Engagement and Impact 2016: Dividend Strategy ESG

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1 CLEARBRIDGE ESG INVESTMENT Engagement and Impact 2016: Dividend Strategy ESG Environmental, Social and Governance (ESG) Investing at ClearBridge ClearBridge s dedicated Environmental, Social and Governance (ESG) Program combines the resources and performance of a mainstream firm with a legacy of specialized ESG expertise. ClearBridge brings the scale, access and infrastructure of a long-term investor with $112.4 billion* in assets under management together with an ESG program that dates back to Combining active investment with active ownership Selecting investments and managing portfolios Advocacy via proxy voting and engagement with company management Client and public education about ESG best practices Risks: All investments involve risk, including loss of principal and there is no guarantee that investment objectives will be met. Investments may be made in small- and mid-cap companies, which involve a higher degree of risk and volatility than investments in large-cap companies. While most investments are in U.S. companies, investments may also be made in ADRs and other securities of non-u.s. companies in developed and emerging markets, which involve risks in addition to those ordinarily associated with investing in domestic securities, including the potentially negative effects of currency fluctuation, political and economic developments, foreign taxation and differences in auditing and other financial standards. These risks are magnified in emerging markets. Limited investments also may be made in non-dividend-paying stocks that are not expected to pay a dividend in the near future. The manager may hold significant portions of portfolio assets in cash equivalents while waiting for buying opportunities. True ESG integration Firm-wide fundamental research incorporating ESG perspectives across industry sectors Research analyst compensation based in part on evaluating ESG factors linked to company performance An ESG ratings system facilitating systematic research and engagement with companies Company Engagement ClearBridge is an active investment manager that meets with companies on a daily basis. As a firm, ClearBridge hosts around 1,000 company meetings every year and many of those discussions include material environmental, social and governance issues. Company Engagements by Sector Dividend Strategy ESG Separately Managed Accounts (SMAs) are investment services provided by Legg Mason Private Portfolio Group, LLC (LMPPG), a federally registered investment advisor. Client portfolios are managed based on investment instructions or advice provided by one or more of the following Legg Masonaffiliated subadvisors: ClearBridge Investments, LLC and Western Asset Management Company. Any information, statement or opinion set forth herein is general in nature, is not directed to or based on the financial situation or needs of any particular investor, and does not constitute, and should not be construed as, investment advice, forecast of future events, a guarantee of future results, or a recommendation with respect to any particular security or investment strategy or type of retirement account. Investors seeking financial advice regarding the appropriateness of investing in any securities or investment strategies should consult their financial professional. Utilities 4% Real Estate 5% Energy 7% Industrials 16% Health Care 8% Materials 10% Staples 15% Financials 10% Discretionary 15% Information Technology 12% 2017 Legg Mason Investor Services, LLC, member FINRA, SIPC. Legg Mason Investor Services, LLC and ClearBridge Investments are subsidiaries of Legg Mason, Inc. 10/17 As of Dec. 31, Source: ClearBridge. Based on weighting in portfolio. * As of Dec. 31, 2016.

2 Engagement Themes by Sector At ClearBridge we proactively and regularly engage companies on Environmental, Social and Governance (ESG) issues. These engagements occur in various ways, including one-on-one meetings with senior management as part of our integrated research process and through our active participation in various ESG organizations. The topics we discuss with companies vary depending on what issues are relevant to the individual company and are based on our analysts knowledge and understanding of the particular industry. The breakdown of ESG themes by sector is shown here. ESG Engagement Themes by Sector Dividend Strategy ESG 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Discretionary Staples Energy Financials Health Care Industrials Information Technology Governance Social Environmental Materials Real Estate Utilities As of Dec. 31, Source: ClearBridge. The above themes and key issues are based on discussions with companies across all ClearBridge strategies. Engagement Highlights from 2016 Texas Instruments Texas Instruments designs and manufactures semiconductors. ClearBridge held a discussion with representatives from Texas Instrument s sustainability team focused on policing labor abuses across the supply chain, diversity of the company s workforce and environmentally responsible practices related to business operations. The company has made significant strides in reducing the sourcing of conflict-free minerals from its supply chain. It continues to pay above-market wages in developing economies as a way of attracting the best talent. Texas Instruments has also put in place several programs to move towards more sustainability within its factory footprint including water recycling initiatives as well as productivity improvements that reduce energy usage and bulk packaging costs. A large portion of its products supply the power management space, which is focused on enabling energy efficiency in markets ranging from electric vehicles to ordinary electrical outlets. Promoting diversity across the organization (and particularly across the management team) remains a key issue, and we are encouraged that the company has implemented a policy where managers are annually appraised 2 and graded on training and retention of talent. The company s focus on manufacturing efficiency through sustainable initiatives has helped drive significant margin expansion over the past several years, and we believe its exposure to high growth power management end markets will allow it to continue to gain share in the analog market. Also, given the shortage of talented analog engineers across the semiconductor industry, we believe that a strong focus on attracting, developing and retaining talent will be a key differentiator for the company going forward. Schlumberger Schlumberger is an energy services company that provides a wide range of services, including technology, project management, and information solutions to the oil and gas industry. ClearBridge has an ongoing dialogue with Schlumberger on their business dynamics and on environmental, social and governance issues. We host and attend a number of meetings each year with senior management of the company. In 2016, in addition to our regular meetings, we hosted the company s Vice President, Government and Industry Relations, who heads the company s sustainability effort

3 CLEARBRIDGE ESG INVESTMENT 2016 ENGAGEMENT & IMPACT REVIEW and engagement, to provide feedback on their current practices. We discussed Schlumberger s sustainability focus and the tools that the company has developed to help its customers quantify their sustainability impact. The company looks to understand, benchmark and address concerns of its various stakeholders related to the oil & gas industry (e.g., workplace safety), the environment (e.g., clean air/water, renewable energy) and local communities (e.g., employment, quality of life and not-in-my-backyard concerns). The company has established key performance indicators including water usage, greenhouse gas emissions, chemical exposure, land disturbance, traffic and noise impacts etc. that enable it to keep track of its progress. We also hosted the CEO in a separate meeting where he discussed the integration of these environmental and community impact assessment tools into their business model. Management also shared their social responsibility efforts related to employee engagement and diversity, STEM-oriented community outreach initiatives and human rights. Schlumberger s technological innovations have positively influenced the industry in terms of sustainable practices in energy services and with its technology leadership position in oilfield services, its ongoing progress in this area can have a continual industry-wide impact. Ecolab Ecolab Inc. is a global provider of products and services for water treatment, sanitation, pest management and other solutions. ClearBridge has been engaging Ecolab since 2009 on a variety of topics including product safety, water efficiency and workplace standards. In 2016, Ecolab initiated a discussion with ClearBridge to review governance matters, including executive compensation and incentive structures. We took the opportunity to also discuss other issues such as diversity of the company s Board of Directors, employee diversity and inclusion, and Board-level responsibility for safety, health and environmental issues. The executive compensation structure at Ecolab focuses on straightforward business performance metrics such as operating income growth. The structure is simple and consistent. When Ecolab did not meet its annual earnings growth target in 2015, for example, no performance payments were awarded. Ecolab s compensation incentives also include individual performance measures that are designed to reinforce ethical and sustainable management practices. These performance measures include safety standards, talent development, and increasing service delivery. Ecolab s Board of Directors has a dedicated Safety, Health and Environment committee that includes the CEO. Having such accountability at the top level of the company indicates that Ecolab takes these issues seriously and has the oversight structures in place to manage them effectively. In addition, the Board committee reviews the company s sustainability report. We also discussed how the Board takes diversity into consideration when selecting Board members, as well as diversity programs at the company more broadly. Ecolab seeks Board members that provide a diversity of experience and have competence in different governance issues. Board members are re-elected every year, a best-practice structure that discourages entrenchment and keeps Board members engaged. ESG Rating Distribution Dividend Strategy ESG A 17% AA 46% AAA 37% AAA, Best in Class: Company has integrated ESG strategy into its business model, usually with full CEO and/or employee support; formally measures sustainability efforts and proactively communicates to investors. Often, these are companies that are providing goods and services that have a positive effect or impact on society or the relevant industry. AA, Intermediate: Company sees value in ESG factors, has begun to incorporate sustainability into business operations and products and has started reporting its progress. A, Beginner: Company recognizes potential to capitalize on ESG improvements B, Uninvestable: Company with poor ESG record or involved in unsustainable industries such as tobacco or coal. As of Dec. 31, Source: ClearBridge. 3

4 CLEARBRIDGE DIVIDEND STRATEGY ESG While the Board displays a wide diversity of experience and a degree of gender diversity (four out of 15 Board members are female), broader diversity at the Board level and within the company are areas that Ecolab continues to work to improve. Developing a diverse talent pool is a long journey and the company has a set of employee networks to support and foster such diversity. Brookfield Renewable Partners Brookfield Renewable Partners initiated this engagement as they wanted ClearBridge one of their top shareowners to participate in a materiality assessment the company is conducting to understand what stakeholders see as the company s most material sustainability issues. The feedback we provided will help shape Brookfield s sustainability strategy and help the company understand which sustainability issues it should be focusing on. We provided our views on material issues such as climate change, environmental regulations, water scarcity, community impacts, life cycle assessments and governance. Engagement Themes: Data Privacy and Data Security Issues of data security and data privacy have become areas of increasing focus for ClearBridge research and engagement in recent years. This is with good reason as the frequency of high-profile data breaches has increased, with breaches at companies like Yahoo!, ebay, Target, Home Depot and health insurer Anthem in the past several years. In addition, there has been a significant rise in data privacy controversies at companies, such as the unauthorized selling of customer information or manipulation of user data for research. Data security and privacy are not only important human rights issues, but also business issues as a breach of customer trust can lower usage of a company s internet platform or online products, resulting in reduced revenues. In 2016 ClearBridge discussed these issues with numerous companies including the example below. Given the speed at which technological capabilities are improving, data privacy and security will continue to be key areas of focus for ClearBridge going forward. Microsoft Corporation Microsoft offers a wide variety of software for desktop and server environments as well as cloud-based services. Its Windows operating system and Office suite of products are the leading brands in their respective markets. Microsoft is also one of the two largest vendors of cloud computing services through its Azure cloud computing platform and Office 365 cloud based . ClearBridge has had a long-running dialogue with Microsoft on ESG issues ranging from diversity to renewable energy & climate change, to data privacy and security. In 2016 this dialogue continued as we spoke with the company s Director of Corporate Citizenship to specifically discuss data privacy and security. Data security has been a barrier to adoption of cloud services for many organizations, so Microsoft s reputation as a trusted partner is essential to the success of its cloud and Azure businesses. Microsoft has significantly enhanced its own security, both within its own products and its cloud offerings, to the point that it now gets plaudits from industry experts for offering among the most secure products in the industry (a far cry from the industry feedback years ago). Microsoft has laid out key privacy principles that form the foundation of its approach to privacy. It was also the first company to adhere to the international standard for privacy protections (ISO 27018) for the processing of personal information by cloud service providers. In addition, Microsoft has been a vocal advocate for greater transparency when responding to governments requests for data. A key priority for Microsoft is giving its customers control over their own data, allowing them to manage their own privacy settings and, as importantly, to be aware of the choices they are making, either overtly or inadvertently. Microsoft is also instrumental in helping its customers understand and adhere to the increasing number of privacy laws globally, and to anticipate changing requirements in advance. Thought Leader Engagement and Public Education Another aspect of ClearBridge s approach to ESG investing is to participate in industry-wide discussions and projects to improve industry practices and collaborate with other investors and organizations on addressing environmental, social and governance challenges. Examples of thought leader engagement and public education activities in 2016 ClearBridge white papers (available at clearbridge.com): Disruption from Electric Vehicles Presents New Growth Opportunities The Future of Investing ESG Portfolios: Changing Beliefs, Perceptions, and Goals ESG Ratings: Integrating Fundamental Analysis with Environmental, Social and Governance Considerations Principles for Responsible Investment (PRI): PRI, the preeminent global organization promoting responsible investment and to which ClearBridge is a 4

5 CLEARBRIDGE ESG INVESTMENT 2016 ENGAGEMENT & IMPACT REVIEW Key Issues Covered in 2016 Company Engagements Environmental Social Governance Biodiversity Carbon emissions Community impacts Data collection and reporting Efficient water infrastructure Energy efficiency Access & affordability of lifesaving medicines Affordable housing initiatives Customer service & education Cyber security & data privacy Drug pricing Employee engagement & retention Accounting practices Allocation of capital Audit practices Board governance over sustainability issues Chairman & CEO separation Environmental regulation Employee health, wellness and safety Executive leadership Landfill environmental control Ethical procurement practices appointments (leaking etc.) Factory worker wages Family ownership & interests Methane emissions and Improving drug safety & efficacy Fraud detection capture Industry collaboration to solve complex social Government investigations Nuclear generation exposure health care issues Long-term strategy vs. Renewable power sourcing Food ingredients transparency activist agendas Supply chain emissions Layoffs fair treatment of employees and Management succession/ Sustainable packaging transitional support appointment of a new CEO Toxic by products Sales practices for financial services New board member nominations Zero waste facilities companies Proxy access Supply chain traceability signatory, released an extensive new report in 2016 titled A Practical Guide to ESG Integration for Equity Investing. The guide is the most comprehensive global report to date on equity integration, with investment case studies presented by practitioners. Neal Austria ClearBridge s consumer discretionary analyst contributed a case study to the report on how strong workplace practices implemented by a U.S. retailer contribute to its earnings growth, as compared to its peers. The intent of the report was to demonstrate the value of ESG integration techniques, most notably the integration of ESG factors into fundamental, bottom-up analysis and share owner engagement. Sustainability Accounting Standards Board (SASB): SASB is an independent non-profit whose mission is to develop and disseminate accounting standards that help companies disclose material, decision-useful ESG information to investors. That mission is accomplished through a rigorous process that includes evidencebased research and broad, balanced stakeholder participation. ClearBridge s two financials sector analysts Steve Rigo and David Hochstim participated in this process through a one-on-one feedback session with SASB to provide detailed input on the reporting framework and metrics SASB is developing for Financials Sector Industry Briefs. Access to Medicine Index: The Access to Medicine Index analyzes the top 20 research-based pharmaceutical companies on how they make medicines, vaccines and diagnostics more accessible in low- and middle-income countries. There are two billion people in the world with no access to medicine and the Access to Medicine Index gives insight into what the pharmaceutical industry is doing to improve this situation. In 2016 ClearBridge signed the Access to Medicine investor statement in support of the Index. The statement acknowledges the issue of access to medicine as material to long-term shareholder value creation and the important role that pharmaceutical companies play in addressing this issue. In addition to signing the statement, Marshall Gordon ClearBridge senior analyst for health care attended an Access to Medicine launch event in New York to discuss the findings of the organization s most recent research. United Nations Environment Program Finance Initiative (UNEP FI): UNEP FI is a partnership between United Nations Environment Programme and the global financial sector created after the 1992 Earth Summit with a mission to promote sustainable finance. ClearBridge has been an active member of UNEP FI since 1997 and has contributed to numerous groundbreaking responsible investing reports over the past decade (available at In 2016 ClearBridge hosted an annual meeting for UNEP FI s North American signatories at its offices in New York. The meeting was an opportunity for ClearBridge and other signatories (insurers, banks and asset managers) to review ongoing work and strategize about future priorities and work streams. 5

6 CLEARBRIDGE DIVIDEND STRATEGY ESG New York Stock Exchange: Mary Jane McQuillen, Managing Director and Head of ESG Investment at ClearBridge, was invited to speak on a panel discussion at the New York Stock Exchange Investor Relations Summit to a group of over 200 companies. The panel discussed the importance of environmental, social and governance (ESG) issues to investors and answered questions from attendees, all of whom were in investor relations roles at companies. Investor relations professionals are the primary contacts for ClearBridge and all other investors when interacting with companies, so it is important for investor relations teams to understand the interest in ESG issues from investors and how to engage investors on these topics. Responsible Investor (RI) Americas Conference: RI Americas is one of the largest conferences for ESG investors in the U.S. It is held annually at Bloomberg s headquarters in New York City and was attended by over 300 delegates in It is a forum for asset owners and asset managers to hear about best practices from those working in ESG investing. At the conference Mike Kagan ClearBridge Managing Director and Portfolio Manager participated in a panel discussion on how institutional investors can engage companies on sustainability issues. Having described our integrated approach to investing, Mike emphasized that the key to good research, analysis and eventual impact is company engagement. ClearBridge has over 1,000 engagements with public corporations each year and many of those conversations involve material ESG issues such as improving corporate governance (e.g., promoting proxy access or changing compensation structures to be more longterm oriented) and better sustainability reporting. ClearBridge is an active member of the below organizations: 6 ClearBridge Investments 620 Eighth Avenue, New York, NY ClearBridge.com