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CalSTRS moving toward low-carbon diet

Christopher J. Ailman called the low-carbon commitment a forward-looking strategy.

Fund calls $2.5 billion push big part of sustainability plan

The California State Teachers' Retirement System's commitment to invest $2.5 billion in a low-carbon index strategy is part of a larger plan to invest its stock portfolio in companies with more sustainable business practices.

The plan also includes increasing the $188.8 billion West Sacramento-based pension fund's allocation to so-called sustainability managers — which invest in alternative energy companies or companies that are committed to sustainable environmental practices — to $3 billion from $1 billion.

CalSTRS Chief Investment Officer Christopher J. Ailman said the investment committee's July 14 approval of allocating $2.5 billion in equity assets to the MSCI ACWI Low Carbon Target index is a smart business move.

“We're looking ahead and saying, "Hey, we think the climate change is going to have a market impact,'” he said in an interview. “We're putting some initial money to be ahead of that and make a return.”

CalSTRS' decision follows that of the $178.1 billion New York State Common Retirement Fund, which in December invested $2 billion in a Goldman Sachs Asset Management custom low-carbon equity index.

For CalSTRS, the initial $2.5 billion allocation is just a fraction of the fund's approximately $100 billion equity portfolio. But Mr. Ailman said CalSTRS will invest a larger percentage in the index strategy if the low-carbon index can outperform the MSCI All-Country All-World index.

Will others follow?

What's unclear is whether the move by CalSTRS, the nation's second-largest pension plan, will help spur other U.S. plans to take similar action. Consultants and money managers say more U.S. institutional investors are expressing interest in sustainability strategies, particularly in light of the Paris Agreement that calls for countries to reduce emissions. That agreement, adopted in December as a result of the United Nations Climate Change Conference, aims to limit an increase in the global average temperature to well under 2 degrees Celsius, the level at which studies say cataclysmic climate events could be triggered.

But while there has been more interest, there has not been a wholesale movement in the U.S. by institutional investors to embrace low-carbon strategies. For example, the $299.4 billion, Sacramento-based California Public Employees' Retirement System, has not adopted a low-carbon index. CalPERS spokesman Joe DeAnda said executives at the country's largest pension plan are exploring the option but no decision is imminent. Mr. DeAnda said CalPERS is aiming to reduce the amount of emissions generated among its portfolio companies by 50% through engagement with those companies.

In Europe, low-carbon investing became more popular several years ago. Sweden's 312 billion kronor ($36.3 billion) AP4, Stockholm, has invested in low-carbon strategies since 2012. AP4 spokeswoman Pia Axelsson said 22% of the plan's roughly $15 billion in equity assets — or more than $3 billion — are invested in low-carbon strategies.

Typically, institutional investors want to see a three- to five-year track record before embracing a strategy, said Chris McKnett, San Francisco-based managing director and head of environmental, social and governance at State Street Global Advisors. The MSCI ACWI Low Carbon Target index was introduced in September 2014.

CalSTRS data show the low-carbon index returned 1.71% for the five months ended May 31, while the MSCI ACWI index returned 1.85% for the same period. For the one-year period ended May 31, the low-carbon index returned -5.34% compared with the MSCI ACWI's -5.42%

The low-carbon index is designed to minimize the carbon exposure in a portfolio subject to a tracking error of 30 basis points relative to the ACWI, said Thomas Kuh, Boston-based executive director and head of ESG indexes for MSCI, in an interview.

Mr. Kuh said companies are over- or underweight in the low-carbon index relative to the amount of emissions they produce and the amount of reserves they have in the ground, unlike the cap-weighted ranking they would receive in the MSCI All Country All World index. This contrasts with the Common Retirement Fund low-carbon index strategy, which only uses emissions to determine company weights.

Another difference, the index used by CalSTRS does not exclude any companies, while that used by the New York State fund omits the worst polluters.

CalSTRS' committee meeting agenda materials said that back testing shows the low-carbon index's performance generally isn't too far off the MSCI ACWI over a full market cycle.

But the material also indicates it might be difficult for the low-carbon index to beat the ACWI, despite Mr. Ailman's hopes.

“Low-carbon indices, in general, do not target performance in excess of comparable market capitalization-weighted indices,” the agenda material states. “Forward-looking expectations are that their performance should be similar to that of the market cap-weighted index; however, the low-carbon indices have a live track record of less than two years, so no conclusive statement can be made about performance results at this time.”

The agenda materials said in the event that carbon is priced meaningfully, low-carbon indexes could provide positive performance, but “there is still no clear indication whether a price on carbon might be implemented, and if so, what form that carbon pricing might take” — a carbon tax or a cap on emissions.

“We do believe climate change is going to have a profound impact on companies and how we do business, but it is very difficult to predict to what extent that will occur and when that will occur,” Mr. Ailman said in the interview.

New York State Common Retirement Fund officials have said they hope to expand investments tied to the low-carbon index. “The Paris Agreement made it clear that the world is committed to a lower-carbon future and smart investors are working to meet the risks and opportunities of this new economic reality,” said state Comptroller Thomas P. DiNapoli in a statement to Pensions & Investments. “Momentum is building for sustainable investments that help protect and grow value in the face of climate change risk.”

Other low-carbon investment efforts in the U.S. include two exchange-traded funds — one by BlackRock (BLK) Inc. (BLK)'s iShares division, another by SSgA — tied to the MSCI ACWI Low Carbon Target index.

iShares ETF

The iShares MSCI ACWI Low Carbon Target ETF was seeded in December 2014 with a total of $143 million by the $53 billion United Nations Joint Staff Pension Fund and the $1.2 billion University of Maryland Foundation. The ETF had $231 million in assets under management as of July 17, said Scott Williamson, a San Francisco-based managing director for BlackRock (BLK)'s iShares division in an interview.

Mr. Williamson said other institutional investors — whom he said primarily were foundations and endowments — invested in the ETF. The low-carbon ETF is small relative to other ETFs, including its $5.6 billion iShares MSCI ACWI ETF, but Mr. Williamson said it had had, “a pretty reasonable growth rate.”

SSgA's SPDR MSCI ACWI Low Carbon Target ETF also was introduced in December 2014 and seeded by the U.N. pension fund with $75 million. SSgA data showed the ETF with $94.6 million as of July 19. While the ETF doesn't have a long-term track record, SSgA's Mr. McKnett said he was pleased with the “uptick” of investor interest and added that interest has grown since the Paris Agreement.

This article originally appeared in the July 25, 2016 print issue as, "CalSTRS moving toward low-carbon diet".