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Superannuation funds are transitioning to low carbon economies with an increased focus on climate-specific investment strategies. Mercer’s Alexis Cheang talks with Darren Snyder about this important cultural shift.

CLIMATE CALLING Alexis Cheang, principal, Mercer

M ercer’s Alexis Cheang hears plenty of verbal commitment from Australian superannuation funds about the development

and implementation of sustainable investment strategies. The con-tinued aspiration is welcome, but Cheang believes proper execution and realisation still has ways to go.

Principal for responsible investment at Mercer, Cheang says both re-sponsible and sustainable investing in Australia is experiencing monu-mental shifts as super funds work through the best way to align environ-mental footprints with their respective organisation’s values and beliefs.

In 2014 it was estimated that global responsible investment ac-counted for US$21.4 trillion in funds under management, present-ing challenges for investors in Australia and across the world.

In the US, for example, there’s still a large focus on traditional ‘ethical investing’ or what an investor can exclude from their port-folio. However pension funds such as CalPERS and NYCERS are leading an approach that invests more holistically, Cheang says.

Over several years European investors have increased focus around integrating environmental, social and governance factors in to the investment process – something that gained quick acceptance in London, especially following the launch of the UN-backed Princi-ples for Responsible Investment.

“Although there’s probably less divergence now than there was when I started 12 years ago, there’s still quite a different way of ap-proaching sustainable investing between the Americans, the Euro-peans and Australians,” Cheang says.

Ultimately, super funds and other instos have to be clear on what they are trying to accomplish.

“If you’re trying to accomplish alignment with the beliefs and values of your organisation, then divestment may be a very good strategy for you. If you’re primary objective is to deliver the best risk-adjusted re-turns for your members, divestment may still be appropriate but other sustainable investing tools may deliver that better for you,” she says.

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Cheang spends time with super funds and their boards work-ing to evaluate the many options in developing and implementing sustainable investment strategies. She says the main focus for super funds in 2016 has been around climate change.

Super funds have attempted to address climate change in vari-ous ways. Whether it be excluding investment in thermal coal, car-bon footprinting investment portfolios or any one of a multitude of options, Cheang says it’s beginning a conversation about where investments are most carbon exposed and what funds can do to address it.

She says many of her clients are trying to partner with in-vestment managers to ask ‘how are you thinking about climate change’ and ‘what are you doing to help me lower my carbon foot-print’ and help society by meeting the aspirations of the recent Paris (COP21) agreement.

“I think that’s quite a new conversation for a lot of investment

managers. They’re not used to their clients asking about carbon footprints or specifically whether they’re addressing climate risk,” Cheang says.

Mercer’s approachOne of Mercer’s most public sustainable investment strategies is run through the University of Sydney’s endowment fund. Cheang ex-plains it was the first university in Australia to set a decarbonisation target, accepting that climate change is an ongoing issue and it will impact them over time – with an overall global commitment to re-duce emissions.

“We’ve been working with them over the last two years to reduce their emissions and I think it’s been really interesting to see how that’s influenced the investment strategies they’ve gone into and left. They didn’t just say ‘oh we’re going to go with a low carbon passive and it’s going to solve all our problems,’” she says.

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Earlier this year Cheang and other industry colleagues present-ed at the Australian Superannuation Investment (ASI) conference, speaking about super funds transitioning to low carbon economies. One investment strategy discussed was to divest from fossil fuels and then reinvest in indices which exclude fossil fuels. Alternatively a fund might use the divest/invest strategy - whereby it divests from the brown areas of the economy and into newer and low carbon economy assets such as renewable energy. Perhaps the most popular strategy is portfolio tilting and optimisation using carbon data.

Cheang says one of her colleagues in the US is working with a group of investors who are trying to model what they believe is a divest/invest approach. It not only involves divesting from fossil fuels but reallocating that capital in to solutions directly dedicated to cli-mate change. The results are imminent.

She adds this is a conversation that’s started with her super fund clients – rather than focusing on what they don’t invest in, the focus is on what they do invest in and working out how to get the returns.

“Your customers or members want to know they’re getting the return they need to retire from and they’re not that concerned about where it comes from, but if it can come from cleaner, more sustainable sources then everyone’s bound to be better off,” Cheang says.

In 2015, Mercer released the comprehensive report ‘Investing in a Time of Climate Change’. It looked at what would be the long-term portfolio-wide impacts of climate change on investments, particular-ly for superannuation funds. It revealed that climate change will have an impact on multi-asset portfolios over the long-term, regardless of the policy and technology scenarios that unfold.

Cheang told the ASI conference that potential sector impacts would be most meaningful over the next decade and that asset class impacts could also be material. She said the two degrees Celsius glob-al warming target reached at COP21 “need not harm total diversified portfolios out to 2050.”

She also said global emerging markets would benefit from the tran-sition to a low carbon economy as would unlisted assets. However at the same time developed market equities would more likely suffer in the transition.

“Time will tell whether we’re right on this one. Climate change is having both positive and negative effects in emerging markets and not all emerging markets are the same. Some are highly commodity dependent and some are commodity exporters,” Cheang says.

“Emerging markets are putting in some of the most aggressive low carbon or renewable targets, so the opportunity to benefit from those policy shifts is great and the cost of moving away from old legacy fossil fuel assets is a lot less difficult than in developed markets where you have a whole grid that’s built on coal fired power.

“So you can leapfrog some of that old technology and you can get some real upside benefit from those low carbon or renewable energy targets. There’s also a real embracing of innovation in emerging mar-kets and some of them can come to market quite quickly so we think they can benefit from technology changes as well.”

Cheang explains one of the regular questions she is asked by su-per fund boards is the issue of child labour and its reputational risk. She says it’s often a tricky topic but says it’s important for funds to remember the overall cultural landscape they’re thinking of investing in to, as well as the details in the broader context of which a com-

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THE JOURNAL OF SUPERANNUATION MANAGEMENT• FS Super

The quote

There’s still quite a different way of approaching sustainable investing between the Americans, the

Europeans and Australians.

The quote

They really just incorporated climate as one of the key indicators in choosing their investment managers.

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THE JOURNAL OF SUPERANNUATION MANAGEMENT• FS Super

pany operates. For example, in China people frequently work 16-hour days and then move on to another job with similar hours and this, from a local point of view, ‘is just earning as much as I can and then I’ll go and do some-thing else.’

She says child labour and other reputation risk ques-tions are fair questions but not an excuse for asking any questions.

Cheang says Mercer tends to take a top of portfolio approach and a ‘very birds-eye view’ in working with in-vestment managers.

“In my previous role we would drill down deeply look-ing at tier one and tier two suppliers – but I think again it comes back to good risk management, if you’re a company with a deep supply chain, what standards do you put in place. If you’re an investor with a position in that company do you understand the kind of supply risk they’re facing and how well are they managing that,” Cheang says.

“If you’re a super fund and you’ve appointed that fund manager, are you satisfied they’re asking those questions well on your behalf. It’s really a matter of good govern-ance and people holding their providers to a reasonable level of accountability as you drill drown.

“The chairman of a super fund may not know Ap-ple’s third-tier supplier, but they should be able to ask some good and reasonable questions of their manag-ers to make sure that the companies you’re invested in are making every effort to operate responsibly and sustainably. There will be bad eggs throughout the world and you can’t try and eliminate every reputa-tion risk and troubling situation but you can ask some good questions to try and at least make sure they’re being kept front of mind.”

A responsible introductionPrior to joining Mercer in 2014, Cheang was previously director, governance and sustainable investments at F&C, a UK-listed asset management firm. She was also recognised as a Rising Star of Corporate Governance in 2009 by the Millstein Centre for Corporate Governance at Yale University.

But she says her entry into financial services, and more broadly, responsible investment “didn’t start with any design or intention.”

“Although I went to university in New York City where everyone wanted to be an investment banker or a stockbroker, I had no interest in that myself. It was really when I was doing my masters at the Lon-don School of Economics I became really interest-ed in sustainability – I was talking to people about how corporations approach sustainability and I was invited to be an intern on a project looking at hu-man rights risk in the banking sector. The study was being published by KPMG and an asset manager named ISIS asset management (now part of the Bank of Montreal) and it was when I was working on that study I knew I wanted to focus on corporate sustain-ability,” Cheang says.

Before too long she was then introduced to the re-sponsible investment side – something she found fasci-nating. Originally she was asking the question whether corporations were doing more harm or more good when operating in emerging countries. Where they were successful, was that good for local development in communities or bad?

“Looking at it from an investment point of view you have got to go one step further and say ‘if I were investing in these companies, would they be good or bad for my investments, my retirement or long term savings.’ It be-came more personal and less remote just thinking about the big corporation end of it,” she says.

“When I started looking at the field of sustainabil-ity and corporate social responsibility, lots of compa-nies took it as a new way of looking at philanthropy and new ways of grant giving. It’s definitely shifted to being a corporate differentiator for talented invest-ment opportunities – so being more tightly linked to corporate financial performance rather than being part of the giving or community minded end of busi-ness. The growth in responsible investment has been a part of that.

“When analysts start asking on quarterly calls about carbon emissions, about water consumption, employee turnover – it moves from the remit of being in public affairs to being in the remit of the chief fi-nancial officer. It influences corporate decision mak-ing and investment decisions.” fs

The quote

We’ve all got a task to make superannuation as easy to understand as your home mortgage.