Fossil Fuel Free. Recent Australian Performance

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1 Fossil Fuel Free ESG Investing: Recent Australian Performance Disclaimer: This report is for information purposes only. The report is not an offer to buy, sell or in any way deal in a financial product. We recommend all investors seek out the services of a financial planner when making investment decisions. Past performance is not indicative of future results.

2 Overview Purchasers of ethical investment products and ESG fund managers are now seeking to avoid exposure to the fossil fuel industry. This paper models the backtested performance of a fossil fuel free, ethically enhanced index. It described fundamental performance over the past 3 years, and highlights the reduced volatility that this this index has demonstrated. Key findings: The number of larger ASX listed companies that pass fossil fuel free, ESG and ethical screens is increasing. The Fossil Fuel Free Ethical Enhanced outperforms the Thomson Reuters Australia index over a three and five year time period. The risk adjusted returns of the Fossil Fuel Free Ethical Enhanced show that the outperformance has been achieved at a much lower level of investment risk (see Sharpe Ratio below). Introduction An increasing number of investors are analysing whether or not their portfolios might be affected by climate change and exposure to fossil fuels. Further, entities factoring in the morality or otherwise of investing in fossil fuels, are looking to understand the impact on portfolios of removing fossil fuels. ESG investing has been a growing trend around the world. Traditionally, ESG screens included removing investments in industries like tobacco, alcohol and controversial weaponry. Investors who have been purchasers of ethical investment portfolios are now increasingly looking to add a strict fossil fuel screen. While many product providers around the world are releasing fossil fuel free screens to their portfolios or indexes, few are adding both traditional ESG screens and fossil fuel negative screens. We believe this is likely to change in response to retail and institutional demand. This paper summarises the results of backtesting conducted on a broad Australian equities index (Thomson Reuters Australia). The Thomson Reuters Australia consists of approximately 320 stocks that closely resembles the S&P ASX 300.

3 Methodology for Creating a Fossil Fuel Free Ethical Enhanced The following provides a description of the approach to create the fossil fuel free ethical enhanced index. The approach involves a negative screen, a positive screen, and a best of sector approach applied to neutral sectors. Process 1: Application of negative screen The negative screen removes companies with exposure to the following activities: Fossil fuels activities such as mining, extraction, burning, transportation, infrastructure Significant services to the fossil fuel industry services provided that are specific to and significant for the fossil fuel industry Finance to significant fossil fuel projects such as mines, ports, railways Gambling Tobacco Armaments Uranium and nuclear exception for nuclear used for medical purposes Old growth forest logging Animal cruelty specifically live animal export, animal testing for cosmetic purposes, intensive agriculture, fur, performance animals. No specific exclusion for meat or animal testing for medical purposes. Chemicals of concern e.g. ozone depleting substances, mercury The following activities, while not an immediate avoid, are scored negatively in evaluating a company. If a company is exposed to more to multiple negative score activities then it will also be assigned a Fail grade. This is because the company is exposed to 2 or more significant ESG risks, or has a significant ESG risk and no adequate policies in place to regulate the risk. A company with any of the negative activities below would need a combination of strong positive activities to be included in the final index. Negative score activities Pay day lending Alcohol Unhealthy foods High carbon intensity and environmental impact Use of tax havens Operations in countries of concern Evidence of anti-competitive behaviour Supply chain from countries of concern Media that promotes misinformation on climate change Financial company with no fossil fuel free investment commitment Animal testing (medical purposes) High level of waste No environmental policy Lack of social or labour policies Alcohol (more than 50% of revenue) Recent or significant fines or convictions Services to detention of asylum seekers Companies found to be engaged in the activities above are assigned a Fail grade.

4 Process 2: Application of positive screen This process adds a positive score for positive activities and behaviours and is applied to companies that have not yet received a fail grade. Positive score activities Renewable energy and energy efficiency Recycling and re-use of waste Water and resource conservation Green buildings Social infrastructure Sustainable timber production Technology Independent media Personal insurance Ethical procurement and supply chain Financial company with fossil fuel free commitment Charitable giving program Environmental policies and reporting Social and labour policies and reporting Diversity of Board (20% or more female or minority representation) Education Healthcare, health and safety products Fair trade and sustainable products Community finance and regional banking services Production of healthy foods Access to affordable housing Public transport and non-fossil fuel transport Independent markets and grocers Social services e.g. employment, aged care Communications Where a company operates in a sector that is considered neutral (neither positive or negative according to the screens), elements of the positive screening such as diversity of board and environmental or social policies and reporting act similar to a best-of-sector type screen. After application of the negative and positive screens to the Thomson Reuters Australia, there are 129 stocks that pass the screens and make up the Fossil Fuel Free Ethical Enhanced. These stocks tend to be in sectors such as healthcare, second-tier banks, communications, information technology, listed property, renewable energy, waste management and online marketplaces. The index listing for this fund is below.

5 Fossil Fuel Free Ethical Enhanced Aust Share Telstra Mirvac Group Metcash CSL Computershare Flight Centre Suncorp Group Dexus Property Group Ansell Insurance Australia Group GPT Group Investa Office Fund Brambles Sonic Healthcare REA Group QBE Insurance Group Bendigo and Adelaide Bank Carsales.com Stockland Seek G8 Education ASX Bank of Queensland Sims Metal Management CFS Retail Prop Trust Cochlear Primary Healthcare Ramsay Healthcare IOOF Holdings TPG Telecom Australand Navitas NIB Fairfax Media Seven West Media Cromwell Property Transpacific Industries JB HiFi Recall Invocare iinet Charter Hall Retail REIT Slater and Gordon Sirtex Medical SAI Global Super Retail Group GWA Group Goodman Fielder IRESS Charter Hall Group Genworth Grencross Bega Cheese Sigma Pharmaceuticals Breville Abacus Property Group Aveo Group Veda Group Steadfast Technology One Virtus Health GUD Holdings Mesoblast Billabong Vocation Southern Cross Media Tassal Amcom Telecom GDI Property Cabcharge Austbrokers Holdings Vocus Communications Corporate Travel Mgt APN News and Media Mayne Pharma MyState Japara Healthcare IAG P.F. Ozforex STW Communications Blackmores Equity Trustees Cover More Peet Pacific Brands Bentham IMF Hills Group isentia BEN CV P.F. Dick Smith Folkestone Education Ramsay Healthcare P.F. iproperty Tox Free Solutions Ingenia Communities Acrux Beacon Lighting Australaland Assets Trust UXC Servcorp SMS Mgt and Technology Capitol Health Wotif NextDC Freedom Foods iselect Bionomics Admedus Mortgage Choice Generation Healthcare REIT Affinity Education Infigen Energy Webjet Ridley Reckon Arena REIT CSG Alchemia Nanosonics GBST Bigair Group Adslot Starpharma Silver Chef Lifestyle Communities My Net Fone Astro Japan Property DWS The stocks are held within the index using market capitalisation weightings.

6 Back-tested index construction In order to back-test the Fossil Fuel Free Ethical Enhanced, the positive and negative screens were applied to the Thomson Reuters Australia at 6 month intervals over the last 5 years. In constructing the back-tested portfolios, the total number of companies which pass the ESG screens diminishes the further the back-testing goes back. At present, 129 stocks pass the screens and make up the index. However, in March 2013 this dropped to 82 stocks and by September 2009 dropped as low as 60 stocks. This is accounted for by the changing nature of the largest 300 (approx) stocks on the Australian Stock Exchange. While 5 years ago the largest companies on the ASX were dominated by energy and resources companies, many of these companies have fallen out of the top 300 of the ASX over the last 5 years and been replaced by companies in industries such as healthcare, communications and information technology. These industries tend to pass ethical negative screens. Combined with the back-tested performance and Sharpe ratio of the Fossil Fuel Free Ethical Enhanced, the shift in complexion at the top end of the ASX makes a compelling case for future performance of a Fossil Fuel Free Ethical Enhanced. The trajectory over the last 5 years shows that the number of ASX listed companies that pass ESG and ethical screens is increasing. Further, it is these companies that are providing superior risk-adjusted returns. Back-tested performance of the Fossil Fuel Free Ethical Enhanced Back-testing was done on this index for periods of three and five years. This showed particular outperformance against the Thomson Reuters Australia. 30/9/ /1/2015 1/7/2009 3/2/2015 Fossil Fuel Free Ethical Enhanced Thomson Reuters Australia Fossil Fuel Free Ethical Enhanced Thomson Reuters Australia Return (p.a.) 25.09% 14.94% 15.07% 12.41% Standard Deviation Annualised Sharpe Max Drawdown % 10.20% 17.93% 21.67% While the outperformance is significant, the Sharpe ratio particularly stands out. The Sharpe ratio is a measure of risk-adjusted performance whether a portfolio s returns are due to smart investment decisions or a result of excess risk. While the fossil fuel free ethical enhanced index portfolio has produced outperformance compared to the Thomson Reuters Australia, investors are typically looking to see that higher returns do not come with unwelcome additional risk.

7 The greater a portfolio s Sharpe ratio, the better its riskadjusted performance has been. A Sharpe ratio of 1 or more is considered to be good, a ratio of 2 is considered to be very good. Over 3 years the Sharpe ratio for the fossil fuel free ethical enhanced index is This places the in the good to very good category and significantly higher over both time periods than the Thomson Reuters Australia. A comparison with the Sharpe ratio of ethical funds that do not have strict fossil fuel screens also shows that the addition of a fossil fuels screen increases the Sharpe ratio and reduces volatility even further. Strong risk adjusted returns are a hallmark of a genuine approach to responsible investment. The companies that pass ethical screens tend to be in more defensive industries such as healthcare, and ethical screens tend to filter out more risky or speculative investments such as resources. Those companies with a poor environmental record or social and governance issues are the companies more likely to face heavier regulation or fines, or suffer damage to their reputation (and hence financial). It is also notable in the 5 year performance chart, that the Fossil Fuel Free Ethical Enhanced trailed the broader index for the first 2 years before significantly outperforming across the final 3 years. This may be explained by the changing nature of the top end of the Australian stock exchange over the last 5 years, as mentioned earlier. While 5 years ago the largest companies on the ASX were dominated by energy and resources companies, many of these companies have fallen out of the top 300 of the ASX over the last 5 years and been replaced by companies in areas such as healthcare, communications and I.T. which tend to pass negative screens. Conclusion The development and performance of fossil fuel free financial products will become increasingly relevant as demand from ethical investors, fund managers and institutions grows. Backtesting has revealed an ethically enhanced fossil fuel free index has provided superior returns to the Thomson Reuters Australia over a three and five year time period, with a lower level of investment risk. This outperformance is significant and reflects the reduced volatility of index as well as the potential of similar ethical and fossil fuel free products. Reference: Thomson Reuters Australia, launched in 2009, is part of the Thomson Reuters Global Equity family that covers over 11,000 stocks from 51 markets, broken down into different countries, regions and sectors. The Australia is a market capitalization weighted, representative benchmark of Australian large, medium and small cap stocks. The, including constituent data, is available on Thomson Reuters financial market data desktop solution (RI is TRXFLSAUP).