Rotman ICPM Discussion Forum June 2012 PGGM Investments Long Horizon Investing in a public equity portfolio Disclaimer - Important information This document has been solely prepared for informational purposes and is not an offer, or a solicitation of an offer, to buy or sell any security or financial instrument, or any investment advice. This policy does not confer any rights to any third parties. PGGM Investments has taken all reasonable care to ensure that the information contained in this document is correct, but does not accept liability for any misprints. The information contained herein can be changed without notice.
Change requires Innovation Innovation requires rethink of the traditional investment processes The most difficult subjects can be explained to the most slow-witted man if he has not formed any idea of them already; but the simplest thing cannot be made clear to the most intelligent man if he is firmly persuaded that he knows already what is laid before him. Leo Tolstoy, 1897 2
Agenda 1 2 3 4 Background Defining LT Responsible Investing Empirical reasoning REP Approach and Process 5 Conclusions 3
Background Genesis of the Responsible Equity Portfolio As a long term investor, PGGM has for many years focused on being a responsible investor, and in 2006 PGGM* became one of the founding signatories to the United Nations backed PRI In 2008, PGGM launched a dedicated portfolio, which we labelled the Responsible Equity Portfolio, to focus on creating Long-term investment returns in a responsible manner Today, we will discuss our journey *in 2006, PGGM was still part of what is now Pensioenfonds Zorg en Welzijn 4
Defining responsible Which is the responsible company? Defining LT Responsible Investing One of the worlds most sustainable chemical companies? Washington Post: Solar Energy Firms Leave Waste Behind in China 5
If there is no black and white, then what is Responsible Investment? Defining LT Responsible Investing Societal Identity Social responsibility Financial Better risk-adjusted returns Investment opportunities 6
Defining LT Responsible Investing How does PGGM integrate ESG within Equities? Description Index investing Capturing the average return of the entire market Universal owner (2800 companies) Active & concentrated Actively selecting individual names Concentrating on a smaller number of names (about 20 companies) Approach Use ESG overlay engagement, exclusion, and voting To maximize financial and ESG value creation and ownership influence, PGGM chose a concentrated investment approach 7
For an active approach, the normal rules of alpha apply - avoid closet indexing Empirical reasoning Investment philosophy Outperformance vs. relevant benchmark Stock pickers +1.26% Concentrated -0.25% Closet indexers Factor bets -1.28% Moderately active -0.52% Closet indexers -0.91% 8 Source: Petajisto (2011): How Active is Your Fund Manager? Active Share and Mutual Fund Performance
When you add ESG to active management, return potential is even higher Empirical reasoning High Sustainability companies significantly outperform their counterparts by 4.8% per annum over the long term Harvard Business School, November 2011 9
Empirical reasoning Summarizing the empirical landscape 1. Stockpicking in a long term, concentrated way + 2. ESG culture of sustainability Should = Outperformance BUT 1. ESG is not black and white 2. What about ESG laggards? Therefore, active ownership must be added to the strategy to manage existing risks and potentially create extra value from transforming laggards. Also, active ownership is obviously a responsibility under the PRI 10
REP Approach and Process REP Investment Process REP Investment Process A Fundamental analysis B ESG analysis C Active ownership Capture companies utilizing traditional long term/private equity style analysis involving rigorous top down sectoral analysis and indepth bottom-up fundamental analysis Deep analysis of environmental, social and governance risks or opportunities to identify existing leaders or laggards for engagement. Determining and monitoring the societal added-value its companies create. As active owners, we lower portfolio risk by having a better perspective on company and industry risks and opportunities For weaker companies, we can create value by catalyzing sustainability or business change through active ownership 11
Responsible Equity Portfolio (REP) overview A new investment model for long horizon equity ownership REP Approach and Process Description Investment Universe Strategy Active, concentrated portfolio. REP invests in the sustainable leaders of the future and manages risk and catalyzes ESG transformation through active ownership + Sustainable Leaders Initial size Current Committed capital EUR 1 billion (2008) EUR 3.5 billion (2012) Financial return Financially attractive companies with weaker ESG profiles that are transformable through active ownership Geographical focus Developed Markets ESG + Exclusion list Don t invest Invest 12
To understand and capture value from ESG analysis, PGGM developed an ESG toolbox REP Approach and Process 1 Management Parameter Rating Priority Weight Issue colour coding ed 1 Willingness to engage with non-owner stakeholders Acceptable 3 Environmental 75 Potential Engagement 2 Suitability of management style of CEO Excellent 125 Parameter No Engagement Rating Priority Weight 3 Communication skills of executive management team Acceptable 75 Potential Engagement ed 4 Proven credibility of management Yes S 125 1 Formal No Environmental Engagement Policy No but pro-active management 50 Active Engagement o 5 Long Term Industry Vision Excellent M 125 2 Reporting No on Engagement Energy Use No but pro-active management A f 6 Stability of Executive management Stable 125 No Engagement t 3 Programmes to Increase Renewable Energy Use No but pro-active management N 7 Uniform represention of company values and strategy by Executive board Yes A 254 Reporting No Engagement on Carbon Intensity No but pro-active management G 8 Manageable number of direct reporting lines to CEO Yes P 255 Reporting No on Engagement Water Intensity No but pro-active management E 9 Accuracy of guidance Acceptable o 15 No Engagement M 6 Reporting on Waste Intensity No but pro-active management E 10 Transparent communication of guidance and targets Excellent l 25 No Engagement 7 Reporting on Recycling of Used materials No but pro-active management i N 1 Having Long Term Strategy Basic c 75 Potential Engagement T 8 Reporting on GHG (non-carbon) emissions No but pro-active management 2 Conservative Accounting Yes y H 25 No Engagement 9 Formal Policy for operating with environmental friendly suppliers No but pro-active management a 3 Publishing Sustainability Report No 0 Active Engagement r 10 Systematic Integration of Environmental Considerations at R&D Stage (Eco-design) Not applicable for the company 4 Social 0 No Engagement 4 Adherence to the GRI Guidelines No 0 Potential Engagement d 11 Programmes to Increase Investments in Sustainable Buildings Yes and pro-active attitude towards this issue 25 Parameter No Engagement Rating Priority Weight Issue colour coding 5 Executive Compensation Tied to ESG Performance No 0 Potential Engagement ed 12 Remuneration for site managers linked to the environmental performance Not applicable for the company 0 No Engagement 6 Executive Compensation Tied to Long Term Performance Excellent E 125 No Engagement 1 Formal Policy on Human Rights No but pro-active management 50 Active Engagement 13 Guidelines and Reporting on Closure and Rehabilitation of Sites Not applicable for the company 0 No Engagement N 2 Formal Policy on Elimination of Discrimination Yes and pro-active attitude towards this issue 125 No Engagement V 1 Proof of repeated environmental misconduct in last 5 years No P 125 No Engagement Management score of the company 3.7 I 3 Formal Policy on Freedom of Association No but pro-active management 2 Positive trend in % Primary Energy Use from Renewables No o 0 Potential Engagement R l 4 Formal Policy on Working Hours and Minimum Wage No but pro-active management 2 Governance O A 3 Very low and/or Declining Energy Use over sales Yes i 25 No Engagement c 5 Formal Policy on Health and Safety No but pro-active management 10 N Potential Engagement Parameter Rating Priority Weight 4 Very low Issue and/or colour Declining codingcarbon Intensity over sales Yes c 25 No Engagement M t 6 Formal Policy Employee Training Yes and pro-active attitude towards this issue ed y 25 No Engagement i 5 Very low and/or Declining Water intensity over sales Yes 25 No Engagement S E 1 Board Diversity Yes v 25 No Engagement 7 Social Supply Chain Standards No but pro-active management t N 6 Very low and/or Declining Waste over sales Yes 25 No Engagement r 2 Board representative for ESG Issues No T i 0 Potential Engagement 8 Remuneration for site managers linked to the social performance No but pro-active management 7 Very low and/or Declining GHG (non-carbon) emissions over sales 25 No Engagement C t Yes 1 Remenuration of executive management team in line with comparable companies (size and or industry) OK A 125 No Engagement 1 Proof of repeated social misconduct in last 5 years No G o L y 8 High or Increasing Percentage of Recycled/Re-used Raw Material Used Yes Low priority A 125 No Engagement 5 No Engagement 2 Remuneration of the Supervisory board in line with comparable companies (size and or industry) OK 125 No Engagement O m S c 2 Continuous Investments in Employee Training Yes and pro-active attitude towards this issue 125 No Engagement I 9 Sustainability of product and packaging Yes 25 No Engagement V 1 Board Independence Yes 125 No Engagement O t 3 Conducting Supply Chain Monitoring and Audits No but pro-active management n 10 Selection and training of suppliers towards environmental standards No 0 E C i Potential Engagement d 2 Board operating through independent committees Yes 25 No Engagement R R v 4 Low or Continuous Reduction of Health & Safety Incidents Yes and pro-active attitude towards this issue 1 LEED certified buildings Yes I 25 No Engagement 25 e No Engagement N 3 Separation Chairman of the Board and CEO No e 0 Active Engagement A i 5 Low or Declining Employee Turnover Rate No but pro-active management 2 External certification and or audit of Environmental performance 25 A No Engagement 1 Current Involvement illegal activities In the past, but solved p Yes and pro-active attitude towards this issue 75 No Engagement L t 6 Community Involvement Programmes / Philanthropy Yes and pro-active attitude towards this issue N P u i 25 No Engagement 3 Inclusion in relevant sustainable indices No but pro-active management 2 Signatory to UN Global Compact No 0 Potential Engagement C o e 7 Regular occurrence of strikes, lock outs and other actions No 10 No Engagement E l 3 Protection of the minority shareholders rights Yes 1 Targets to reduce total Energy use Not Clearly defined 15 Potential Engagement 125 No Engagement s i T 8 Social training of suppliers No but pro-active management 4 Acceptable level of share Non-Audit Fee to Audit Fee Acceptable Level 25 2 Targets No to Engagement reduce Carbon intensity Not Clearly defined 15 Potential Engagement c a R 1 Health and Safety Certifications No but pro-active management y 5 Transparency of Public Policy and Political Contributions No r 0 3 Targets Potential to Reduce Engagement Waste Generation Not Clearly defined e 15 Potential Engagement 2 External certification and audits of Social performance No but pro-active management 10 g p Potential Engagement 6 Formal Statement on Bribery and Corruption Yes 254 Targets No to Engagement Reduce Water Intensity Not Clearly defined 15 Potential Engagement e u 3 Great Place to Work Awards No but pro-active management t 5 Targets to reduce GHG (non-carbon) emissions Not Clearly defined T 15 Potential Engagement Governance score of the company s 3.6 1 Targets to Increase Workforce Diversity Not Clearly defined 15 Potential Engagement 6 Recycling targets Not Clearly defined a 15 Potential Engagement r 2 Targets for Health and Safety Not Clearly defined 15 Potential Engagement 7 Targets for sustainability of products and packaging Not Clearly defined 15 Potential Engagement g 3 Targets for Employee Training Good 25 No Engagement e Environment score for the company 4 Targets for Socially responsible 3.2suppliers No 0 Potential Engagement t Social score of the company 3.5 ESG Toolbox is an internally developed measurement tool... with an non-static output Provides an ABSOLUTE measure of ESG risk, as opposed to the RELATIVE measures provided by sustainability ratings Determines whether ABSOLUTE level of ESG risk exceeds long term financial-only attributes Defines the main focus areas for risk mitigation through the ESG dialogue with the company Tracks evolution over time Maps out the non-operational monitoring agenda 13
Conclusions Conclusions Outperformance has been good, even in light of concentration risk Risk, as measured by Absolute VAR, has been roughly equal to the benchmark over last 3 years, tracking error below 7%, beta below 1 Portfolio ESG risk, as measured by CO2 footprint, has been 2/3rds lower Reputational risk as measured by NGO activity or negative newsflow is also substantially lower than the index Engagement has achieved some major successes in transforming companies from no sustainability to full sustainability strategy Where does it go from here? 14
Questions? 1. How might you design a REP 2.0 to make it better and more scaleable? 2. How should this mandate be structured to achieve the long term objective? 3. If higher scale=more influence and hence potential return, are there opportunites to collaborate on this and if so in what form? Alex van der Velden Head of Responsible Equity PGGM Investments alex.v.d.velden@pggm.nl