The first half of 2022 has been tumultuous, with many predictions at the beginning of the year. Uncertainty will continue to plague markets for the remainder of the year, but one thing we are more certain of is the continued integration of ESG factors into investment portfolios, the plethora of responsible investing strategies, and that decarbonization is a key objective for companies. and governments around the world. Private equity has an important role to play in the transition to carbon neutrality. We question the narrow opt-out approach required of Default KiwiSaver providers.
At 2021 Intellectual Property Research Fund Manager of the Year Award we have shortlisted three investment managers who are leading the way in responsible investing:
Responsible investing has been upgraded to a major category for 2021, with the award recognizing the investment manager who demonstrates the most commitment to responsible investing and its benefits for stakeholders. Pathfinder won Research IP Responsible Investment Manager of the Year for 2021.
Greenwashing and token signatories of the UNPRI or bodies like the RIAA will no longer cut the mustard. ESG is not new. Research IP’s focus is the shift towards sustainability and impact, the transition to carbon neutrality and the important role capital must play in keeping the lights on yesterday, today and tomorrow.
Effective implementation of this by investment managers is easier said than done. There are a multitude of approaches an investment manager can use to invest responsibly. But how do you carefully assess an investment manager’s approach to responsible investing? Does the investment manager ultimately offer good value for money?
Our research dissertation, Below the Surface of Responsible Investing, examines in more detail the investment merits of different managed fund approaches applied in New Zealand, Australia, the United States and Europe. We assess the application of the UN Sustainable Development Goals in an investment context, the Principles for Responsible Investment and broader ESG considerations.
We believe that independent, objective and holistic analysis is necessary to understand the effectiveness and nuances of different responsible investment strategies and how they relate to investors’ altruistic goals. Independent research will give investors something to hold on to when evaluating which managed funds are right for their goals. This is particularly relevant for Kiwis who find themselves in a Default funds and may wish to make an active choice and switch to another KiwiSaver provider.
Recent changes to Default KiwiSaver funds require fund managers to now exclude investments in fossil fuels and illegal weapons.
Definition of illegal weapons exclusion:
The default supplier shall exclude from the assets of the default product companies that are involved in the prescribed activities relating to:
- cluster munitions; Where
- Landmines; Where
- nuclear explosive devices.
The above exclusion applies to all investments:
- when the shares are held directly in companies that carry out the prescribed activities;
- in shares of majority shareholders of excluded companies (eg parent companies);
- in shares of subsidiaries of excluded companies when that subsidiary is involved in the prescribed activity;
- in managed investment funds that have listed investments in companies in accordance with the points above
Definition of fossil fuel exclusion:
The Default Supplier shall exclude from the Default Product Assets companies that:
- have proven or probable reserves of coal, oil or gas and derive at least 15% of their income from the exploration and extraction of coal, oil or gas; Where
- has its main business activity in one of the excluded sub-sectors prescribed in the table below.
|Classifications of sub-sectors||Definition|
|60101000 Integrated oil and gas||Companies active in all three areas of oil production: extraction (upstream), transportation (midstream), and refining and marketing (downstream).|
|60101010 Petroleum: Crude producers||Companies engaged in the exploration and drilling, production and supply of onshore crude oil.|
|60101015 Offshore drilling and other services||Companies that primarily explore and drill for oil and gas in offshore areas.|
|60101030 Petroleum equipment and services||Suppliers of equipment and services for oil fields and offshore platforms, such as drilling, exploration, seismic information services and platform construction.|
|60101040 Coal||Companies that extract, transform and market coal.|
|Classifications of sub-sectors||Definition|
|10101010 Oil and gas drilling||Drilling contractors or owners of drilling rigs who subcontract their services for the drilling of wells.|
|10101020 Oil and gas equipment services||equipment and suppliers of supplies and services to businesses involved in the drilling, appraisal and completion of oil and gas wells.|
|10102010 Integrated oil and gas||Integrated oil companies engaged in exploration, oil and gas production, and at least one other significant activity in refining, marketing and transportation, or chemicals.|
|10102020 Oil and gas exploration and production||Companies engaged in the exploration and production of oil and gas not elsewhere classified.|
|10102050 Coal and consumable fuels||Companies primarily involved in the production and extraction of coal, related products and other consumable fuels related to power generation. Excludes companies producing mainly gases classified in the industrial gases sub-industry and companies extracting mainly metallurgical (coking) coal used for the production of steel.|
The above exclusion applies to:
- all investments where shares are held directly;
- investment in managed investment schemes which hold investments in the companies described above.
For the purposes of these exclusions, oil includes oil sands, gas includes shale (as a source of gas) and metallurgical coal is not included in the term coal.
What was omitted from the definition of exclusions?
The classifications above come from two of the largest investment support firms in the world. Regarding the exclusions based on the ICB definitions (Table 1), there are actually two other sub-sectors in the Oil, Gas and Coal classifications that have not been included in the requirements. default exclusion from KiwiSaver. These are:
- 50101020 Petroleum refining and marketing: Enterprises primarily engaged in the refining and marketing of petroleum products (downstream).
- 60101035 Pipelines: operators of pipelines transporting oil, gas or other forms of fuel. Excludes pipeline operators that derive the majority of their revenues from direct sales to end users, which are classified as gas distribution.
There are also two other GICS sub-sectors (Table 2) that have not been included. These are:
- 10102030 Refining and marketing of oil and gas: enterprises engaged in the refining and marketing of oil, gas and/or refined products not classified in the integrated oil and gas subsectors or independent power producers and energy traders.
- 10102040 Storage and transport of oil and gas: Companies engaged in the storage and/or transport of oil, gas and/or refined products. Includes diversified midstream natural gas companies, petroleum and refined product pipelines, coal slurry pipelines, and oil and gas transportation companies.
Why were these other sub-sectors not included in the exclusion list? Where do you draw the line on exclusions? Investors should be aware of terms used in managed fund disclosures, such as “significant”, “significant involvement”, “directly involved” or “x% of earnings”. Ultimately, it is about materiality and proximity to business activity.
In addition to the question of materiality, why were fixed income assets not included in KiwiSaver’s default review, given that global debt markets are significantly larger than global debt markets? global stock exchanges? The green, social and sustainability (GSS) bond market is in its infancy, but it will grow over time as the broader approach to impact investing becomes more mainstream. Research IP analyzes this space as it grows and will publish research for investors interested in this approach to responsible investing.
If the purpose of these KiwiSaver exclusions is to fight global warming, why not specifically mention reducing carbon emissions instead of a narrow equity exclusion policy?
Exclude or manage?
Private equity has an important role to play in the transition to carbon neutrality. An excellent example of the transition is the Danish company Ørsted. It was once one of the most coal-intensive energy companies in Europe. Today they claim to be the most sustainable energy company in the world and a global leader in the transition to green energy. It’s a prime example of where capital should arguably be headed, but was on many do-not-lists.
Capital allocation is an essential part of the transition, are gross exclusions the right approach?
Check out our research paper, Below the Surface of Responsible Investingfor an in-depth look at the wide range of responsible investment approaches used in the investment industry today.