North American funds getting aggressive on climate change

With the clock ticking more loudly on the universal goal of net-zero greenhouse gas emissions by 2050, some North American pension funds are moving more aggressively to tackle climate change. They are addressing climate change across their entire portfolios, spurred in part by more data on the risks and opportunities, as well as the need to catch up with their overseas counterparts.

"We are now seeing a growing movement of investors that are going to set high-ambition targets for the whole portfolio, using good data across every asset class. There is a rising sense that (climate change) is not something you can address in one sector," said Kirsten Snow Spalding, San Francisco-based senior program director of the Ceres Investor Network on Climate Risk and Sustainability, which represents 175 asset owners with a combined $30 trillion in assets.

"Almost every investor in our network is taking steps toward addressing climate change in their portfolios. The direction of travel is toward science-based targets," Ms. Spalding said.

Case studies developed by Ceres and several global investor networks highlight the various approaches being taken to assess and manage the two fundamental risks of climate change: the physical risk from events such as droughts, wildfires, sea level rise, floods and storms; and transition risk, which can include government climate policies such as carbon pricing and taxes, and technology transition to renewable energy and more resource-efficient technologies.

"An increasing number of large asset owners in North America and other regions are digging deeply into climate risk and opportunities … in ways that are tangible," said Chris Davis, Boston-based senior director of the Ceres Investor Network. While public equities are common targets, "a lot has been done in fixed income and real estate and investors are increasingly moving into private asset classes," he said.

The biggest trend is decarbonization, followed by searches for opportunities to invest in climate solutions, Mr. Davis said. The approaches range from assessing the carbon footprint of different asset classes to developing scenario analyses of how their particular portfolios would perform under various climate policies and transition scenarios.

One common measure of carbon footprints is data from the Financial Stability Board's Task Force on Climate-related Financial Disclosures, which developed voluntary, climate-related financial risk disclosures for companies to share with investors and other stakeholders.

Many of the investors studied by Ceres also turn to ESG data providers such as MSCI Inc., Sustainalytics and Bloomberg LP, which continue to roll out tools, including ones that measure risk intensity by industry or asset class such as real estate.

For more quantitative analysis, investors such as the C$207.4 billion ($154.5 billion) Ontario Teachers' Pension Plan, Toronto, also use specialized data tools, Ceres found.

OTPP is working on a sector-specific ESG maturity framework for assessing companies' sustainability management practices. It is also collaborating with Wellington Management Co. LLP and Woods Hole Research Center to dig deeper into climate change research applicable to specific investment strategies.

Investor demand is expected to spur even more options. "I have witnessed increased urgency from investors to quantify their climate risk exposures when constructing and analyzing portfolios," said Remy Briand, head of ESG at MSCI in Geneva.

Convinced that the market is not accurately pricing the risks and opportunities associated with the transition to a low-carbon economy, Wespath Benefits and Investments, the investments division of the Glenview, Ill.-based $24 billion General Board of Pension and Health Benefits of the United Methodist Church, turned to BlackRock Inc. to customize an investment framework for managing risks and opportunities. So far, Wespath and subsidiaries have committed more than $1 billion to Wespath's transition-ready strategies, and about 26% of their passively managed equity strategies now employ the framework.

While U.S. pension funds may be not be the global leaders on climate change, several "are doing really deep work," Ceres' Mr. Davis said. He cited the $194.3 billion New York State Common Retirement Fund, Albany, which through its Climate Action Plan is doing risk-related work and developing minimum standards for investing.

Other U.S. leaders include the $246 billion California State Teachers' Retirement System, West Sacramento, for which the board of directors has commissioned work on climate and energy transition strategies, along with a low-carbon index strategy.

Other pension funds are stepping up, too. The $25.9 billion San Francisco City & County Employees' Retirement System plans to make its total portfolio net-zero carbon emissions by 2050, and officials at the $15 billion Maine Public Employees Retirement System, Augusta, are looking at climate risk in private asset classes such as infrastructure and renewables.

Pension funds with smaller staffs rely on managers and investment consultants for climate change direction. Others actively addressing climate change risks and opportunities, such as the $211 billion New York City Retirement Systems, which uses their procurement process and annual reviews to set expectations for staff members and managers.

To meet its ambitious goal of 25% carbon reduction across the portfolio by 2025, the C$340.1 billion Caisse de Depot et Placement du Quebec, Montreal, assigned carbon budgets to each asset class and made them the performance target for the investment staff.

The "next big step" in climate data will come from regulation, which is already driving the European Union's action plan for climate change, said Maximilian Horster, managing director and head of Institutional Shareholder Services Inc.'s ESG climate solutions unit in Frankfurt. With steps such as California's landmark 2018 bill requiring the $403.8 billion California Public Employees' Retirement System, Sacramento, and CalSTRS to consider and report on climate-related financial risk to their portfolios, "it is not a choice anymore," and reporting will become "more and more mandatory," Mr. Horster said. "We have plateaued with voluntary reporting."

MSCI's Mr. Briand sees two sides of the debate over the adequacy of current data. "If you want to act, you have enough data to (analyze) the portfolio and reduce the risk. If you rely only on the company, you will be suffering. It's a question of doing your homework. The laggards are whining about disclosure; the leaders are looking for solutions," Mr. Briand said.

The $22 billion OPTrust managing the Ontario Public Service Employees Union's defined benefit plan, falls into the second category. "Our view is that we have to put a stake in the ground and start somewhere," said Alison Loat, Toronto-based managing director for sustainable investing and innovation. OPTrust just completed a carbon footprint analysis across the entire fund and is now in discussion with data providers to help devise bottom-up climate change risk metrics for physical risk and transition risk for all asset classes. With a sizable allocation to alternatives such as private equity, for example, "we have direct ownership and higher influence than we would in public companies. For public companies, we are working closely with our managers, making sure our managers align with us," Ms. Loat said.