How the world’s largest wealth fund looks at climate risk

Welcome back.

Ugly news today, with a warning from the World Meteorological Organization that the global average temperature is set to reach nearly 2C above preindustrial levels — in the next five years.

With the world on course for even higher levels of warming, what will be the long-term implications for financial markets? Massive, according to the managers of the world’s biggest investment fund. So what are they doing about it?

CLIMATE RISK

Should Norway’s $1.8tn fund take a more assertive climate stance?

Earlier this year, Norway’s giant sovereign wealth fund gave an alarming update that got less attention than it deserved.

Norges Bank Investment Management — which manages a $1.8tn pot of cash from the country’s oil revenues — said it believed that the financial sector’s conventional approaches to estimating climate risk were massively understating the scale of the threat.

NBIM’s own modelling, it said, suggested that the long-term impacts of climate change would wipe out 19 per cent of the value of its US equity holdings.

Carine Smith Ihenacho is the woman tasked with responding to this problem. As NBIM’s chief governance and compliance officer, she’s responsible for the world’s largest investment fund’s approach to “active ownership” — with climate issues at the top of the agenda during her five years in the role.

NBIM is due to update its climate strategy this year, amid pressure from some civil society groups for it to take a more assertive stance.

When we met in London a few days ago, I asked Smith Ihenacho whether she agreed with the idea that the fund should use its financial firepower more aggressively to support climate change mitigation — given that its beneficiaries, the Norwegian people, would benefit from less extreme global warming.

That, she argued, would risk over-reaching the mandate that NBIM was given by the Norwegian government, “to create the highest return with reasonable risk, low cost, but also being a responsible owner”.

NBIM’s mandate was revised in 2022, to give it a long-term goal “that portfolio companies have operations that are compatible with global net zero emissions”.

So far, Smith Ihenacho and her colleagues have pursued that target largely through holding meetings with portfolio companies, and asking them to set science-based targets for emission reductions. The number of companies doing so has risen strongly in the past few years. Seventy four per cent of “financed emissions” in NBIM’s portfolio are now covered by net zero goals, up from 43 per cent in 2021.

“Is that us, or would they have done it anyway? It’s very hard to find out, but at least we do what we can to get companies to set targets,” Smith Ihenacho said.

Critics say NBIM should be using its voting power to much greater effect. “NBIM’s failure to endorse climate resolutions in line with internationally agreed goals undermines its role as a steward of sustainable finance,” Anja Bakken Riise, chief executive of Norwegian non-profit group Future in our Hands, wrote last year.

NBIM voted for 34 per cent of sustainability-related shareholder proposals last year, down from a peak of 52 per cent in 2018. The lower support rate, Smith Ihenacho said, was due in part to a large number of overly “prescriptive” resolutions, demanding measures that were “really up to the board to decide”.

NBIM has also taken a fairly restrained approach to investment exclusions, blacklisting only 28 companies for environmental reasons such as heavy involvement in coal or inadequate management of local pollution. As it turned out, those limited environmental exclusions have given NBIM’s stock portfolio a small performance boost of 0.02 percentage points a year.

This year’s strategy review is unlikely to bring a sudden lurch towards larger-scale divestment of high-emitting assets, despite the dire long-term picture painted by NBIM’s climate modellers.

“Do you divest or do you stay and engage?” Smith Ihenacho said. “We like to be an owner. That’s a way we can make money, but it’s also the way we can influence the company.”

This month, a group of Norwegian non-profits published the result of what they called the country’s first national “citizens’ assembly”. Its 56 members were chosen to provide a cross-section of the adult population, and asked to discuss how Norway should use its wealth for the benefit of Norwegians and the wider world.

They concluded that the country should play a bigger role in tackling climate change — including by using part of the oil fund for “sustainable investments where we accept higher risk and lower returns”.

But it’s important, Smith Ihenacho argued, to be “realistic on what investors can do”.

“Clearly, it also needs political solutions,” she said. “Investors alone can’t solve the climate crisis we’re in.”

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