Since the start of the new pension system almost 15 years ago, AP4 has worked with various sustainability issues. We have actively worked with two focus areas - corporate governance and climate change - over the past five years.
Let me give some tangible examples of how this work is carried out as a matter of practice and how this has affected AP4's risks and returns.
Corporate governance drives long-term profitability
How a company is governed is perhaps the most important starting point in driving sustainability. In Sweden, it is given that the shareholders are ultimately responsible for how companies operate. Anomalies that are revealed require owners to intervene, and this intervention is founded on the idea that the company and its stakeholders would otherwise be tarnished.
A clear governance model, with clear division of roles between owners, the Board, management and its auditors, is something to strive for, preserve and develop. It is also a great advantage when, as in Sweden, you have a large degree of shareholders with controlling interests that are also long-term investors.
I believe that the reason that the Swedish stock market over time has developed better than the rest of the world, as measured by a global index, can be attributed to the combination of the corporate governance model and ownership structure. AP4 has, by having a third of the portfolio invested in Swedish equities, generated additional value at just over 25 billion kronor over the last 15 years. We would not have had this outcome if AP4’s investments in Swedish companies had corresponded to Sweden’s share in a global index, namely one percent.
During the 40 years the Fund has been in operation, AP4 has taken an active role in developing and defending the "Swedish model". AP4 has achieved this by, among other things, serving on nomination committees and on the self-regulatory bodies existing in Sweden and by actively driving public opinion on important issues.
During 2015, AP4 was one of four Swedish institutions that drove the changes in ownership surrounding the so-called "Industrivärden Sphere". This was a group of companies that was held together through cross-shareholdings. This is a structure that is fundamentally unsound. Cross-ownership easily leads to ambiguities about the responsibilities taken and delegated. On one day you are "boss", the next day you are "subordinate"; and to approve each other's accounts is another less successful elements of this structure.
It is with pleasure to note that due to the strong position taken by institutions that lead to a fundamental change in the right direction of the structure of this group of companies. Although there is still an element of cross-ownership, several steps were taken to create a sound structure and hopefully a sound ownership culture.
To drive and engage in so-called ownership issues rarely produces quick returns for a portfolio manager. However, it is important that institutions take this role seriously. It is this kind of engagement that contributes to Sweden, hopefully, being able to continue to deliver excess returns compared to passive global index management.
The climate in focus preceding the environmental summit in Paris
Approximately five years ago AP4 chose to work with reducing the risk that climate change presents to us as investors and shareholders. To my great surprise there were few pension funds at that time that had recognized climate as a risk. The general view was that a pension fund’s risk is defined by measures that often have a starting point in different volatility measurements.
Price volatility for a pension fund like AP4 is however a poor measure of risk because we do not have any solvency capital to protect from one day to another. The entire regulatory framework that is emerging for pension funds unfortunately constrains funds to be more short-term in nature. This is despite the fact that there has never been a greater need for long-term investment horizons, and that the foundation of a funds mission should be to invest with a long-term perspective and to disregard short-term fluctuations.
The climate and the threats that exist in the form of temperature increases represent, in my world, a real risk that can lead to a permanent loss of capital. The probability of a temperature rise of 6 degrees is 1.6 percent according to the latest IPCC report (Intergovernmental Panel on Climate Change). This risk seems to be one we are willing to take. If we translate this risk to the airline industry, with the same likelihood that an aircraft would crash, it would mean that 1,500 airplanes would crash every day. No one with knowledge of these odds would ever put themselves in an aircraft ever again. In other words we are willing to take risks with the climate that we would never expose ourselves to privately.
For several years AP4's strategy to manage climate risk has been to work with reducing the carbon footprint of our equity portfolio. We choose systematically the exclusion of companies that perform poorly in this regard, and we do this on an industry-by-industry basis. The method means that in practice we are not taking any significant risks in terms of returns, but instead we lower the portfolio’s risk. Once again it has been shown that the choice of prioritizing sustainability does not mean that you give up returns. On the contrary!
At the climate summit in New York in September 2014, AP4 was one of four initiators of the Portfolio Decarbonazation Coalition (PDC). Our promise was to aim to accumulate pension assets with a value of $100 billion that would be invested in different strategies with the goal to reduce and highlight the climate issue.
To my great pleasure I can say that the coalition, after the end of the reporting period, had surpassed its goal and has now assembled about 25 pension funds, which together represent $2.2 trillion. Of this amount, $230 billion is invested in various strategies focused on reducing climate risk. This clearly shows that pension funds around the world have started to take climate change seriously. The financial sector must play a significant role if the world will be able to remain within the target of a maximum of +2 degrees.
Sustainability and fund management
For many years now sustainability has been a fully integrated element of our management organization, which is a prerequisite for success.
AP4 also seeks to broaden the concept and strategies surrounding sustainability. For several years, AP4 has been an active and driving force in so-called Green Bonds. It is a rapidly growing source of financing for companies, municipalities and organizations, and requires that there are long-term stakeholders that contribute to the products standards and further development.
Further, after the end of the reporting period in the autumn, AP4, as the first investor in a fund, has been involved in finding companies that are role models on the basis of the rights of children.
It is probably obvious to most people that sustainability is a multifaceted subject. There is not one correct way or strategy to address these issues. I think it is important that we try to follow a path, based on the famous quote by Mao Tse Tung, to "let a hundred flowers blossom".
Mats Andersson, CEO.