Norway's $1.4 trillion sovereign wealth fund and its impact on climate

If you are interested in the impact of the world's big institutional investors on the climate, you will not want to miss Episode 138 of Cleaning Up Podcast . My guest was Carine Smith Ihenacho, Chief Governance and Compliance Officer at Norges Bank Investment Management (NBIM), which manages Norway's giant $1.4 trillion sovereign wealth fund. Our conversation strips away the layers and lays bear how, with the best will in the world, NBIM is locking the world into its current climate trajectory.

Listen to Episode 138 of Cleaning Up with Carine Smith Ihenacho on any good podcast platform, or watch it on YouTube

Carine is an old friend of mine. Each year between 2002 and 2008, I put together a group of fund-raisers to take part in Switzerland's famous Engadin Marathon - think New York marathon, but on cross-country skis, through forests and across frozen lakes. At our height there were 60 "Engadin Marathonistas", completing the course in anything between two and eight hours, and over the years we raised a few hundred thousand pounds for various charities. Carine led a Norwegian contingent that added enormous credibility to our otherwise enthusiastic but clumsy efforts on the snow.

NBIM is the largest stock market investor in the world, owning around 1.5% of every quoted company. As part of her role, Carine is responsible for sustainability - developing and implementing NBIM's its 2025 Climate Action Plan, which sets out the organisation's ambition to be "a global leader in managing the financial risks and opportunities arising from climate change."

NBIM's Climate Action Plan 2025

NBIM has been thinking about climate change for 15 years and calculating the carbon footprint of its portfolio since 2014. It recently published its Climate Action Plan 2025, which demonstrates a high level of knowledge about climate risk and opportunities:

"Investments are exposed to two types of climate risk: physical risk and transition risk. Physical climate risk stems from the physical changes resulting from climate change, either the temperature increases themselves or associated changes in weather patterns, sea levels, ecology or human habitation. There is also uncertainty around tipping points in the climate system that – when exceeded – may lead to irreversible changes. Transition risks are generated by the economic and societal shifts towards a low-carbon economy. They can stem from policy changes to achieve climate goals, but also from new technologies and changing consumer behaviour. Producing and consuming goods and services in ways that emit less greenhouse gases also create investment opportunities."

The fund excluded investments in coal in 2016, and more recently, as Carine and I discuss during the episode, divested from upstream-specialist oil and gas companies - though not from the world's big integrated oil and gas companies as we shall see.

NBIM has not signed up for the alphabet soup of climate finance initiatives - GFANZ, NZAOA, IIGCC and so on - but its Climate Action Plan 2025 explains how the organisation is nevertheless working hard to manage climate risks and opportunities: by working at the market level on standards and collaborating with other stakeholders; at the portfolio level by analysing risk and making adjustments; and at the company level by engaging with management, demanding transparency, voting on resolutions and steering portfolio companies towards net zero pathways.

It is clear both from the Climate Action Plan 2025 and my conversation with Carine that NBIM considers engagement "the key tool for managing the fund’s climate risk exposure." Carine describes this process as Engage for Change, and she is clearly proud of her and her colleagues work on it.

So if NBIM is taking climate change very seriously, has invested enormous efforts in understanding and analysing it, and is working hard to steer its portfolio companies towards towards pathways to net zero, what is the problem?

Context - where does investment need to flow?

Before I explain, let me provide some context. For the global economy to get to Net Zero, we need to see tens of trillions of dollars invested in three things over the coming decades: new low-carbon technologies; infrastructure for mitigation and adaptation; and the developing world, in particular the Global South.

• Low-carbon technologies. According to the IEA, all the technologies required to achieve Net Zero by 2050 already exist, somewhere along the spectrum from small prototypes through to full maturity. However, only 12% of required emissions reductions can be delivered by technologies currently judged as "mature". The rest are still in early stages of market uptake (40%), or still at prototype or development stage (48%). Under-invest in the next generation of technology and we won't get to Net Zero.
• Infrastructure. Whether in energy, transport, industry, agriculture or housing, almost all of changes needed to get to Net Zero consist of spending more up-front followed by savings down the line for fuel and maintenance. What this means is that a far larger proportion of global GDP needs to be dedicated to infrastructure spending over the coming decades than has been the case in the past. And of course almost all spending on adaptation will take the form of infrastructure investment. Under-invest in infrastructure and we won't get to Net Zero.
• Developing world. The IEA estimates that reaching Net Zero by 2050 will require annual investment in the energy sector of $5 trillion by 2030. BloombergNEF estimates average annual investment per year between now and 2050 of $6.7 trillion. The bulk of that investment has to go, not OECD countries whose emissions are already reducing, but to countries in the developing world experiencing rapid economic and population growth. Africa, with 18% of the global population, is currently attracting just 0.6% of clean energy investment. Under-invest in the Global South and we won't get to Net Zero.

In many ways you could replace the entire edifice of emissions tracking, scopes, disclosures, pathways and ESG data with a simple question for big investors: are you investing in those three things: new clean technologies, infrastructure and the developing world. Because if not, you are on balance helping the global economy maintain its current, disastrous trajectory.

So, how is NBIM doing?

70% of the money managed by NBIM is in equities, just under 30% in quoted debt, with a few percent in real estate and a "small, small part" in unlisted renewable infrastructure (since 2021 the fund is allowed to invest up to 2% in unlisted rewable infrastructure, but so far has made only three investments).

NBIM has no allocation whatever to private equity. All those startups and smaller companies developing the zero-carbon technologies of the future? Completely excluded until they get aquired or join the public markets. Meanwhile, as we learn from NBIM's 2022 annual report, it is the fund's investments in big integrated energy companies Exxon Mobil Corp, Shell PLC, and Chevron Corp that are among the fund's biggest holdings and deliver the biggest contribution to returns.

What about geography? As of 30 June 2023, according to NBIM's website, just under 50% of its equity portfolio was invested in the US; 28% was in Europe excluding Norway (which is explicitly outside NBIM's mandate). Other OECD members accounted for another 11%, and China, Taiwan, Singapore and Hong Kong a further 7%. That leaves less than 5% for the rest of the world.

Carine was at pains to point out that India is "quite a big market" for NBIM - in fact the fund invests just 2% of its equity portfolio in a country with 18% of the world's population. Just 2.5% of NBIM's equity portfolio is invested in countries home to the remaining 48% of global population.

For the fixed income portion of the portfolio, the benchmark consists of 70 percent developed market government debt and 30 percent developed market corporate debt - in other words no allocation whatsoever to developing market debt. As of June 2023, just under 50% of the debt was dollar-denominated, 30% in Euros and the rest in a basket of currencies, of which only Hong Kong and Singapore dollars were non OECD.

As for infrastructure, Carine is right to point out that some of it is owned by public companies, in which NBIM invests, but as a percentage of the value of infrastructure globally, and particularly as a percentage of the amount of investment required, NBIM is dramatically underweight.

Overall, therefore, NBIM invests almost exclusively in large incumbent companies in the developed world, including a significant allocation to oil and gas players. That's almost the exact opposite of the allocation you would expect to see from an investor committed to a dramatic, rapid and just transformation of the global economy to achieve net zero.

The problem is the mandate

This woeful state of affairs is not Carine's fault. Indeed it is not the fault of anyone at NBIM, with the possible exception of the CEO and board.

It arises almost entirely from the mandate given to NBIM by the Norwegian Ministry of Finance, voted on once a year by the Norwegian Government. It is this mandate that guides the NBIM's asset allocation and decides the performance benchmarks for the various constituent parts of the fund.

The equity portion of NBIM's portfolio is measured against a version of the FTSE All-Cap index with modified country weightings. NBIM is not an index fund - passively investing in stock market indices no matter what - but what Carine calls a "near-index fund". Under the mandate from the Norwegian Government NBIM can exclude certain companies (some types of weapon providers, recreational drugs, coal, upstream oil and gas, and so on) and is allowed up to 125 basis points of "tracking error" - or deviation from the performance of the index - which gives some leeway for judgement by NBIM's asset managers, to avoid a particularly risky index constituent, or jump on a particularly obvious opportunity, but that is all.

So while NBIM states that its ambition is to be "a global leader in managing the financial risks and opportunities arising from climate change", the reality is it is doing so only within the very narrow constraints of its mandate.

Carine and her colleagues have only one weapon in their armoury, engagement, and that one is looking less and less functional with every passing month. In June this year, the Church of England Commissioners and the Church of England Pensions Board, among the most vocal proponents of engagement, announced their decision to disinvest from Shell and other oil and gas companies, accusing them of "failing to show sufficient ambition to decarbonize in line with the aims of the Paris agreement." Their CEO John Ball said "there is a significant misalignment between the long-term interests of our pension fund and continued investment in companies seeking short-term profit maximization."

The truth is that if engagement really worked, the world would be on track for 1.5C, not somewhere between 2.4C and 2.8C, as we currently are.

Summary and conundrum

None of this is intended as a criticism of Carine or NBIM. All I am doing is pointing out the fact that NBIM's mandate inevitably means that the fund acts as a $1.4 trillion handbrake, pouring money into the status quo and starving rapid climate action of capital.

There are no easy solutions. After all, as Carine explained in the episode, dividends from NBIM fund 20% of the Norwegian state budget - one in every five doctors, nurses and teachers.

Were the Finance Ministry to change the mandate, to encourage NBIM to invest massively in new technologies, new infrastructure and the Global South, that could help bend the curve perceptibly away from catastrophic climate change in the second half of the century, but it would also most likely result in lower distributions to fund Norwegian social provision.

It is too easy to claim that Norway would benefit overall as a result of a revised reallocation; the likelihood is any benefit to rich Norway of a marginally more stable climate - most of the benefits of which would accrue to more vulnerable non-Norwegians - would be outweighed by the reduction in distribution to Norwegians. So the question is one of distribution and justice: should Norwegians risk having to make do with fewer doctors, nurses and teachers, in exchange for reducing damage suffered by less well-off people in the Global South?

Carine is right to point out that NBIM is is not, as things stand, a policy tool of Government in the fight against climate change. The real and difficult conundrum is whether it should be - particularly given that Norway has many other such tools at its disposal.

As Carine points out, at the end of the episode, that is not really a question for her. I was only half joking when I issued an open invitation to Norway's Finance Minister or even Prime Minister to come on the show. I can't think of a much more important topic. After all, they will almost certainly be heading to COP28 to discuss, among other things, how to get more money flowing to climate solutions in the Global South.

It only remains for me to thank Carine again, sincerely, for coming on Cleaning Up. For me, our conversation shone a much needed spotlight on the impacts of asset allocation decisions by major investors - their vital role in either addressing climate change or locking in our current, carbon-intensive trajectory.

I look forward to a vibrant debate.

Listen to Episode 138 of Cleaning Up with Carine Smith Ihenacho on any good podcast platform, or watch it on YouTube.