Approach to responsible investment

Given the nature of the value active strategies, these portfolios tend to have a higher exposure to the transition risks of moving to a low carbon economy. These will be ongoing risks if left unaddressed in the investment strategy.

A higher exposure to fossil fuel presents a market risk which may lead to increased costs and decreased revenues for companies. As we are moving away from fossil fuels towards more renewable resources, there is an increased potential of stranded asset risk with high exposure to fossil fuel reserves over the next decade and beyond.

The high reliance on fossil fuels for power generation will be associated with a higher regulatory risk over the short and medium term. Without clear revenue diversification plans these companies could be impacted by policies introducing carbon pricing, or potential carbon border tariffs, or even the introduction of stricter environmental standards.

There is also increased reputational risk for any portfolio companies with exposure to fracking, arctic drilling, oil sands and shale oil which are all considered to be controversial energy extraction methods.

In addition to the transition risk, our exposure to agriculture, mining, oil and gas companies will also translate into physical impact risk. If we do not transition quickly enough, the financial impact from extreme weather events such as floods, droughts, cyclones and wildfires will only increase. In order to mitigate those risks, significant capital expenditure by these companies will be needed for adaptation or building resilience for these assets.

The climate related risks in the portfolios are identified in a number of different ways. We consider carbon footprinting and the carbon intensity of our portfolios. We conduct scenario analysis which looks at not only how the portfolios are tracking against science based targets but also the exposure to different fossil fuels and renewables. This helps us identify many of the transitional, reputational, regulatory and physical impacts risks that the portfolios face.

We assess company’s alignment to net zero to see how the portfolio is tracking in relation to, and its overall alignment to, net zero. We also consider transition metrics to see in which areas (e.g. product, operations and assets) the portfolio is transitioning to a low carbon economy and where those transitional risks may lie. We conduct climate risk analysis to understand which climate hazards present the greatest financial risks.

The risks are addressed in a number of different ways depending on the type of portfolio.

In a number of our portfolios, we have excluded oil sands which is a controversial energy extraction method, as well as revenue limits on thermal coal mining and power generation.

For all our active portfolios (value weighted and diversified alpha) we incorporate a number of signals into the model that address some of these risks. We consider the carbon intensity and changes in the carbon intensity of companies. This ESG integration results in a tilt away from more highly carbon intense companies. We also consider reputational risks by monitoring company controversies and tilting away from companies that have had severe reputational risk issues previously.

For all of our portfolios, engagement and voting is used to delve further with companies as to how they are assessing their climate related risks and opportunities and what they are doing to address these risk and opportunities. We discuss their alignment to net zero and the strategy they are undertaking to achieve this. This is for all companies we engage with, not just those that we have assessed as high emitters. Our voting is aligned with improved climate disclosure and tends to favour shareholder proposals on climate especially those that are looking for improved climate disclosures and a clear climate strategy. We look at both shareholder and management proposed ‘say on climate’ resolutions making sure they have a clear strategy, strong governance around that strategy and a clear transition path. We will vote against directors of companies that have not been responsive to any of our engagements in relation to climate over a three year period.

We have set a number of different targets based on the strategy.

All portfolios will have a focus on engagement. For our market cap weighted index strategies, engagement is our primary focus. We commit to discuss net zero with all companies that we engage with at least once a year. We encourage them to move up the scale of the Net Zero Investment Framework Implementation Guide (NZIFIG) i.e. from not aligned to commit to aligning etc. In our engagement, we encourage companies to disclose scope 1, 2 and 3 emissions, set science-based short, medium and long term targets on their path to net zero, and align their capital expenditure to meet their net zero goals.

For our Value strategies, in addition to engagement, we are progressing towards the target of reducing the carbon intensity of the strategy by 30% by 2025 (AUM adjusted for the 2020 baseline). We will look to increase this to a 50% reduction by 2030.

For our diversified alpha strategies, in addition to engagement, we aim to reduce carbon intensity by at least 20% relative to the benchmark. We look to reassess this target in 2025 and 2030 depending on how the benchmark has evolved.

These targets have been formulated based on: (i) available information and representations made to Realindex by third parties, including, but not limited to, portfolio companies; and (ii) assumptions made in relation to future matters such as the implementation of government policy in climate-related areas, enhanced future technology and the actions of portfolio companies. Such information and representations may ultimately prove to be inaccurate and such future matters may not ultimately be realised. As such, Realindex cannot guarantee the achievement of these targets. These targets are subject to ongoing review and may change without notice.