How ethical can an investor be?

KiwiSaver default funds are about to go exclusive.

Or at least that’s what Climate Change Minister and Green Party co-leader, James Shaw, claimed when announcing the new set of rules for KiwiSaver default schemes late in February.

“No New Zealander should have to worry about whether their retirement savings are causing the climate crisis,” Shaw said in a statement. “That’s why our Government is moving default KiwiSaver funds away from fossil fuels, putting people and the planet first.”

The real news, of course, is more subtle than Shaw’s grand statement suggests.

Under the government proposal, all KiwiSaver default funds, which manage the retirement savings of New Zealanders yet to make an active investment choice, will have to exclude “investments in fossil fuels and illegal weapons”.

“While default fund providers have in recent years divested any investments in companies involved in illegal weapons like cluster munitions and anti-personnel landmines, the changes now enshrine that requirement in default fund settings,” the government announcement says.

The rush to remove ‘illegal weapons’ - as defined in NZ legislation – from all KiwiSaver schemes followed the 2016 public uproar over potential exposure to cluster munitions manufacturers in retirement savings and other investment products.

But while cutting controversial weapons did require a few structural product changes for some providers, the process was relatively simple: the portfolio ‘clean up’ involved dumping the stocks and bonds of, at most, about a dozen companies.

The fossil fuel investment universe is a little larger – and open to interpretation.

To date, the government has not provided any detail on how fossil fuel investments will be defined for KiwiSaver default funds, other than a broad reference to the NZ Superannuation Fund (NZS) methodology.

Commerce Minister Kris Faafoi said at the time: “In 2017, the $47 billion NZ Superannuation Fund adopted a climate change investment strategy that resulted in it removing more than $3 billion worth of stocks that exceed thresholds for either emissions intensity or fossil fuel reserves, without negatively affecting performance.”

The NZS, however, continues to own dozens of oil and gas companies across the world, not to mention transportation, agribusiness and other heavy fossil fuel-using firms. According to the latest NZS list of stocks in the fund, all the big-name oil firms like BP, Chevron and even the controversial Russian company, Gazprom, remain in the NZ government-owned investment portfolio.

For some, the NZS fossil fuel ‘line in the sand’ likely does not go far enough. Clearly, though, scrubbing portfolios of fossil fuel exposure is as difficult as draining oil from the real-world economy.

That hasn’t stopped the calls from some quarters for investors to drop all fossil fuel investments immediately or the flood of funds featuring ‘green’ labels.

In response to the growing number of investment products bearing names such as ethical, responsible, sustainable or green, the Financial Markets Authority (FMA) last year opened up consultation to better-define the space. As well as trying to impose consistency on labeling, the FMA hopes to prevent ‘greenwashing’ – or businesses using ‘ethical’ as a sales technique rather than a substantial investment process.

In a release last September, Nick Kynoch, FMA general counsel, said: “... in an area like this, with a lack of consistent, agreed-upon definitions, we are keen to benchmark what good conduct and good disclosure look like, to ensure issuers focus on meeting investor needs.”

The FMA may establish clear ‘green’ marketing guidelines but, ultimately, consumers will need to understand both their own ‘ethics’ and how they translate to their investments.

Given the definition of ‘ethical’ is generally an individual matter, it’s impossible for a fund manager to exactly match the morals of all underlying investors.

Nevertheless, investment managers can work within broadly-agreed legal and ethical boundaries. For example, the Lifetime Income Fund holds about 35 per cent of its investments in two Vanguard funds, covering global shares and bonds, that screen out certain sectors.

The Vanguard International Shares Select Exclusions Index Fund cuts out tobacco, controversial weapons, and nuclear weapon stocks while the Vanguard Ethically Conscious Global Aggregate Bond Index Fund further “excludes issuers with evidence of owning fossil fuel reserves regardless of their industries”.

Lifetime also keeps a close eye on the rest of its underlying portfolio, which includes Harbour Asset Management, ANZ and Milliman as managers, to monitor exposure to sectors on the ‘ethical’ radar.

We know, for instance, that about 3.4 per cent of our investments lie in the global energy sector. As the data improves, fund managers will develop new ways to invest both exclude harmful companies and identify positive growth firms without sacrificing returns.

And Lifetime will continue to monitor the global investing environment, looking for funds that best align with our exclusive goals to generate income for retirees.