Introduction to Sustainable Investing

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www.contrast-capital.com

Introduction to Sustainable Investing

Contrast Capital AG

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www.contrast-capital.com –

... “Is a long-term investment approach”

... “Environmental, social, and governance (ESG) factors are potential

drivers of return and risk”

... “The impact of an investment is taken into account”

… ”Sustainable investment approach can be applied across all existing

asset classes”

Sustainable Investing

…

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Summarising on Definitions

•  

There is no single definition for sustainability nor for sustainable

investing.

•  

Each stakeholder has its own definition and as such it is initially difficult to see through this market.

•  

Investors are required to develop their own objectives for sustainable

investing, and thereafter to integrate them in their investment approach:

"Policy for Sustainable Investment"

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Objectives of Sustainable Investing

Ethical / Moral values

Exposure reduction to controversial activities / Reputational risk reduction Universal Ownership (stewardship: engagement and voting) Risk reduction by investing in an uncorrelated investment style Risk reduction through in-depth analysis of individual investment Search for additional return (alpha) Alignement with Business objective / Foundation Investment 4

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US Market for Sustainable Funds

Source: US SIF Foundation (2014): “Report on US Sustainable, Responsible and Impact Investing Trends” •  $6.6 trillion in the US as of end 2011

•  More than one in out of every six dollars under professional

management in the United States

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European Market for Sustainable Funds

*EUR 16.8 trillion assets under management in Europe as of end of 2013, EFAMA estimates of European professionally managed assets cover 27 countries

Source: Eurosif (2014): “European SRI Study 2014”

•  EUR 8.7 trillion in Europe as of end 2013

•  This corresponds to nearly 60% of all assets under management*

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34 European SRI Study 2014

The European SRI Study 2014 confirms some industry trends already detected in the previous recent editions. All surveyed Sustainable and Responsible Investment strat-egies are continuing to grow. As shown in Table 12, growth

rates range from 22.6% (Sustainability themed) to 91% (Ex-clusions), outpacing the yet impressive 22% growth rate of the industry over the period. Impact investing is the fastest growing strategy, registering 132% over the period.

TABLE 12: Market Growth by Strategy

In € million (EU 13) 2011 2013 CAGR 2011 - 2013 Growth 2011-13

Sustainability Themed €48,046 €58,961 10,8% 22,6%

Best-in-Class €283,081 €353,555 11,8% 24,9%

Norms-based Screening €2,132,394 €3,633,794 30,5% 70,4%

Exclusions €3,584,498 €6,853,954 38,3% 91,2%

ESG Integration (incl. research available) €3,164,066 €5,232,120 28,6% 65,4%

Engagement and Voting €1,762,687 €3,275,930 36,3% 85,8%

Impact Investing €8,750 €20,269 52,2% 131,6%

EU Industry (EFAMA est.) €13,800,000 €16,800,000 21,7% Source: Eurosif.Note: EFAMA estimates of European professionally managed assets (AuM) cover 27 markets.

The Study also confirms that Exclusions remains the domi-nant strategy and has exhibited the strongest growth rate across conventional SRI strategies. Exclusions (beyond those required by law) represent about 41% (€7 trillion) of European total professionally-managed assets today. If one only considers voluntary exclusions related to investments into Cluster Munition and Anti-Personnel Landmines (CM & APL), this percentage is about 30% (€5 trillion). Yet, other types of Exclusions are almost as significant, covering about 23% (€4 trillion) of the overall European investment market. The strong continuous growth of Exclusions should not overshadow the growth of Norms-based screening (+70%), largely due to the French, Dutch and Swedish markets, and the significant growth of Engagement and voting (+86%) over the period.

The Study also shows significant progress of ESG integra-tion: all forms of integration practices have grown by 65% between 2011 and 2013, making this strategy one of the fast-est growing ones. Systematic and non-systematic integra-tion practices now cover an estimated 31% of the overall European investment market.

A key finding of the Study is that the European Impact invest-ing market, excludinvest-ing public and philanthropic grants and commitments, has grown to an estimated €20 billion mar-ket, with a 132% growth rate between 2011 and 2013. While this figure is certainly underestimated, it still is the fastest growing SRI strategy in Europe, now representing about one third Sustainability themed investments. The Netherlands and Switzerland are key players in this segment.

In terms of asset allocation, equities represented about half of the European SRI assets at the end of 2013, from 33% in late 2011. By contrast, the allocation to bonds fell sharply, from 51% in 2011 to 40% last year. Allocation to real estate and commodities recorded significant growth.

The most prevalent perceived market driver for the near future remains institutional demand. Institutional inves-tors continue to drive the market with an even higher mar-ket share than in 2011. However, the Study mentions several legislative developments in specific jurisdictions or at Euro-pean level that will also underpin future growth. Self-regula-tion and transparency will certainly also have a role to play to enable growth and preserve the credibility of the industry (See Focus 5).

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Financial crisis: due to the financial crisis, investors and investment managers are revisiting the basic assumptions: traditional financial analysis can no longer explain all sources of risk and return.

Sustainable Investing is Rapidly Gaining in Importance

UN PRI: The investor initiative ‘Principles for Responsible Investment’ (PRI) of the United Nations has accelerated the process: 16 of the 20 largest asset managers and a total of 1,260 asset managers and institutional investors with

an investment volume of 45 trillion U.S. dollars have signed the principles (as of

June 2014).

Performance: institutional investors, asset managers and private investors have recognised that environmental, social and governance (ESG) criteria can have a positive impact on the risk-return profile of their investments.

Social change: corporate social responsibility has become part of the social debate, particularly in the field of investments (e.g. board independence, executive bonus limits, exercising voting rights).

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Growth Drivers

Demand from Investors:

• Institutional Investors

• Retail

International Initiatives:

• United Nations Principles for Responsible Investing (UN-PRI)

• Carbon Disclosure Project (CDP), S&P Dow Jones Sustainability

Index (DJSI)

External Pressure:

• NGO’s, Media, Unions

Legislation:

• National pension system, Information disclosure

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Performance-oriented capital

investment

• 

Adding shareholder value

• 

Future-driven

• 

Best-in-class or industry

specific

• 

Integration of ESG criteria

Sustainable Investing: Evolution over Time

Values based capital

investment

• 

Ethical motivation

• 

Exclusion of defined

industries

• 

Focus on a narrow

selection of social and

environmental criteria

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Ethical, Value-based vs. Performance-based Investment

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Developments in Sustainable Investing

Socially Responsible Inves1ng (SRI) – norm based, posi1ve and nega1ve screening Ethical Inves1ng Environmental, Social and Governance Inves1ng (ESG)

– Best in class, integra1on Green Inves1ng

(GI) Ownership Ac1ve

Social Inves1ng Theme Inves1ng Impact Investment

Va

lu

es

Mission based Investment 11

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Where will the Money be Invested?

Socially Responsible Inves1ng (SRI) – norm based, posi1ve and nega1ve screening Ethical Inves1ng -‐ exclusions Environmental, Social and Governance Inves1ng (ESG)

– Best in class, integra1on Green Inves1ng (GI) Ac1ve Ownership Social Inves1ng Theme Inves1ng Impact Investment

Performance / Risk Focus

Va

lu

es

Mission based Investment 12

Source: Contrast Capital

ESG Integra1on (“mainstreaming”)

Limited Market Size – Satura;on and lack of investment opportuni;es

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1  Equity: Sustainability investing was initially developed as an equity style

approach. It has gain yet little traction in the private equity/venture capital space

2  Bonds: Becoming more widely accepted. Initially used for corporate debt.

Recently, sustainability approaches have been developed for government bonds

3  Property: Focus on impact of CO2 emissions and the potential social impact of

property developments. Relatively low number of funds

4  Commodities/Real assets: Carbon markets, forestry/timber and agriculture/

land. In particular, they are exploring the synergies between these asset classes and their interest in climate change

5  Cash: Some funds launched primarily in France. No acceptance yet (where are

the differences?)

Sustainability Investing Across Asset Classes

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Strategic Focus in Sustainability Investing - Equities

Beta

Alpha

Ethical Investing, Norm based screening Best in class Passive Investment Strategies Active Investment Strategies

Higher

Lower

_Complexity

Fo

cu

s

Negative Screening Active Ownership Positive

Screening ESG Integration

Positive Screening

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Sustainable Investing Developments in Corporate Bonds

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There has been a significant increase in demand for fixed income investors to show that they have a process to address risks and

opportunities related to ESG factors. In a previous PRI survey, over 800 pension funds, investment managers and other institutional investors claimed nearly 701

percent of their fixed income assets under management were invested subject to ESG considerations. But it still remains to be seen exactly how they use ESG analysis in practice and to what extent.

At present, there is little visibility on the investment industry’s responsible investment practices in this asset class. That’s something that the PRI is keen to change this year, with two new developments.

A New Era of Transparency for Fixed Income Investors

First, completion of our newly launched Reporting Framework is mandatory for any signatory that manages assets. The publicly available Framework includes a new module dedicated to understanding how institutional investors are practically integrating ESG factors in their credit analysis, valuation and portfolio allocation decisions, how they communicate this approach to their clients and other stakeholders, and how they measure the performance of these activities. These developments reflect signatory interest, as the Framework’s

redevelopment involved the largest consultation process in the PRI’s history.

Reporting on responsible investment activity is critical for fund managers. It allows their clients, whether they are pension funds, insurers or foundations, to get a better sense of their ability to measure and incorporate ESG factors, and promotes greater alignment of interests throughout the investment chain. Importantly, far from being “just another survey,” it has been designed to complement – rather than duplicate – other investment industry responsibility standards and codes such as the UK’s Stewardship Code.

Aside from transparency, the framework also delivers accountability and promotes ongoing learning among the PRI’s signatory base. By asking investors

to report on their responsible investment activities in fixed income and assessing those activities, the PRI hopes investors will aim to continuously improve their approach, in healthy competition with their peers, as part of an annual cycle of responsible investment implementation.

Structure and scope of the fixed income module

The new framework is made up of 12 modules shown in Figure 2. At the core is the organisational overview module which looks at an investor’s asset

allocation to different asset classes. If a signatory allocates more than 10 percent of assets under management to fixed income, they are eligible to respond to the indicators from the fixed income module. Based on this threshold, the PRI expects a little over one-third of signatories – i.e. some 400 investors – to complete the new module this year because they invest directly in this asset class.

FEBRUARY 2014

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www.responsible-investor.com

!

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the PRI hopes investors will aim to continuously improve their approach, in healthy competition with their peers, as part of an annual cycle of responsible investment implementation

”

Figure 1: The relationship between ESG factors, credit factors and measures of creditworthiness.

Source: PRI Corporate Fixed Income Working Group

ENVIRONMENTAL

■ Climate change

■ Biodiversity

■ Energy resources and management

■ Biocapacity and ecosystem quality

■ Air/water/physical pollution

■ Renewable and non-renewable natural resources

FACTORS INFLUENCING CORPORATE CREDITWORTHINESS

■ Profitability ■ Cost of capital

■ Employee productivity ■ Leverage

■ Competitive advantage

CREDIT RISK INDICATORS

■ Credit ratings ■ Bond yield

■ Breach of covenants ■ Default

■ Volatility ■ VCDS spreads SOCIAL ■ Employee relations ■ Human rights ■ Community/stakeholder relations ■ Product responsibility

■ Health and safety

■ Diversity

■ Consumer relations

■ Access to skilled labour

GOVERNANCE ■ Shareholder rights ■ Incentives structure ■ Audit practices ■ Board expertise ■ Independent directors ■ Transparency/disclosure ■ Financial policy ■ Business integrity ■ Transparency and accountability

“

investment managers and other institutional investors claimed nearly 70% of their fixed income assets under management were invested subject to ESG considerations

”

Source: Corporate Fixed Income Work Stream PRI

The rela1onship between ESG factors, credit factors and measures of

creditworthiness

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The Sustainable Investing Ecosystem

Source: SRI Connect, Contrast Capital 16

Investment & Finance Media

CSR/Sust Dev. Media

Asset Managers

Asset Owners Companies

Investment Consultants ESG Research

Pension

Consultants Managers Wealth Financial Advisors

Sell-‐side

brokers ESG Research Companies Financial news and data Independent

Research Coali1ons Investor

Industry Bodies Stock Exchanges Professional associa1ons Headhunters PR & Comm. consultants CSR Consultants IR Consultants Management Consultants Universi1es Governments Policy & Research Org. SRI Consultants NGOs Trade Unions Conference Organisers ESG/SRI Media

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Sustainable Investing Providers: Who does what?

Special providers (PAX World, SICM,

Inflection Point) Institutions with special funds (Blackrock, BCIMC) Integrated Approaches (Generation IM, APG)

ESG-Research Providers (Sustainalytics, MSCI ESG) Proxy Voting Services (ISS, Glass Lewis) Engagement Services (Hermes EOS, F&C, Robeco)

Asset Managers ESG Research, Independent Research, Sell side brokers SRI Investing Forums Euro SIF US SIF Investor Coalitions UN PRI CDP Index- Providers (S&P DJ, FTSE) Financial News and Data Bloomberg ESG Thomson Reuters – Asset 4 17

Sell Side Brokers (Cheuvreux, Citi Research, Oddo)

VBDO (Dutch SIF)

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• Positive selection / best in class: portfolios with a positive tilt towards

sustainable companies show a positive alpha versus traditional benchmarks. • Negative selection: portfolios which exclude ‘sin stocks’ show a negative alpha

versus a traditional benchmark (controversial companies can deliver above average stock performance: institutional investment restrictions, bad reputation and high litigation risks lead to lower demand and, therefore, lower price and higher earnings yield).

à  A positive selection of sustainable companies has great potential for alpha

creation. Performance-oriented investors choose this approach.

à  Exclusion criteria tend to neutralise the positive effect of positive selection.

For value-oriented investors the exclusion of questionable industries and business practices provides benefits that go beyond performance.

Results of Studies on Sustainability and Fund Performance

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And what about Sustainable Funds?

•  Studies on sustainable fund performance show mixed results.

•  A review of Derwall, Koedijk, Ter Horst resulted in 6 neutral and 1 negative outcome.

•  However, this review does not distinguish between different approaches to sustainability.

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Results depend on the Approach to Sustainability

ESG Screening (often meaning exclusion) leads to mixed results as:

• Exclusion of sin stocks hurts

performance.

• Overweight of sustainable companies

helps performance.

ESG Integration supports alpha

creation as it simply broadens the scope of financial analysis without the burden of formal restrictions.

Correlation of

sustainability approach and alpha

# of s tu di es

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Impact of Sustainability on Corporate Performance

Large meta-study on sustainability and corporate performance (62 studies and meta-studies)

The vast majority of studies confirmed: the more sustainable a company is,

– the lower the cost of capital

– the higher the profitability achieved

– the better its market performance

The results of sustainable investment funds, however, are mixed: not all funds can extract a positive alpha signal from their portfolio construction process (e.g. funds with exclusion criteria).

Correlation of

sustainability and corporate performance

Source: Fulton, Kahn, Sharples, Serafeim 2012 21

# of s tu di es

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Terminology I

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Ethical investing refers to the application of an individual/organisation code of ethics (or moral code) to the stocks that are in the portfolio

•  

Social & community investing, where capital is specifically directed to traditionally underserved individuals or communities, to businesses with a clear social or environmental purpose, or to revenue-generating

non-profits

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Mission based investments are investments made by foundations and other mission-based organizations to further their philanthropic goals

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Green Investments are traditional investment vehicles in which the underlying business(es) are somehow involved in operations aimed at improving the environment

•  

Impact investing refers to targeted investments, typically made in private markets and aimed at solving social or environmental problems

•  

Socially Responsible Investing (SRI) incorporate ESG issues as well as criteria linked to a values-based approach. It can involve the application of pre-determined social or environmental values to investment selection such as negative screening (weapons, tobacco, alcohol, etc. exclusions)

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Terminology II

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Norm-based screening refers to the exclusion of companies that are considered to have violated internationally accepted norms in areas such as human rights and labour standards

•  

Positive screening involves preferentially investing in companies or

sectors on the basis of criteria relating to their products, activities, policies or performance

•  

Active ownership involves investors using their formal rights (e.g. the ability to vote shareholdings) and informal influence (e.g. their ability to engage) to encourage companies to improve their management systems, their ESG performance or their reporting

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Best-in-class involves preferentially investing in companies with better governance and management processes and ESG performance.

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Integrated ESG analysis involves the proactive consideration of ESG factors in investment research and decision-making. This may involve considering these factors as part of top-down or bottom-up stock selection or in asset allocation

•  

Thematic investment involves selecting assets on the basis of investment

themes such as climate change or demographic change. ₂₃

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