The Swedish public pension fund Fjärde AP-fonden (AP4) is governed by legislation that requires it to take sustainability into account, but without giving up returns. When AP4 decided to scrutinise the climate-related risks in its investment portfolio, it began by measuring the carbon footprint of the S&P 500 index. The pension fund’s managers decided that, as they sought to mitigate the climate-related risk in their holdings in the index, they did not want to take any sector stances—specifically, they did not want to take any explicit bets against fossil fuels.
Instead, AP4 kept its S&P 500 holdings sector-neutral by divesting only those stocks that proved to have the heaviest carbon footprints among banks, retailers, automotive manufacturers, oil companies, coal companies and more. By taking out the 150 worst stocks on a sector-neutral basis, leaving AP4’s holdings at 350, the firm continued to track the S&P 500 with a tracking error of between 0.7% and 0.8%. “The surprising part of this was that we took down the carbon footprint by 50%,” recalls AP4 CEO Mats Andersson.
“So we will get a free option if carbon is wrongly priced, which I believe it is.” He adds: “If I’m right, we’ve taken down the risk for our clients—the Swedish pensioners—in terms of climate risk in our portfolio, without jeopardising returns in the short term because we get more or less the same returns.”
A further surprise was in store. After one year AP4’s carbon-light S&P portfolio had outperformed the wider S&P 500 by some 70-80 basis points. “I still don’t know why,” says Mr Andersson. “One reason could be that companies that look after the carbon footprint will probably look after the rest of the business in the same manner. So this is actually a way to pick the good companies.”
AP4 has now rolled out a similar model in Europe and plans to do the same in Japan. The management plans to decarbonise the fund’s entire equity portfolio within two years. “I think that we will end up actually having within the span of 50% to 70% lower carbon intensity, and that is without giving up returns,” Mr Andersson comments. “On the contrary—we get this free option.”
