Stockholm (NordSIP) – According to their yearly reports, the First, Second, Third and Fourth AP Funds had aggregate earnings totalling SEK236 billion for 2019, equivalent to a 17.6% average return. Over the last five and ten years, the AP funds’ average returned 8.1% and 8.8%, well exceeding their benchmark income index*, which only grew by an average of 2.5% and 2.4% per year over the corresponding periods.
“We are proud to deliver a strong result for 2019”, say Teresa Isele, Managing Director at AP1, Eva Halvarsson, Managing Director at AP2, Kerstin Hessius, Managing Director at AP3 and Niklas Ekvall Managing Director at AP4 in a joint statement. “The AP funds have contributed to the financial system’s stability by strengthening the pension system’s total assets,” the CEOs added with regards to the AP Funds overperformance of the income index.
Both AP1 and AP3 claimed to have achieved the best results in a decade in 2019. AP2 and AP4 went further, describing 2019 as record-breaking. Given this performance, NordSIP was interested to hear more from the four AP funds and took this opportunity to catch up with each of them and hear about the role of sustainability in achieving these results.
Sustainability and ESG at the Heart of Performance
According to all the AP funds, sustainability and ESG integration played an important role in the funds’ 2019 success. “We have developed our sustainability strategy around three main objectives: to ensure we invest in line with our values, to maximise risk-adjusted returns by integrating material ESG aspects, and to contribute to sustainable development through active ownership and dedicated investments,” Magdalena Håkansson, Head of Sustainable Value Creation at AP, explained. “It’s primarily from the integration of material ESG aspects that we expect positive contributions, such as those delivered by the ESG factors applied in our quant strategies.”
Echoing this sentiment, Ulrika Danielson, Head of Communications & Corporate Governance at AP2, noted that sustainable considerations “give us a broader and better decision-making basis.” Danielson was also keen to highlight the importance of sustainability stewardship to the funds’ fiduciary duty. “To fulfil the AP Funds’ mission, we must emphasise the promotion of sustainable development without compromising the overall goal to be of the greatest possible benefit to the pension system,” she added.
“AP3’s belief is that, over time, better-managed companies that incorporate relevant and financially material ESG information in their strategy, management and operations will reach better results and strengthen their positions,” Anne-Charlotte Hormgard, Senior Sustainability Manager at AP3, explained. That being said, the results must be put into a broader context. “Any single year’s results are impacted by many different factors, both macro and micro, including a sustainable approach and strategy.”
“We integrate sustainability aspects into our thematic analysis, which in turn is input into our macroeconomic scenarios,” Tobias Fransson, Head of Strategy & Sustainability at AP4 said regarding the role of sustainability in the fund’s approach. “We make portfolio decisions based on sustainability when it comes to lowering risks in the portfolio as well as when we look for opportunities.”
Climate Change, ESG Integration, Alternatives and Exclusions
According to AP1’s Håkansson, 2019 was a turning point for climate change. “During 2019, we noted a substantial shift in society when it comes to climate change, both when it comes to awareness and raised ambitions to transition to a low-carbon economy. This will be reflected in the way we manage our climate-related financial risk exposure to ensure it’s in line with the overall risk level of the fund.”
AP2 focused on ESG integration in 2019. “For many years, we have worked actively to apply sustainability factors in our equity management. In 2018, we implemented new, proprietary, multi-factor indices with sustainability aspects for the foreign shareholdings. The Fund worked on further developing the indices in 2019, and also on creating similar indices for the credit portfolios,” Danielson explained.
“The strategic portfolio comprises investments that contribute directly to sustainable development. For quite some time the Fund has had a strategic allocation to green bonds,” Danielson added. “In 2019 it was decided that that allocation should be increased from 1% to 3%, equivalent to a more than SEK11 billion. The Fund also started investing in sustainable infrastructure.”
At AP3, Hormgard highlighted the new opportunities in alternatives created by political reforms. “The change in the AP Funds Act opens up for more alternative investments that will have the potential to contribute to the results. In 2019, equities and real Estate had a good performance. We believe that the integration of sustainability was one of the contributing factors. However, we do not measure that effect separately,” she said.
According to Fransson, exclusions have played an essential role at AP4. “While ethical exclusions contributed positively to the performance of the fund, the exclusion of nuclear weapons contributed negatively to 2019’s performance.” However, both of those are conventions-based exclusions, not pursued for business reasons, according to Fransson. “Among our business-related exclusion decisions, which we believe will add to the returns over time, the exclusion of tobacco and low carbon equity strategies have contributed to the returns. Exclusions of oil sand and thermal coal have not had an impact on the returns.”
In April 2019, the AP1, AP3 and AP4 joined forces in setting up Polhem Infra, an investment fund targeting long term sustainable infrastructure investments in Sweden.
Carbon Footprint Reductions: Portfolios and Companies
According to the joint statement by the four AP funds, they have developed their own model for measuring carbon footprints. In total, the funds reduced their carbon footprint for listed shares by another 6% in 2019. Since 2015, the AP funds have reduced the carbon footprint by a total of 23%. Of the year’s reduction in total carbon dioxide emissions, 10 percentage points were driven by changes in the portfolio holdings. However, the portfolio companies’ increased emissions have undermined this decrease by 4 percentage points.
In 2019, AP1 lowered its emissions to 1.8 million tonnes of CO2, from 1.9 million tonnes of CO2. The CO2 intensity of the AP1’s portfolio also fell from 25.2 tonnes of CO2 emissions per million crowns invested to 16.5. The 34% reduction in the intensity of CO2 emissions was driven mainly due to changes in the portfolio’s holdings. However, as much as 5 percentage points of the portfolio’s decreased intensity in CO2 emissions was accomplished by improvements from the companies themselves. “It’s important to distinguish between carbon reductions achieved from reallocations in our portfolio and carbon reductions achieved by the companies we invest in. When companies reduce their carbon footprint, we see a change in the real world,” AP1’s Håkansson explained.
According to AP2’s report, its equity portfolio generated in 1.6 million tonnes of CO2 emissions in 2019, down from 1.7 million tonnes in 2018 and from 2.6 million tonnes in 2017. Most of the decrease in emissions was achieved through a change in the companies held by AP2, although changes in companies’ emissions generated a little less than half of the emissions decrease. “The Fund’s total carbon emissions were reduced by around 40 per cent in the course of two years. The reduction is mainly related to how the Fund introduced new ESG indices for global equities in 2018. During this period, the portfolio companies’ emissions increased, with the exception of Swedish companies, whose emissions declined somewhat from 2017 to 2018,” Danielson adds.
AP3’s experience is similar to that of the other funds. It was able to cut the intensity of its portfolio emissions by 30%. Of this, 19 percentage points were cut due to changes in the portfolio holdings to more carbon emission efficient companies. In contrast, the remaining 11 percentage point decrease was achieved by the companies themselves. With 49% fewer CO2 emissions than the MSCI ACWI, the fund also remains environmentally competitive in relative terms.
“AP3 has been able to meet the 2014 target for reducing its equity and credit portfolios’ carbon footprint by half by the end of 2018,” Hormgard said to NordSIP. “For 2019-2025 the Fund’s target is to halve the CO2 emissions of its portfolio once again. Accomplishing that goal will require real reductions in the CO2 emissions from the investee companies. Moreover, timberland and real estate holdings will become increasingly important in accomplishing our emissions reductions target as we go forward.”
“We have lowered carbon emissions by 34% since we started measuring them in 2013,” Fransson added. “During 2019, the total carbon footprint of the equities portfolio decreased by another 11%.” AP4’s Ekvall, commented. “Out of this 16 percentage points came from our portfolio changes while continued increases in emissions from the portfolio companies added 5 percentage points to the emissions,” Fransson elaborates. “AP4’s carbon footprint is now 48% lower than for a broad, global equities index,” Ekvall concluded.