Virtue signalling, with your money

I haven’t written about the New Zealand Superannuation Fund (NZSF) for a while, and a well-informed reader has been encouraging me to get back to the economics of the Fund (and some of the important issues raised in a recent review paper).  I will, but for now I remain of the view that the Fund is serving no useful purpose and should be wound up.

But while we have it, it needs to be run well.

One of the annoying aspects of the Fund is the way in which the Board and management get to take your tax money and mine, and invest (or not) in causes which they happen to find appealing.    Of course, the Act isn’t written that way, but that is what it boils down to.   I’m not too keen on my money being invested in abortion providers or private prison operators –  just to span the ideological spectrum –  but obviously Adrian Orr and his Board don’t have a problem with such exposures.   They, on the other hand, object to tobacco companies and whaling, which don’t greatly bother me.

But the other day, they announced a big new policy shift that has substantially reduced the carbon exposure of the Fund (somewhat puzzlingly, I saw no mention in any of their documents of methane exposures, and as we know in New Zealand at least methane exposures make up a very large chunk of greenhouse gases).

To their credit, NZSF pro-actively released several background and Board papers relevant to this move, as well as several pages of question and answer material (all at the link in the previous paragraph).

This shift is dressed up as a simple matter of economic and financial management.  Indeed, they are at pains to assert that ethical (or presumably political) considerations played no part in the shift.  But, on the material they have presented it just doesn’t ring very true.

For example, they released a presentation to the Board from a few months ago.  In it, the chief investment officer and the “head of responsible investment” told the Board that

We believe climate change is a material long-term risk for which the Fund will not be rewarded.

What they appear to mean is the market prices of shares with (adverse) exposure to climate change and any associated policy responses do not adequately reflect those risks.

It is an arguable proposition, for which you might expect that evidence would be marshalled.  But the Board appears to have been presented with no evidence whatever, just assertions, and questionable economic reasoning.  Thus, on the next page

Climate change is a market and policy failure: markets are producing too many emissions and are over-invested in fossil fuels. We believe carbon risk is under-priced partly because the time horizon over which the effects will manifest is too long for most market analysts – but it is relevant to the time horizon that matters for the Fund.

This is a hodge-podge paragraph. For a start, climate change itself isn’t a market failure, but may well arise from market failures (costs aren’t properly internalised etc).   But the fact of climate change –  whatever role past policy or market failures may have played – tells one nothing about whether shares in companies exposed to carbon are now fairly priced or not.  They are just two completely different things.

And there is still no evidence presented for the proposition (“belief”) that markets have overpriced these companies (such that expected future risk-adjusted returns on them won’t match those available elsewhere).  Other market participants know as much (or as little) as NZSF staff know.

There was a more detailed Board paper in April containing the final recommendations.   It has more text, but no more analysis of the risks or of why the Board (or we) should believe that NZSF is better placed than the market to appropriately value climate change related risk.    Instead, we get a repeat of the same assertions,

NZSF quote

followed by a sentence which is best summarised as “but we really don’t know”.

There are repeated references to lines such as “ignoring Climate Change presents an undue risk”, but that isn’t even remotely the issue.  The issue is whether (a) the market on average is mispricing that risk, and (b) whether NZSF staff, management, and Board are better placed to evaluate the complex mix of scientific, economic, technological, and political factors that determine how things will play out (and thus what fair value pricing will prove to have been).     Thus, it is quite likely that the market on average has the appropriate pricing of these risks wrong, because much of what is relevant is inherently unknowable.  But if it is likely that the market is wrong, there is no particular reason to be confident which side the error lies on.   And it isn’t obvious why it is easier for NZSF to be confident it is right about this, than about any of the other very long-term risks embedded in many sectors, or in the market as a whole.

There are also hints that really this has little to do with a careful evaluation of financial investment risk and a lot more about politics and “good causes” –  virtue signalling.


Consistent with this political focus, the very first item in the proposed communications strategy reads

“Recommend engaging with the Greens to explain to them the approach we have taken”

(And, sure enough, they were lauded by the Greens – although not for the quality of their financial analysis –  when the new policy was finally announced the other day.)

NZSF’s detailed public story is contained in the Q&A document they released.  This is text that they will have had months to refine, the Board having made this decision in April.

But again, there is no analysis presented or summarised to indicate why the Board is confident the market has it wrong. Instead they seem reduced to lines like this

We believe that now is the right time to act. Even if there remains some uncertainty about global policy, its general direction is consistent with meaningful carbon reductions.

This is the basis for a major strategic investment choice by the Board managing taxpayers’ money??   “General directions” are one thing, assessing market pricing and demonstrating with a high degree of confidence that market prices are wrong is quite another.

Or lines like this

The Mercer climate change study that we participated in during 2015 found that the biggest risk to investors from climate change was to be on the wrong side of strengthening global policy and/or technological disruption. Mercer found that investors who got ahead of the curve could mitigate the potential downside.

Well, of course.  If you read markets well, and judge policy correctly, there is plenty of money to be made.  But doing so is hard…..very hard, and NZSF provides no evidence that they are able to beat the market uniquely well is this particular area of their global exposures.

There is further evidence that this move is about politics and virtue signalling, rather than robust financial analysis.

Will your active managers be allowed to hold stocks that have been sold from the passive portfolio on the Fund’s behalf?
Our active NZ equity managers (who may also from time to time invest in Australia) will not invest in these stocks.

If this were just a strategic view that markets were systematically mispricing this risk, there would be no reason to bar active managers from holding such stocks from time to time (after all, even if one average the market is mispricing this risks, it doesn’t mean there won’t occasionally be opportunities in individual stocks that are exposed to such risks.)

There is very strong sense that NZSF decided to reduce its climate change exposures, and then back-filled the (rather weak) argumentation in support of that.  As it is put early on in the April Board paper, setting the scene for the recommendation.

“a reduction of climate-change related risks for the Fund is a key goal of the CCIS [Climate Change Investment Strategy]”

Perhaps there is some other economic and financial analysis, that they haven’t yet released, to support that strategic preference (I’ve lodged an OIA request to that end) but at the moment it looks like a political choice not a financial one.

The NZSF has implemented this strategic choice by the Board and management by altering their so-called Reference Portfolio benchmark.   They have long argued that the reference portfolio is what their performance should be benchmarked against  (the numbers scream out at one, in large type, when one goes onto their website).  I’ve long argued that is the wrong benchmark for citizens and taxpayers to focus on (useful as it might be for the Board to judge staff active management choices against).  In this case, the Board itself has taken what amounts to a punt (an active call) that the market is underpricing risk in a particular sector.  They need to be evaluated on the results of that call over time, not avoid accountability by burying the implications of their policy decision in what looks like a passive benchmark that is beyond their control.

Perhaps the NZSF choice will be widely popular.  But that isn’t their job.  In fact, it has always been one of the dangers of the Fund.    It isn’t their job to be playing politics by tilting the portfolio towards trendy causes.  If anything, long-term investors (the advantage they constantly assert) might be better positioned to take somewhat contrarian stances, leaning against the tide of opinion at times (but only when backed up with sound analysis).    And if they really believed that the market was underpricing climate change risk, why not be rather more open about the resulting investment choices  –  leave the reference portfolio unchanged, and implement the market call through active management positions?

And you do have to wonder how, in a country where policy is still aimed at opening up further oil and gas deposits, a New Zealand government agency now has an official ban on buying shares in companies that might be developing those resources.  Will an NZSF ban on dairy exposures be next?

We have elections to choose the people who will make policy decisions.  If the public want to ban dairying, or oil and gas exploration, then elect the politicians to make those calls, and hold them to account.   But lets not have bureaucrats and unaccountable Board members pursuing personal agendas (even popular ones) with our money.  If the economic and financial case is really there –  and remember that active management calls of this sort don’t have a great track record globally –  then lay it out for us to see.  On what they’ve released to date, this look much more like a virtue-signalling call than one consistent with the NZSF’s statutory mandate, or with the sort of professional expertise we should hope for from well-remunerated investment managers.