Sustainable Investment: Opportunities for Mainstream Investors CFA Ireland

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Sustainable Investment Opportunities for
Mainstream InvestorsCFA Ireland

• Steven A. Falci, CFA
• Vice President-Sustainable Investment
• KBC Asset Management Ltd.
• January 21st 2009

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Evolution of SRI
Terms Mercer Emphasis Broad Vehicles
Primary Market Focus Examples
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SRI ? Sustainable Investment
1st Generation SRI
Sustainable investing
Criteria Focus ESG / Investment
Process Time Orientation
Ethical
Materiality
Exclusionary
Inclusionary
Separate
Integrated
Historical
Future
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Global Market Size

• Hard to precisely define But various Indicators
  point to a Large and Growing Market
• Eurosif 5 trillion
• European Social Investment Forum
• Begin to distinguish approaches (Core and Broad)
• UNPRI 14 trillion
• 380 Asset Owners and Asset Managers
• Assert intention to integrate Environmental,
  Social and Governance Factors into investment
  process

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Global Growth SRI
Source Eurosif
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Sustainable Investment Strategies

• Thematic Strategies
• Investment opportunities in companies providing
  solutions to our most pressing global challenges
• Renewable Energy, Water, Climate Change
• ESG Integration
• Material risks and opportunities related to
  Environmental, Social and Governance factors are
  an integral part of investment analysis
• Companies with strong sustainability and
  financial profiles

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Global Mega Trends
Innovation to meet challenges to our environment
are driven by 3 Global Mega Trends.

• Worlds changing demographic profile
• The combination of population growth,
  industrialization, economic growth and
  urbanization will continue to test the limits of
  our ecosystem and will require investment in
  innovation and infrastructure in the developed
  and developing world to meet the needs of
  growing, more affluent global population.
• Natural resource supply/demand imbalance
• A growing, more affluent global population has
  and will continue to put increasing pressure on
  the supply of natural resources. Meeting the
  needs for energy, water and food is a major
  challenge of the 21st century.
• Climate change -and operating in a carbon
  constrained world
• Sustained pressure for lower carbon economies
  continue to gain momentum through efforts to
  mitigate and adapt too combat the effects of
  climate change. The growing demand for energy
  will need to be met through less reliance on the
  historically dominant carbon emitting sources of
  oil and coal and with more reliance on renewable
  alternative energy and energy efficiency.

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Alternative Energy Investment Thesis

• Global Energy Demand Population
  Industrialization
• Limited Supply of Fossil Fuel Energy
• Falling Costs of Renewable Energy Technology
  Investment
• Security of Fuel Supply Local Source Necessary
• Climate Change Political Regulatory Support

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Renewables as of Energy Mix
International Energy Agency 30 of all energy
related Investments in next 30 years will be in
renewables

• Renewable Energy

• Wind
• Solar Biofuels
• Fuel Cells Waste to Energy

Renewable electricity capacity, share of 2005
electricity production
Source Renewables Global Status Report 2006
Update, REN 21
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Falling Costs of Renewables
Source United Nations Economic and Social Council
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Alternative Energy Portfolio Summary
Source KBCAM Data as at 31.12.08.
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Water Investment Thesis

• Demand Population growth / Demographics
• Supply problems Availability, Infrastructure
  Pollution
• Regulatory Drivers
• Technological Advancements

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1 of Water Useable
Less than 1 of all water is available for human
consumption
There is no substitute for water thats why it
is rapidly becoming such a valuable resource.
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Water and Population Growth Chart
Standard of Living
Population Growth
Economic Growth
Sources US Census Bureau / German Ministry of
Environment
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Population/Water Divergence
Asia has 36 of the worlds water supply and 60
of the population
Source UNESCO
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Investment Required
Source Boenning Scattergood
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Water Portfolio Summary
Source KBCAM, Data as at 31.12.08.
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Climate Change Investment Thesis

• Growing Population, Industrialization and
  Urbanization has led to increased carbon
  emissions.
• Immediate action required to mitigate long term
  human, environmental and economic costs
• Demand for Cleaner Energy, Energy Efficiency
  Waste Management
• Technological Advancements
• Political, Regulatory Popular Support

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Regulatory and Policy Initiatives continue to
support increasing investment
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Energy Efficiency Multiplier Effect
Fuel Coal
Power Plant
65 Loss
10 Loss
Transmission Lines
Every 1 unit of energy saved at home or business
represents up to 4 units saved at the power plant
Source Sustainable Energy, Choosing Among
Options (Tester, Drake, Driscoll, Golay, Peters),
UBS Research
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2/3 of Projected Co2 emission savings to come
from energy efficiency
Source International Energy Agency
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Climate Change Portfolio Summary
Source KBCAM. Data as at 31.12.08.
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ESG Integration
Environment
Social
GHG Emissions Eco Efficiency Environmental
Management Systems Environmental
Products Environmental Liability Water Consumption
Human Capital Practices Health and Safety
Issues Consumer Markets Labor Markets
Supply Chain Management Human Rights

• Costs and Revenues
• Cost of Capital
• Balance Sheet Risk
• Brand and Reputation Risk
• Competitive Advantage
• Valuation

Governance

• Executive Comp Tied to Performance
• Board Structure and Accountability
• Transparency

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ESG Integration Opportunities and Challenges

• Opportunities
• Capture sources of Intangible Value
• Approximately 80 of market value driven by
  intangibles - Prof Baruch Lev, NYU Stern
  School of Business
• Opportunities and Risks
• Underpriced in market place
• Challenges
• Assessing materiality over time
• Assessing materiality across industries / sectors
  / regions
• Quantification and measurement

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Goldman Sachs Sustain - Integrated Process
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GS Sustain ESG Weightings
Management Quality (ESG)
Social
Source Goldman Sachs Research
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Relative Carbon Exposure
Source CFA Magazine / Sept-Oct 2008
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Innovest Sustainability Matrix
10 9 8 7 6 5 4 3 2 1 0
Performance of Company
0 1 2 3 4
5 6 7 8 9
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Alpha Intensity of Sub-Factor
Source Innovest Strategic Value Advisors
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Proposed DCF framework for integration of ESG
Factors
Exposure to ESG issues
Strategy, policies, management systems
Transmission Factors
Financial value drivers
Valuation components

Risk premiums
WACC
Costs
Shareholder value
Revenues
Free cash flows
Others (tax, reinvestment rates)
Source Expanding the Investment Frontier The
Conference Board
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ESG Ratings Development

• Materiality of ESG Factor for Sector
• Comparative Ranking
• Support Wide Array of Implementation Options
• Top Quintile ESG Top Quintile
• ESG Tilt
• ESG Beta
• Hybrid Strategies Quant / Fundamental Blend

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Performance Studies Definitional Challenges

• SRI vs Sustainable Investment
• Risk characteristics in individual strategies
• Time period, market conditions, geographic
  markets
• Performance impact of specific ESG factors

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SRI vs Sustainable Investment

• Cary Krosinsky The Rise of Sustainable Investing
  in Sustainable Investing the Art of Long Term
  Investing 2008
• Time Period 2002-2007
• 135 mutual funds
• Meir Statman The Wages of Social Responsibility
  December 2008 Time Period 1992-2007
• KLD Research Scores
• Tilt toward stocks with positive SRI scores
  Positive Return Impact
• Exclusionary practices detracted from returns

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Performance Reviews

• Demystifying Responsible Investment Performance
• 2007 UNEP-FI Asset Management Working Group /
  Mercer Consulting
• Compilation of 20 Academic Studies and 10 Broker
  Research
• 13 positive
• 10 neutral
• 4 neutral / positive or neutral / negative
• 3 negative
• Lloyd Kurtz-Answers to Four Questions
• SRI Performance and Risk
• Positive ESG Alpha
• Environment 13 studies
• Governance 7 studies
• Employment Practice 6 studies

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Studies on ESG Factors

• Environment
• Derwall, Guenster, Baver, Koedijk The
  Eco-Efficiency Premium Puzzle 2005
• Gluck and Becker Can Environmental Factors
  Improve Stock Selection 2004
• Social
• Edmans Does the Stock Market Fully Value
  Intangibles? Employee Satisfaction and Equity
  Prices 2008
• Governance
• Gompers, Ishii, Metrick Corporate Governance and
  Equity Prices 2003

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Conclusion

• As with all active management what matters most
• Rigorous Investment Process
• Unique Insights
• Innovation
• Vision

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Reading - Sustainability, Investing and Business

• Matthew Kiernan Investing in a Sustainable World
  (2008)
• Cary Krosinsky and Nick Robbins, eds. Sustainable
  Investing The Art of Long Term Performance
  (2008)
• Thomas Friedman Hot Flat and Crowded (2008)
• Holiday, Schmidheiny, Watts Walking the Talk The
  Business Case for Sustainable Development (2002)
• Mark Epstein, Making Sustainability Work (2008)