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Investing

OPTrust pushing climate change into LDI framework

James C. Davis believes the innovative process is just beginning.

OPTrust, Toronto, which has put climate change risk management front and center with its C$20.3 billion ($15.7 billion) in investments, is working to align its pledge to reduce climate risk with its version of liability-driven investing, said James C. Davis, chief investment officer.

"This is evolutionary," said Mr. Davis, adding that metrics that work in the public markets don't necessarily apply to climate risk measurement. "For us, we've said there's been a lot of talking about climate change but not a lot being done about it," he said. "Our ability to apply innovation has put us on the leading edge, but we're not anywhere near done on this."

He said member-driven investing — OPTrust's version of LDI that focuses on maintaining full funding for the Ontario Public Service Employees Union Pension Plan, Toronto, instead of targeting a plan termination date — "is about pension certainty, that our members get the pensions they're promised at the current cost. When I look at that, I look at all the risks that can affect that today — equity risk, interest-rate risk, longevity risk. But I can also look at it in terms of longer-term risk, like climate change. It's not acceptable to pick and choose the risks you want to price. You can't do that with climate-change risk, but that doesn't give you an excuse to ignore it."

Hugh O'Reilly, president and CEO of OPTrust, agreed that measuring climate risk is a long-term endeavor. "When it comes to climate change and LDI, I think it's more like a cricket game than a baseball game," Mr. O'Reilly said. "Baseball games usually end after nine innings, but cricket games can go on for days. We think in the long run, our position on climate action fits with our member-driven investing strategy."

But for now, Mr. O'Reilly said, the inability to currently price climate-change risk is a major issue for a plan that was 111% funded as of Dec. 31.

"With our member-driven investing strategy — our LDI — we must get properly rewarded for the risk we take," said Mr. O'Reilly. "We find the issue we need to grapple with is how do we price climate change. With investors like us, even with the information and the technology we can apply, it's hard to properly price it, so that affects us as investors."

Some reinforcement

Mr. O'Reilly reinforced that point in a Sept. 25 presentation to a New York seminar organized by MSCI Inc. in partnership with the United Nations-supported Principles for Responsible Investing.

"As a pension management organization, OPTrust looks at investments over a long time horizon," Mr. O'Reilly said at the seminar. "Funded status is our key measure of success — it is the measure that matters. In order to preserve our funded status and fulfill our pension promise to our members, we endeavor to fully understand and price our risk exposure. That includes climate risk. Accurately pricing risk, however, in a world without commitments to proper climate-related disclosure from corporations is almost an impossible task. That brings us back to the need for action."

OPTrust in June announced its own action plan to manage climate-change risk, focusing on eight points — of which three directly deal with measurement issues.

Mr. Davis said the points of the action plan dealing with measurement present the biggest challenge. "As investors and accountants, there's a lot of emphasis in getting the numbers and looking at things around those numbers," Mr. Davis said. "Well, I'd like to know the price of carbon, but I don't. Accountants don't, investors don't — but that doesn't mean we don't consider carbon in choosing what we invest in."

Without data to price climate change, Mr. Davis said OPTrust is finding more holistic ways to measure it. "What in the investments we're making is being affected by climate change?" he said. "Maybe not in dollars and cents, but maybe by looking at peer groups, we can compare firms in a given sector and see which are looking at climate change more than others. It's also important to see what the boards of companies we invest in, the management of those companies, are doing in considering climate change in their daily operations. There's not some kind of metric to do that."

'One step further'

Along with comparing companies' management and boards, Mr. Davis said, "We take it one step further. We're looking at how we and our partner companies can look to incorporate climate change in investments."

Mr. Davis said OPTrust just asked the boards and management of companies in which they invest what they're doing to measure or monitor climate-change risk, which could guide how OPTrust measures it.

"We're hoping to get standards that can serve as a baseline, not only to compare companies but also to decide on specific company investments," he said. "That way, we have something we can track. That way, we're not fixated on one measure, like greenhouse gas emissions, but we can look at that as one aspect of climate-change risk and look at the entire risk in a more holistic way."

Artificial intelligence can also help, Mr. Davis said. OPTrust works with ClimateAI, a Palo Alto, Calif.-based enterprise software platform provider that uses AI to make quantitative and qualitative evaluations of climate change-related impacts, particularly geographic.

"Geography also matters," Mr. Davis said, adding that ClimateAI can help assess "the impact of climate change on a geographic area as well as an individual company. It can look at downtown Toronto and determine the risk of flooding; it also can look at how wind pattern changes could affect a wind farm in Australia. That provides us with better information and better ways of determining the effects of climate change on our investments."

The issue with pricing risk isn't only with public markets, Mr. Davis said. "The advantage we have here is that attention has been paid to public markets, but the private market is a great place to try new things, especially since we have a seat at the boardroom table," Mr. Davis said. "We get to see the impacts directly."

While using climate change as a factor in determining investments, Mr. Davis said companies that do take climate-change risk into account doesn't automatically ensure an OpTrust investment with them.

"You can argue that you're making a thematic play," Mr. Davis said, "but if it's not good for us, we won't invest in it. This theme will play out as we move forward. Technology and climate change are likely to be overlapping. We're not just looking at impacts on oil and gas and wind farms, we need to know where we are with all investments from a risk-return view when it comes to climate change. It's everybody's problem, everybody's challenge. The more pension funds, regulators and companies talk about this, the more likely we are to resolve this issue."