”
In 2019, Alecta also turned its attention to physical climate risk, plotting the factories and offices of their equities holdings onto a map and comparing them with a climate risk index from NGO GermanWatch to identify hot spots. “We hope in 2020 external vendors will increase their capacity to provide data and methodologies in this area too,” says Asplund. “That would be a big help.”
Inadequate data is not all in the hands of the vendors, though, the pair acknowledge.
“The data isn’t there partly because the disclosure isn’t there,” says Billing, pointing out that only 60% of Alecta’s own portfolio companies disclose Scope 3 emissions. “We want that to be 100%. We need it to be 100%. So that will be a big theme for us in 2020.”
Alecta will engage with its holdings to encourage more disclosure – efforts Billing hope will be assisted by the recent, similar pledge from BlackRock, the world’s biggest investor. It could also be helped by another recent announcement closer to home: Sweden’s FSA, with whom Alecta has been engaging on these topics, confirmed to RI last week that not only will it investigate “the possibility of promoting, at both national and international level, that companies increasingly report an internal price for carbon dioxide emissions”, but it is also looking at climate scenario analysis and stress testing.
"We found companies with emissions 20-times higher than the estimated data" – Daniel Asplund, Chief Risk Officer
Alecta’s been engaging with Nasdaq Nordic, too, asking them to introduce mandatory Scope 3 reporting as part of their disclosure requirements for listed companies. In a statement, Nasdaq Nordic told RI that “while ESG reporting is not a formal requirement on our Nordic Exchanges, it is certainly encouraged”, pointing to a dedicated reporting guide it published last year, which references the TCFD. “Our experience is, however, that true development on sustainability is driven by demand, rather than regulatory intervention… At this point, we do not see reason to create additional layers of regulation and administration that could harm innovation and companies’ ability to access the public market. We consider this particularly important in a market like ours, since the majority of our listed companies are small- and medium-sized enterprises leveraging the public markets for capital.”
In a year in which countries will have to review their climate goals under the Paris Agreement, Alecta will be keeping a close eye on governments. In addition to concerns that another recession could see sustainability fall down the agenda for the world’s financial rule-makers, there are is also specific national risks that could impact issuers, says Asplund.
“We carved up the [corporate] bond portfolio to see which countries we have exposure to, and how they might be effected by the transition. We have exposure to the US, for example, which doesn’t have the best energy mix and is leaving the Paris Agreement.”
Billing describes this final point, the US exit from the climate deal, as “a major headache for the market”, predicting that “working out how, as investors with certain values, you should respond to that – whether it is still okay to invest in US sovereign bonds – will be one of the big questions this year”.
“It’s very difficult and we’ve only just started to talk about these issues internally, not even with our board yet, so it’s still very early days,” he adds, saying that it would be hard for a pension fund to follow Sweden’s central bank, which made history last year by exiting bonds from sub-sovereigns in Australia and Canada due to concerns over climate risk – especially when it came to flagship assets like US Treasuries.
As well as all this, Billing wants Alecta to continue to lead on social and governance issues – namely SDG 8 (promoting decent working conditions) and tackling money laundering and tax issues – so it will be another busy year for Sweden’s biggest pension fund.
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