November 2008 | 1
11 novembre 2008 Designator | author 1
New Generation SRI: Making financial sense of ESG
Stewart ArmerCIO of Sustainable and Responsible Investment
Fortis Investments
| November 2008 | 2
Overview
Perverse outcomes: The climate change case
Making financial sense of ESG:Introducing the time dimensionMapping the internalisation processCompany responseWho pays the price?Market mispricing of sustainability risk & opportunities
Back testing for perverse outcomes
5 key insights
November 2008 | 3
Perverse outcomes
Fortis Investments
| November 2008 | 4
Perverse outcomes – the climate change casePhase I – Polluters Profit
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janv.-05 mai-05 sept.-05 janv.-06 m ai-06 sept.-06 janv.-07 mai-07 sept.-07 janv.-08 mai-08 sept.-08
EU ETS Y07 EU ETS Y08
Fortis Investments
| November 2008 | 5
Perverse outcomes – the climate change casePolluters who should pay don’t pay
Fortis Investments
| November 2008 | 6
Global Perverse outcomes – the climate change caseFood for biofuels (feedstock price evolution)
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is In
vest
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els
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FIM B IOF UEL IND EX C BOT C om m o dity In d ex
Sources: Bloomberg,Fortis Investments, période 01/01/2004 – 18/08/2008
Fortis Investments
| November 2008 | 7
Perverse outcomesSRI indexes: poor performance and exposure to CC
Dow Jones Sustainability Index / Focus on the Utilities sector
10 companies retained in DJSI Stoxx / Utilities– Centrica, E.ON, Endesa, Iberdrola, National
Grid, RWE, SVT, Union Fenosa, United Utilities, Veolia Environnement
27 companies in MSCI Europe Utilities Sector
10 companies retained in the DJSI Stoxx represent 50% of the direct GHG emissions of the MSCI Europe Utilities
DJSI Stoxx Utilities: 542 t.CO2/yMSCI Europe Utilities Sector: 1089 t. CO2/y
Average cost of CO2 emissions is higher in the DJSI compared to MSCI Europe Utilities Sector
DJSI Stoxx: EUR 1347 mn / co.MSCI Europe Utilities Sector: EUR 1043 mn / co.
November 2008 | 8
Integrating sustainability issues into finance
Fortis Investments
| November 2008 | 9
Integrating sustainability issues into finance From exclusion to integration
Exclusion Best-in-class Integration
Satisfy ethical clients
Avoid involvement in controversial activities
Not able to catch sustainability trends
Negative impact on expected return and on risk
Focus on reputation and risk
Practice driven concept
Cannot capture transition, change and technological innovations
Relatively small impact on risk (sector neutral) and return
Focus on sustainability drivers
Product driven concept
Able to capture transition, change and technological switch
Positive impact of risk/return profiles (diversification, exposure to new businesses)
Fortis Investments
| November 2008 | 10
ESGNot an investment framework
Environment:
Greenhouse Gases
Waste
Water Abstraction & Scarcity
Natural Resources Depletion
Polluting Emissions
Biodiversity
…
Social
Human Rights
Food Crisis
Toxicity
Health & Safety
Obesity
Nanotechnologies
…
Governance
Independence and Effectiveness of Board
Shareholder Rights
Compensation of Board Members
Audit Independence
Bribery & Corruption
…
Fortis Investments
| November 2008 | 11
Introducing the time dimension
Sources: Fortis Investments
Sustainability IssuesEMERGING MOMENTUM ESTABLISHED
Fortis Sustainability Radar™
Legislation in place
Voluntary Codes
Calls for tighter
legislation
Growing Political/ Media
Attention
Strong Scientific EvidenceSome
Scientific Evidence
Fortis Investments
| November 2008 | 12
Issue development
Sources: Fortis Investments
Sustainability IssuesEMERGING MOMENTUM ESTABLISHED
Fortis Sustainability Radar™
Gre
enho
use
Gas
es (E
)
Ele
ctro
Mag
netic
Fie
lds
(S)
Wat
er A
bst
ract
ion
(E)
Asb
esto
s (S
)
Nan
ote
chno
log
y (S
)
Lab
our
Rig
hts,
Hea
lth &
Saf
ety
(S)
Aud
it In
dep
end
ence
(G)
Fo
od
Cri
sis
(S)
Was
te (E
)
Ob
esity
(S)
Fortis Investments
| November 2008 | 13
The transition to sustainability
Sources: Fortis Investments
Fortis Sustainability Radar™
SUBSIDIES
Eg: Capital subsidies, grants or rebates, Feed-in tariff
FISCAL INCENTIVES
Eg: Tax credit, sales tax, energy tax, VAT reduction
PROCUREMENT DECISIONS
Eg: Public investment, loans, or financing, bidding
MANDATORY TARGETS
Eg:Tradable certificates
INCENTIVES
PENALTIES
CONSUMER CHOICE
MANDATORY STANDARDS
Time & political implication
Fortis Investments
| November 2008 | 14
How do companies respond?
Sources: Fortis Investments
PRODUCTSTRATEGIC
WORSTPRACTICES
BESTPRACTICES
Business Response
Fortis Sustainability Radar™
Companies who achieve competitive advantage through
better practices
Companies with a defensive or minimalist approach
Companies with products or services that solve the problem
Fortis Investments
| November 2008 | 15
How do companies respond?
Sources: Fortis Investments
PRODUCTSTRATEGIC
WORSTPRACTICES
BESTPRACTICES
Business Response
Fortis Sustainability Radar™
Companies who achieve competitive advantage through
better practices
Companies with a defensive or minimalist approach
Companies with products or services that solve the problem
Big-Cap Companies strategically transitioning to more sustainable
model
Fortis Investments
| November 2008 | 16
Investment Insight:Carbon redistribution / Who internalizes?
Sources: Fortis Investments
PRODUCT SUBSTITUTION
Potential replacement of existing products by less carbon-intensive products
BARRIERS TO ENTRY
Competitive situation on the current marketInvestments required by carbon constraint
PRICING / PURCHASING POWER
Capacity to pass carbon costs through to consumers/suppliers
CARBON EXPOSURE
ProductProduction process
KEY QUESTIONS
Fortis Investments
| November 2008 | 17
Sustainability insight:The right technological path (avoiding blind alleys)
Sources: Fortis Investments
PRODUCTSTRATEGIC
WORSTPRACTICES
BESTPRACTICES
Business Response
Sustainability IssuesEMERGING MOMENTUM ESTABLISHED
INVESTMENTOPPORTUNITY ZONE
Fortis Sustainability Radar™
Sustainable investor “backcasts” from future
Conventional investorConventional investor““forecastsforecasts”” from presentfrom present
Example: IKEA
Fortis Investments
| November 2008 | 18
Investment insightMarket mispricing of sustainability risks/opportunities
Sources: Fortis Investments
PARAMETERS ARE NOT CLEAR –
TOO EARLY
PRODUCTSTRATEGIC
WORSTPRACTICES
BESTPRACTICES
Business Response
Sustainability IssuesEMERGING MOMENTUM ESTABLISHED
PARAMETERS ARE VERY CLEAR –
TOO LATE
SustainableWinners
UnsustainableLosers
INVESTMENTOPPORTUNITY ZONE
Fortis Sustainability Radar™
Fortis Investments
| November 2008 | 19
Back-testing for perverse outcomesPhase I – polluters profit
Investors need to focus on what policy makers “really” want
0.0 €
5.0 €
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15.0 €
20.0 €
25.0 €
30.0 €
35.0 €
janv.-05 mai-05 sept.-05 janv.-06 mai-06 sept.-06 janv.-07 mai-07 sept.-07 janv.-08 mai-08 sept.-08
EU ETS Y07 EU ETS Y08
Fortis Investments
| November 2008 | 20
Back-testing for perverse outcomesPolluters who should pay don’t pay
Investors need to ask “who
internalises”
PRODUCT SUBSTITUTION
Potential replacement of existing products by less carbon-intensive products
BARRIERS TO ENTRY
Competitive situation on the current marketInvestments required by carbon constraint
PRICING / PURCHASING POWER
Capacity to pass carbon costs through to consumers/suppliers
CARBON EXPOSURE
ProductProduction process
KEY QUESTIONS
Fortis Investments
| November 2008 | 21
Back-testing for perverse outcomesFood for biofuels
Investors need to “backcast”
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is In
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FIM BIOFUEL INDEX CBOT Commodity Index
Fortis Investments
| November 2008 | 22
Back-testing for perverse outcomesTraditional SRI frameworks are carbon intensive
SRI frameworks need to fully integrate the clean
tech opportunity
Fortis Investments
| November 2008 | 23
5 Key Insights
Polluters will not always pay – investors need to know who are the winners and losersESG factors are not by themselves a sustainability or investment frameworkTraditional SRI indexes are carbon intensivePerverse outcomes likely until sustainability built into policy making - the “time dimension”
is criticalInvestors need to capture the clean-tech opportunity
A strategic sustainability-based approach helps us avoid technological “blind alleys”and avoid “perverse outcomes”!
Fortis Investments
| November 2008 | 24
Mapping the SRI Market
TRADITIONALBEST-IN-CLASS
(Non-integrated approach creates trade-off between strength of financial and
sustainability process).
RISK FOCUS
ENVIRONMENTALTHEMATIC
(no sustainability screening)
OPPORTUNITY FOCUS
ETHICALEXCLUSIONS
(Non-integrated approach, lack of sustainable product dimension removes
alpha drivers)
RISK FOCUS
STRONG
WEAK STRONGSustainability Process
FinancialProcess
INTEGRATED“NEW GENERATION” SRI
(Sustainability and financial analysis integrated in one strong, coherent process)
RISK and OPPORTUNITY FOCUS
Fortis Investments
| November 2008 | 25
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