Application of ESG to investment strategy

Transcription

1 Responsible investing: Application of ESG to investment strategy June 7, 2011 Head of Pension Clients, Distribution Germany

2 Topics for discussion Evolution of responsible investing: What does ESG mean? Global growth and drivers of ESG investments What is the investment rationale for ESG? How can ESG be applied to investment strategy? Case study: ESG best-in-class and carbon overlay applied to an investment-grade corporate credit portfolio Global Fixed Income Seminar

3 What does ESG mean?

4 Evolutionary development of ESG over time ESG is a response to several needs and trends: Comprehensive analysis that goes beyond merely excluding securities of non-responsible firms Need for standardization to address proliferation of confusing, overlapping terminology (SRI, SEE, etc.) Growing adoption of extra-financial risk analysis and increased corporate social responsibility Ethical exclusions Sustainability SRI Socially responsible investment Responsible investing CG Corporate governance SEE Social Ethical Environmental CSR Corporate social responsibility ESG Environment Social Governance Global Fixed Income Seminar

5 What ESG means to Responsible investing at Combines environmental, ethical, social and governance considerations with investors' financial objectives. This means responsible investing without compromising investment performance opportunities Global Fixed Income Seminar

6 Growth and drivers of ESG investments

7 Strong growth in global ESG market ESG market CAGR of 25% versus overall market of 7%* CAGR of 25% 2003 EUR 1.9 trillion 2007 EUR 5 trillion 2009 EUR 7.2 trillion North America 84% Europe 16% Australia/ Asia 8% North America 39% Europe 53% Australia/ Asia 1% North America 29% Europe 70% As of October/December 2010 Source: Eurosif European SRI Study 2010, US SIF 2010 Socially Responsible Investing Trends in the United States, BCG Report Global Asset Management 2010 * Note ESG CAGR of 25% between 2003 and 2009, overall market CAGR of 7% between 2002 and 2009 Global Fixed Income Seminar

8 Key ESG drivers backed by visible investor commitment Top four drivers of SRI demand in next 3 years 1 Record number of investors commit to UN Principles of Responsible Investment 2 Over 10% of est. total value of global capital markets Signatories from >45 countries > April 2011 AuM (in USD trn) No. of signatories Source: 1 Eurosif European SRI Study UN PRI Annual Report 2010, UN PRI press release January 27, 2011 Global Fixed Income Seminar

9 Demand from institutions and consultants is key 89% of consultants expect greater client interest in ESG matters in the next 3 years 2 Pension funds play dominant role Type of institutional investors (by volume of SRI assets) 1 Inclusion of ESG questions in RFP? 10% 15% 42% Yes, routinely for ESG issues Yes, routinely for governance issues only Yes, routinely for E&S issues only Public pension funds or reserve funds Universities & other academies Insurance companies & mutuals 12.0% 20.3% 63.4% Only for specific RI mandates Others* 4.2% 25% 8% No Global institutional asset distribution 3 4% 10% 8% 54% 24% 100% Banks Corporates Source: 1 Eurosif European SRI Study 2010 Insurances 2 Eurosif Investment Consultants & Responsible Investment Study Global Asset Management 2010, Boston Consulting Group * Public authorities & governments, NGOs & foundations, religious institutions & charities, corporate/occupational pension funds Non - profits and states Pension funds Global Fixed Income Seminar

10 Investors shift focus from equity to fixed income Global institutional asset allocation* 100% European institutional asset allocation** 100% European ESG asset allocation*** 100% 27% 25% 33% 38% 54% 53% 11% 16% 3% 5% 10% 5% 6% 5.6% 1.6% 1.6% 3.1% 0.5% 1.6% Alternative Hybrid/balanced Fixed Income Structured products Money Market Equity Other alternatives Cash Equity Real estate Fixed Income Others Money Market Property Fixed Income Commodities PE / VC Alternative/HF Equity Source: * Global Asset Management 2009, BCG, July 2009 ** IPE European Institutional Asset Management Survey 2009 *** European SRI Study 2010, Eurosif Global Fixed Income Seminar

11 ESG in terms of performance and fiduciary duty Value added performance Is financial performance a sufficient indicator? 1 Value added / extra-financial mindset / sources of financial value added Long- vs short-term orientation: Economic benefits or avoided liabilities by ESG materialize slowly Credible and transparent extra-financial reporting Double return: E.g., microfinance fighting poverty and investment performance Factor E: Significant relationship between environmental practices of borrowers and credit risk perceived in the market Firms with strong environmental profiles have up to 64 bps lower credit spread 2 Fiduciary duty Past Sacrificing performance in favor of sustainable investing contradicts fiduciary duty; exclusion of companies increases volatility Present 70% of European institutional investors believe that it is "a trustee s" fiduciary duty to include ESG in their decision-making process and during manager selection processes 3 Source: 1 University Maastricht 2008, 2 Hann, University Maastricht, May 2011, 3 Competitor Trend Book November 2009 Global Fixed Income Seminar

12 What the UN says about fiduciary responsibility Today... it is necessary for investment management agreements... to use ESG language... it is important... that ESG is regarded as a mainstream investment consideration UNEP FI Fiduciary Responsibility II, July 2009 Global Fixed Income Seminar

13 ESG performance on the positive side Equity mainly positive; fixed income neutral to positive Equity** Evidence of a relationship between ESG factors and financial performance 36 academic and 10 broker studies 20 Fixed Income Limited research and analytical pitfalls ESG fixed income mutual fund performance matches* ESG IG corporate bond performance slightly better than index Portfolio value indexed Portfolio -5.02% Benchmark -5.37% 88 Positive Neutral - positive Neutral Neutralnegative Negative ESG IG Corporate Bond Portfolio Merrill Lynch EMU Corporate Bond Source: * Derwall/Koedijk, September 2, 2008 (data sample based on bond mutual funds labeled by the US Social Investment Forum as socially responsible in investing; 09/87-03/03) ** WestLB Dr. Gartz, May 2010 based on UNEP FI / Mercer (2007) and Mercer (2009); other:. Past performance is no guarantee of future results. Global Fixed Income Seminar

14 What is the investment rationale for ESG?

15 Image: A key motivation for investing responsibly Main reasons European institutional clients demand consulting services for responsible investing* Desire to be branded as responsible asset owners Pressure from beneficiaries to act Image motivators Political pressure to act Understanding that true fiduciary duty means considering all risks, including ESG ones Want to know how to implement the PRI Other 0% 10% 20% 30% 40% 50% 60% 70% 80% (100% = highest score possible) For 74% of German institutional investors, image is the key driver behind ESG investments** Source: *Eurosif Investment Consultants & Responsible Investment Survey, 2009; **Citywire May 2010 Global Fixed Income Seminar

16 Potential performance drivers behind ESG investing Strategic analysis ESG analysis extends traditional financial analysis with a long-term non-financial strategic view Risk management Regulatory compliance ESG analysis may help investors see beyond blind spots (e.g. competitive positioning, potential financial burdens, company governance, innovative capacity, anticipation of future operating environments, etc.) Considering ESG factors supports compliance with regulatory requirements and investment guidelines ESG considerations becoming mainstream Acceptance of ESG in investment valuation Regulators, investors, public/ngos, data vendors, research houses and companies worldwide are embracing ESG Perceptions of the right valuation models are changing; models that include ESG aspects are gaining widespread acceptance Global Fixed Income Seminar

17 How can ESG be applied to investment strategy?

18 Classification of ESG investment approaches External versus internal External ESG ratings from external rating agencies Sustainability indices Broad versus core Broad Simple screening (up to two negative criteria) Engagement Integration Internal Negative approach Exclusion of investments which are non-compliant with ESG factors Positive approach Selection of investments which actively apply ESG criteria determined by the investment company Best-in-class approach Selection of best performing companies in each sector Core Negative screening / ethical exclusions More than 2 negative criteria Positive screening Including best-in-class and SRI theme funds Combination of ethical exclusion and positive screening Global Fixed Income Seminar

19 ESG investment approach: Best of two worlds Traditional financial information Non-financial information Top-down Bottom-up Cross market Sentiment analysis ESG aspects Reputational risk/exclusions Carbon footprint Higher conviction investment decisions and security selection Global Fixed Income Seminar

20 High complexity of fixed income instrument analysis Sovereigns Developed / EM Agencies Supranationals Corporates Financials Structured Finance Covered Bonds Standards, treaties Corruption level, factual governance Analyse as sovereign Analyse as company Listed Not listed Good coverage of listed equity Extend universe to non-listed equity? Look-through Assess issuing bank in case of covered bond CO 2 emissions Global Fixed Income Seminar

21 ESG best-in-class approach with additional criteria Optional additional criteria CO 2 optimization Exclusion criteria Best-in-class approach: Investment in issuers with ESG-rating A C ESG score (0 100) ESG issuer rating (A F) 30% - 40% 30% - 40% 30% - 40% Environment Social Governance e.g. Environmental policy e.g. Freedom of association e.g. Press freedom CO 2 per capita Weighting Country indicator Gender gap Company indicator Separation: chairman / CEO Source:, June 2010 Global Fixed Income Seminar

22 Case study: Applying ESG best-in-class and carbon overlay

23 Case study: German pension fund Applying ESG to an investment grade corporate credit portfolio and hedging financial risk resulting from carbon exposure Strategic and tactical asset allocation Overall allocation Fixed income allocation Fixed Income 84% Overlays Equities 10% Overlay and Hedging 6% Euro IG Corporates 79% Applying ESG to the IG corporate credit portfolio and the overlay segments US High Yield 8% Euro Government 7% Emerging markets 6% Credit Overlay Duration overlay Inflation overlay Hedging segment For illustrative purposes only. Global Fixed Income Seminar

24 Case study step 1: ESG best-in-class portfolio ESG rating allocation before best-in-class approach 1 A B C D E F NR Cash 0% 10% 20% 30% 40% 50% ESG Rating B Basis Materials 3.46% Consumer, cyclical 5.50% Energy 5.62% Industrial 5.95% Consumer, noncyclical 9.29% Covered Bonds Utilities 10.21% 1.52% Diversified 1.40% Communications 10.56% Financial 45.64% ESG rating allocation after application of best-in-class approach Cash 0.85% EUR IG Corporates Regular Average coupon 4.9% Average yield 4% Mod. Duration 4.2 Average S&P rating A Average ESG rating B A B C D E F NR 0% 10% 20% 30% 40% 50% 60% ESG Rating A- Industrial 7% Utilities 12% Financial 44% Undefined 4% Basis Materials 4% Communications 9% Consumer, cyclical 5% Consumer, noncyclical 11% Diversified 1% Energy 4% EUR IG Corporates ESG Average coupon 5.1% Average yield 4% Mod. Duration 3.9 Average S&P rating A Average ESG rating A- Result: Average ESG rating improved to A level Note: Data as per March/May 2011, 1 based on model portfolio; Source:, for illustrative purposes only. Numbers may not sum due to rounding. Global Fixed Income Seminar

25 Case study step 2: CO 2 optimization Overall carbon intensity (in t CO 2 /USD million sales) Deviation (%) in carbon footprint by sector (fund vs. iboxx EUR Corp Index) Energy -10% Materials Indust. -59% -12% Cons. disc. -51% Staples -43% Health -54% Fin. -25% Info. tech. Telecom 0% -6% ESG portfolio iboxx EUR Corp. Utilities -23% Result: CO 2 footprint reduced by 20% vs benchmark Source:, for illustrative purposes Global Fixed Income Seminar

26 Case study step 3: Hedging carbon exposure Carbon hedging process Analyze individual portfolio data Calculate portfolio s carbon footprint Invest in carbon on individual basis Portfolio & risk management Carbon overlay Basic toolkit Carbon intensity of the pension fund portfolio: approx. 1.9 mt CO 2 e Carbon offset: Purchase 1,900,000 EUAs (European Union Allowances) in the market Notional of required EUAs: EUR 30m* Financial hedging Distribution of direct carbon emissions of companies Austria Spain 3% 4% Czech Rep. 6% Italy 7% US 9% Luxembourg 10% Portugal 2% Others 5% France 19% Germany 35% Building Gas Materials 1.80% 2.10% Water 4.60% Oil & Gas 9.00% Iron/Steel 10.30% Others 4.50% Electric 67.70% Result: Carbon strategy hedges carbon financial risk over all assets Source:, for illustrative purposes, *assuming EUA price per 1 t CO 2 of EUR 16. Numbers may not sum due to rounding. Global Fixed Income Seminar

27 Conclusion: ESG becoming mainstream ESG has evolved as an asset class to acknowledge the need for more comprehensive analysis that includes "extra-financial" factors There are numerous rationales for ESG investing, including the desire to influence a firm s culture, enhance image, comply with regulations and improve investment returns ESG investing has grown markedly especially in Europe, which now accounts for about 70% of ESG assets Both institutional and individual investors are fuelling growth, with fixed income gaining prominence in ESG portfolios Fiduciary duty is cited as a reason to include ESG issues in investment decisions; this view represents a shift from the past when ESG was considered a contradiction of fiduciary duty Global Fixed Income Seminar

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