Issue: March 2013 / May 2013 Issue

Water scarcity poses potential investment risk for pension funds

Given that the Government Employees Pension Fund (GEPF) invests 90% of its portfolio within SA, it is important for us to understand water scarcity as a potential investment risk to our portfolio returns. Institutional investors - such as GEPF - play an important role in shaping this transformation towards a greener and more sustainable economy; one that is resource-efficient, lower in carbon emissions, resilient and equitable.

GEPF principal officer John Oliphant has made it clear: “The era of profits and more profits at the expense of the environment and society is a distant memory. Responsible investing is now an integral part of any long-term investing.”

Climate change and water scarcity were flagged as a risk (and an investment opportunity) that would have a significant impact on GEPF’s portfolio over the long term.
The World Wildlife Fund (WWF) was commissioned to measure our portfolio in terms of the carbon and water footprints. The report, “Navigating Muddy Waters: securing investment returns under carbon and water constraints”, highlighted the fact that SA is vulnerable to the impacts of climate change and unevenly distributed water resources.

The WWF report calculated the “external price of water scarcity”. It found that the annual external value of water used by operations and first-tier suppliers of JSE top 100 companies could total more than R56bn (US$6,78bn). In essence, they are paying “less than 1% of the true value of water”. The potential risks to companies from disruption, higher water tariffs and “rising input prices due to water stress will negatively impact companies’ financial results, operations and, ultimately, valuations”.

Institutional investors are failing to factor in climate change and freshwater risks when making investment decisions, said the WWF. This posed a risk in that the listed bonds and equities of
companies in high-carbon sectors may be mispriced. It could lead to “financial instability when the market recognises the realities of resource constraints owing to water scarcity and
greenhouse gas (GHG) emission limits, and re-prices these securities accordingly”.
The Carbon Disclosure Project (CDP) encourages investors to understand how companies build water constraints into their core business strategies so that leading practices can be
shared. Its water disclosure report for SA in 2011 found that our “most significant corporate water users are not yet able or ready to report on their water-related risks”. This presents a significant risk to institutional investors who rely on “publically available and audited data from companies to help inform their investment decisions”.

The Asset Owners Disclosure Project (AODP) revealed that a typical fund has 55% of its assets in high-carbon investments and only 2% in low-carbon. The carbon footprint of aggregated holdings in GEPF equity portfolios invested in SA was valued at 72 tonnes of carbon per Rmn value. This was 9% lower than the average carbon footprint of the FTSE/JSE Top 100 companies.

The GEPF SA bond portfolio carbon footprint was measured against the benchmark Bond Exchange of SA (BESA) Corporate Credit Index. The carbon footprint of GEPF bond holding was 12 tonnes of carbon per Rmn. This is 17% more carbon efficient than the BESA Corporate Credit Index, mainly due to the relative carbon efficiency of debt holdings in the Basic Resources sector.

GEPF, as a defined benefit pension fund, is by nature a long-term investor. We believe that GEPF’s integration of environmental, social and governance issues across our portfolio – and the allocation of 5% of our portfolio to investments of a developmental nature – will produce sustainable and suitable returns relative to the actuarial liabilities of the Fund.