Denmark’s largest pension fund ATP has just added a newly-devised formula to the stock-selection algorithm for its foreign equities portfolio, which it said predicts which utility companies will make the biggest reductions in their greenhouse gas (GHG) emissions in years to come.

Identifying the stocks in this sector which will improve – rather than those that have already made the green transition – not only has a bigger impact on global emissions, but also creates marginally better returns on investment, the DKK936bn (€126bn) fund claimed.

Christian Kjær, head of liquid markets, told IPE: “What we’ve done proves that investing in green utilities is fine, but it won’t lower global emissions, so investing there will not create a lot of impact.

“We’re going after the companies that are able to lower their emissions, and our research shows that these will be the financial winners,” he said.

Extensive data crunching including back testing resulted in Kjær’s team discovering that a modified version of MSCI’s ESG score for utility companies had in fact been an accurate predictor of how much those firms would go on to reduce their GHG emissions, according to ATP.

“There are a lot of fortune tellers out there who have opinions about what will happen, but this seems to be something quite precise,” Kjær said.

The model created from this has now been implemented in ATP’s algorithm for the international quant portfolio, which accounts for around DKK49bn of its return-seeking investment portfolio, which has a market value of DKK348bn.

Another effect of adding the new selector for utility companies is, ATP said, that it keeps companies building new coal-fired power plants out of the pension fund’s portfolio.

Kjær said the process began with his team considering which industrial sector would be most affected by the coming reduction of GHG emissions around the world.

“If you believe in this green transition and that greenhouse gas emissions are going to have to come down, then you also have to believe it is definitely going to affect utilities because they account for most of the emissions,” he said.

Utilities make up 39 of 479 stocks in ATP’s global equity portfolio,  because the sector’s risk profile suits the pension fund’s low-risk tilt, Kjær explained.

However, utility stocks are also among the highest emitters, he said, and while utilities cover just above 6% of the total market value in ATP’s global equity portfolio, they account for 70 % of the portfolio’s GHG emissions.

As part of a policy implemented about two years ago, though, ATP already excludes utility companies deriving more than 50% of turnover from coal.

“We started out with this conjecture that it’s going to be important for utility companies, and then went down into the ESG data to find what could help us along the road – since the global equity portfolio is a very data-driven operation,” Kjær said.

“In this process we tried to identify the companies we believe will reduce their greenhouse gas emissions the most, and we thought we could show that that’s also the way you get the highest impact on emissions.

Christian Kjær at ATP

“There are a lot of fortune tellers out there who have opinions about what will happen”

Christian Kjær, head of liquid market, ATP

“By investing in companies that have started on this transition but are not there yet, we think we can support this transition while making money, and we think also that’s the best way to actually make an impact on greenhouse gas emissions globally,” he said.

By refining available ESG data on companies, he said the liquid markets team produced an investment lead indicator.

After testing that model on market and company data going back to 2013, Kjær said it proved itself to reliably predict the extent to which individual utility companies would subsequently reduce their GHG emissions.

ATP said the model focused on reducing global GHG emissions as much as possible, not on bringing down ATP’s emissions – which Kjær admitted could either go up or down as a result of the new model.

At the same time, the Danish pension fund found its new model also created marginally better returns on investment.

“Buying these companies in a long-short strategy, and selling those with a lower ESG score, produced nearly three percentage points more in annualised returns, than not using the scores,” Kjær said.

The research also showed that investing in utilities that were already efficient in renewable energy terms – an ESG approach taken by some investors – was less important for the overall move towards greener energy and also produced poorer returns, ATP said.

“The analysis work shows that the impact on global emissions is minimal if you as an investor focus on utilities that have adjusted,” the pension fund said.

This portfolio-improving exercise comes nearly two years after ATP added environmental data as a fourth ‘signal’ to its stock-picking algorithm for the whole foreign equities portfolio, alongside low-risk, momentum and value.

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