Climate risk is a top priority for Norges Bank (NBIM), the manager of the world’s biggest sovereign wealth fund, the US$1.38 trillion Government Pension Fund Global (GPFG). While NBIM has made significant efforts to slash its carbon footprint, it still has a further journey to make even to match some of its peers – and the slow pace of transition is denying GPFG potential growth.
NBIM’s report entitled “Climate Change as a Financial Risk to the Fund”, which was published this week, indicates that exclusions remain a central part of its efforts to reduce climate risks. Yet, the nature of its governance framework and restricted mandate means that impact investment has been out of reach.
The fund manager noted that over the past decade, it had reduced exposure to climate risk through 170 divestments and 77 exclusions. It also claimed that in 2020, “the fund’s carbon footprint was 12 percent lower than the benchmark’s” and “since 2013, the carbon-intensity of the equity portfolio has decreased by 50 percent.” NBIM recognizes it still has work to do. In its paper, NBIM states that “We reviewed the economics of climate change and the results from climate scenario analysis and found that the fund has a vested interest in an orderly transition to a low-carbon economy that prevents severe physical climate risk from materialising.”
NBIM has come under criticism for a lack of ambition towards net zero – or even setting any kind of target. The GPFG equity portfolio carbon footprint was nearly 108 million tonnes of CO2 equivalent in 2019, which is more than twice the amount of Norway’s annual total emissions, and triple when excluding Norway’s emissions caused by oil and gas extraction. This prompted calls by leading climate experts and economists this month for NBIM to sign up to the Net Zero Asset Owners Alliance and achieve net zero in its portfolio by 2050, if not sooner.
In its defense, NBIM points out the challenges it faces in setting carbon targets due to poor data quality, the limitations of models as well as uncertainty, although these are challenges facing all investors seeking to curb climate risks.
Aside from the problems in quantifying carbon intensity and ascertaining how to adapt the portfolio to various scenarios, the fund manager is also missing out on opportunities provided by impact investment.
In a report prepared by Global SWF and presented by Framtiden in a Norwegian Parliamentary seminar in April 2021, we analyzed the performance of its oil and gas or “black” stocks against “green” stocks, including renewables generation. We found that NBIM was losing out on returns due to a slow transition from black to green assets.
The research, published in a recent Global SWF newsletter, found that the black portfolio lost -23%, -10% and -11% in the one-year, two-year and three-year periods ending December 31, 2020, while the green portfolio earned +92%, +257% and +316%. In other words, if NBIM had fully divested from O&G and reinvested that money into renewables in November 2017, when it first proposed exiting from black stocks, its balance sheet would have been 10% larger today. The opportunity cost is estimated at nearly US$126 billion.
NBIM’s own data also makes the case for a faster greening of GPFG’s portfolio. At the end of 2020, it had NOK100 billion invested in equities in 90 companies in its environment-related mandate. The annualized return on these equity investments since 2010 has been 9.5% - far higher than the 10-year accumulated annualized return of 6.3% for the whole portfolio, of which 25% is in fixed income, 73% in public equities and the remainder in real estate. The overwhelming focus on public equities has denied the fund potential higher yield from early-stage impact investment and venture capital, and put it behind some of its peers in the state-owned investor sector.
Lengthy decision-making over choosing asset classes has also constrained its ability to reach environmental goals. Altering its mandate can take years to push through parliament, by which time opportunities to invest early for strong returns have passed. For example, in November 2017, Norges Bank recommended to the Ministry of Finance the removal of black stocks from GPFG’s benchmark index, but by end-2020 it still possessed an estimated US$23.3 billion in oil and gas equities.
As well as a lack of nimbleness, NBIM’s conservative approach to portfolio allocations, with a highly limited exposure to private markets, undermines opportunities to move beyond a risk-based approach to adopting an impact approach to climate change. Although it has pledged to invest 1% of AUM in renewables by end-2022 (potentially equating to US$140 billion), so far it has pursued acquisitions of existing assets in developed markets rather than funnel liquidity into new projects to expand green energy capacity – notably its acquisition of a 50% stake in the Borssele 1 and 2 wind farm off the Netherlands for US$1.63 billion in April.
This contrasts with the approach taken by other state-owned investors, such as Mubadala and Temasek, who have opted for impact investments in renewables and venture capital in new technology to combat climate change – even though they have retained large exposures to carbon emitting industries and have yet to state targets. These investors are keen to initiate projects and participate in growth stories, rather than simply snap up mature assets. If NBIM took a similar approach, it could play a crucial role in providing the capital to support global energy transition.
In a joint article for OMFIF published in March, Global SWF’s CEO Diego López and Håvard Halland, Senior Economist at the OECD Development Centre, noted that diversification “would require extensive capacity building, since NBIM’s internal teams focus almost exclusively on public markets.” Global SWF points out that reallocating even small percentages of a fund as huge as GPFG carries significant challenges. Yet, scale can bring diversification difficulties.
NBIM’s approach to renewables is similar to its cautious approach to real estate, which has focused on prime markets in developed economies. As a result of this self-imposed restriction, it has failed to meet its initial target of 7% in unlisted properties with a policy of investing in prime locations; the target was revised down to 5% but the current level is still 2.5%.
Where NBIM does have strengths is as an active investor in its public equities. It frequently challenges boards that “fall significantly short of our expectations or are unresponsive to our engagements.” Exclusions are one thing, but if NBIM can influence listed entities through its muscle as a shareholder (albeit typically with small stakes), it can effect some change – although it is still left with the dilemma over quantifying the impact it has on climate change.