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Sustainable Investing

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Presentation on theme: "Sustainable Investing"— Presentation transcript:

1 Sustainable Investing
Finance and Sustainability The Financial Case Empirical Studies Live & Model Investment Portfolios Financial Analysis Incorporating Sustainability Case Studies Logical Connection to Known Value Drivers Socially Responsible vs. Sustainability Investing Sustainable Investing November 28, 2001

2 What’s here & what’s not
How do you think about the financial case for corporate sustainability? What are Wall Street investors are up to in this area? Not here Other sections deal with how to work with internal financial people and investors Red hot investment advice

3 Finance & Sustainability
Systems perspective Capital & related financial services play crucial roles: Investment: capital formation for growth, compensation Insurance: risk underwriting let’s firms reduce the risk they face directly Lending: capital formation The business world can be seen as it’s own ecosystem with financial services playing specific roles that enable operating companies to either thrive or fail. Different financial functions play different roles and have different connections to the corporate sustainability agenda. All too often, people in operating companies think of financial functions as being separate from what they do or even a whole separate system.

4 Forces for Change Physical Forces population climate H20 soils
megacities etc. Magnifiers connectivity transparency social action CNN World victory of markets etc. Operating Environment for Companies > expectations accountability disclosure target for action Analysis by Investors new risks unfamiliar actors connection to society is key odd partners & opportunities. While more complicated than the simple line suggests, the Forces for Change can be understood as a process that begins with physical forces which are magnified by societal trends to create a new and different operating environment for companies. The changes in operating environment are reinforced as investors note the changes and adapt their investment decision-making process to take them into account.

5 Forces for Change and Finance
For financial service companies: Lenders & Insurers: no upside, so risk management at operating company is crucial. Understanding changes affects pricing (interest rates & premiums) Investors: face upside and downside for companies’ performance as well as how they behave when combined in a portfolio Intermediaries: face upside and downside for companies’ performance during transactions These forces rock the world of operating companies. Therefore, they change the operating environment for financial services companies too. Different types of financial services companies have different interests in these changes. If specific clients of lenders and insurers are disadvantaged by the forces of change, those financial services firms face a downside of greater risk for which they did not already charge. If, however, a specific client is advantaged by the changes, insurers and lenders have limited ability to capture that upside potential. Investors on the other hand, face both the upside and downside in the performance of the companies in which they invest. Investors also face the potential of uncompensated risks within their portfolios if they are over-weighted towards companies disadvantaged by the forces of change and they do not know they have this concentrated risk. Intermediaries face both the upside and downside, but typically for short periods of time.

6 Sustainability and Finance
Overview Sustainability and Finance The cases for connection & how they “fit” Socially Responsible Investing (SRI) Mainstream financial institutions System change Getting CFOs to “Get It” Making the business case Creating value and communicating Targeting the right investors This section of Pathways deals with Sustainability and Finance, SRI, the involvement of mainstream financial institutions and how the overall financial system might evolve. There is a related section of Pathways called “Getting CFOs to ‘Get It’” that addresses the financial aspects of corporate sustainability from the perspective of operating companies. [I assume that this would all be done so that the reader could click and go directly to these sections.]

7 Sustainability – Finance Connection
The Case comes from: Empirical Studies Live & Model Investment Portfolios Financial Analysis Incorporating Sustainability Case Studies Logical Connection to Known Value Drivers A preponderance of evidence exists that social and environmental strategies can build shareholder value. These are the major categories that make up the business case that there is value in these strategies.

8 Empirical Studies Most studies conclude there is a positive relationship between financial and sustainability performance Problems with statistical approaches: Lack of data (i.e., What to really measure?) Causation vs. correlation Coincidence Even if it were true, so what? “It doesn’t say anything about my company.” Of 95 studies of the relationship of social and environmental performance to financial performance, three-quarters showed a positive relationship. Even if the empirical work were less ambiguous and had clearer data inputs, it is not certain that many would invest differently anyway. See,, sarasin site, For more on these empirical studies, see the following websites: and However, studies lack of consistent and comparable data for measuring the social and/or environmental performance of companies. Although there’s interesting work, not clear that much of this research isn’t merely measuring noise and not a clear measure of social and/or environmental performance.

9 Investment Portfolios
Asset managers using “best-in-class” on environmental and/or sustainability criteria overall have outperformed their benchmarks regardless of: Active versus passive (index) Large or small companies US or global focus The following 5 slides show this for different sustainability investment products using different investment approaches. None of these funds have been around a very long period of time. This makes it difficult to determine whether or not their out-performance relative to their benchmark is the result of the power of the sustainability insight or whether it is pure chance. The fact that all of them outperform the benchmark reduces the odds that it is purely a matter of chance. Evaluating investment performance is always tricky business. Most important are the selection of the right benchmark and the relevant period. For purposes here, it is important to note that most actively managed funds of all kinds fail to outperform their benchmarks over time.

10 Dow Jones Sustainability Index (DJSI) Performance 1994 - 12/31/00
Passively Managed Gobal Large Cap Dow Jones Sustainability Index (DJSI) Performance /31/00 Total Return

11 DJSI Performance 1994 - 12/31/00 by Region
Passively Managed Global Large Cap DJSI Performance /31/00 by Region Total Return The performance is not uniform across regions.

12 Actively Managed Global All Cap: Sustainable Performance Group
Market capitalization CHF 400 mio. Performance 1999: 36% Performance 2000: 17% 62.5% 32.2%

13 Actively Managed Global Small Cap
SAM Sustainability Pioneer Fund Performance: November, – January 31, 2000 46.2% 16.6%

14 Passively Managed US Large Cap: Weighted to Environmental Leaders

15 Model Portfolios Innovest eco-efficiency premium
Top and bottom rated companies return 12/27 1/10 1/24 2/7 2/21 3/7 3/21 4/4 4/18 5/2 5/16 5/30 6/13 6/27 7/11 7/25 8/8 8/22 9/5 9/19 10/3 10/17 10/31 11/14 11/28 12/12 12/26 Total return for the top rated companies was 17.0 percent higher than for the bottom rated companies, for 1998.

16 Detailed Financial Analysis
The next big horizon Best way to demonstrate that environmental and social issues can be “material” in specific industries and at specific companies Can integrate analysis of sustainability issues with analysis of other financial issues Few examples beyond WRI’s Pure Profit “Proves” business case only in specific instances, but shows the way for main-stream analysts Is based on understanding causal relationships, not correlation Although there are only a few examples of detailed financial analysis of sustainability issues in particular industries and about specific companies, this one of the most promising approaches for investors. Most importantly, this detailed financial analysis fits well with existing techniques of securities analysis, enabling mainstream investors to incorporate sustainability considerations into their existing analysis. The following slides describe the approach to detail financial analysis of environmental issues used in WRI’s publication Pure Profit.

17 Financial Analysis: WRI Methodology
It is forward-looking and uses scenarios to envisage different futures It can readily be integrated into conventional valuation techniques

18 Financial Analysis: The Four Steps
PHASE 1 Identify salient impending environmental issues PHASE 2 Develop scenarios around each PHASE 3 Assess individual company exposures PHASE 4 Analyze financial implications of each scenario

19 Expected Financial Impact (as %age of market value)
Financial exposure of major pulp and paper companies to pending environmental issues Expected Financial Impact (as %age of market value) Each point is the expected positive or negative impact on share price from the pending environmental issues for each company. For example, Company M has an expected positive impact on share price of approximately 3% while the figure for Company F is a negative 10% of share price. The vertical bars represent the range of uncertainty about the estimates. For example, the scale of the expected negative impact at Company A is much more certain than at Company K even though the estimated points are fairly close. This scale of uncertainty is very important in financial projections where investors are willing to pay more for greater certainty.

20 Anecdotes of financial experience of companies
Case Studies Anecdotes of financial experience of companies Same old [tired] examples: 3M Interface Electrolux Often not rigorous, but do bring some of the potential to light It is not clear how much anecdotes matter; they don’t appear to move other people or organizations Sources for these: Aspen Institute paper GEMI papers

21 Connection to Known Drivers
Standardized shareholder value Ecos Corporation screens for strategies that: Improve margins Reduce risks Increase revenues Increase capital efficiency Doesn’t “prove” business case; “proves” that the right sustainability strategies can produce value There is a standardized theory of what increases shareholder value. It is generally accepted although an imperfect means of anticipating how markets will value particular companies. Figge and Schaltegger go from this basic theory and show how different sustainability strategies would theoretically increase shareholder value.

22 The Overall Business Case
Empirical Evidence Preponderance of evidence Different methods Different data, time periods, analytical techniques Doesn’t mean “be sustainable and financial success will follow” A measure of good management Does mean that value is at stake: companies create or destroy value on sustainability issues The empirical business case for corporate sustainability includes research in the following categories: event studies regression studies model portfolios

23 So Who Understands the Value of Sustainability?
Lenders understand environmental liability associated with properties & big issues, but most US lenders don’t see additional risks to their repayment based on sustainability performance Insurers understand the connection to liabilities, but are insulated from many ongoing risks by contractual provisions Reinsurance industry is beginning to understand climate change Investors Socially responsible investors get it Mainstream showing hopeful signs but no more The CFOs of leading companies get the operating issues, but have yet to apply the same to their role as investor in other companies both directly and through their pension funds

24 Investors on Sustainability
Moving toward “best-in-class” and understanding the business case Socially Responsible Investing (SRI) Most still just screen out undesirable industries & companies Some apply positive screens for good performers Sustainable Investors Use “best-in-class” rather than negative screens Short track records, but interesting results Sustainability as investment insight Mainstream Long-term value investors are place to start How investors apply an understanding of corporate sustainability is undergoing a transition. Socially responsible investors in the US have typically emphasized screening out “undesirable” industries and “bad actors” in other industries, while engaging in shareholder activism as an extension of the activist community. While this is large still the case, several leading SRIs in the US are offering products that emphasize a “best-in-class” approach. Most casual observers don’t distinguish among the different types of investors who apply an understanding of corporate sustainability to their practice. We think it is useful to not that there is a relatively new breed of “sustainable investors” who apply and understanding of corporate sustainability as an investment insight rather than as a matter of morale right and wrong. These sustainable investors tend to use “best-in-class” techniques to identify which companies are well prepared for the Forces of Change and which are not. Most mainstream investors have kept a safe distance from corporate sustainability. Several large financial services firms have developed and offered SRI or sustainable investment products. It is not clear how fart the analytical techniques have crossed over from these practices to their mainstream colleagues.

25 Socially Responsble vs. Sustainable Investors
SRI Avoid companies whose industry or practices offend Impact: raise cost of capital shareholder action Sustainable Investing Select “best-in-class” Not “good & bad”, but best prepared for Forces of Change Impact: Create competition on sustainability performance Different value propositions to investors: SRI – earn good risk adjusted returns without being associated with companies with which you don’t want to be associated because of their industry or practices Sustainable Investing – earn good risk adjusted returns by applying an understanding of how Different expected impact, or how does this change the world?: SRI – fewer investors in screened out companies mean less demand for their stock and a higher costs of capital. Shareholder activism is a separate vector for influence that depends upon the success of the activism. Sustainable Investing – the “best-in-class” decision tool common to this approach to investing often promotes competition within an industry for which company has the best sustainability performance.

26 Socially Responsible/Sustainable Investors
Significant and growing part of capital markets in US, Europe, Japan & Australia Reliable US estimate is $100B in US SRI mutual funds plus perhaps a slightly larger amount in private accounts Estimates of trillions in SRI in US are based on counting all the assets of investors who employ at least one of the tools of SRI in their investment decision-making. Many investors, for example, have a policy of screening out tobacco stocks. They do not advertise their practice as being SRI. $100B figure is from fund tracker Wiesenberger, a division of Thomson Financial done for Pax World Funds.

27 The Record of Socially Responsible Investment
Morningstar: 21% of SRI funds in Morningstar database have 5-star ratings—twice the rate of the overall fund universe. SRI funds look even better when compared to their specific Morningstar categories. ¼ have 5 stars; half have ratings of 4 or 5 stars. SRI funds have top category ratings in seven different categories. “That doesn’t mean social screens add value, but it’s hard to make the case that they subtract it.” (source: Calvert Funds Presentation)

28 Mainstream Investors Main game in town
Some using “best-in-class” approach CitiAsset Mgmt UBS Credit Suisse Storebrand Friends, Ivory applies sustainability engagement across whole portfolio Hermes Investment Management: portfolio companies should report on “social, environmental & ethical matters” The overwhelming majority of assets under management in the US and elsewhere are not subject to SRI criteria. Some leading mainstream asset managers also offer products that use the “best-in-class” approach. They may be the most likely instances of the practice crossing over to the mainstream. One leading UK asset manager with both SRI and mainstream assets under management is Friends, Ivory, which has recently adopted a portfolio-wide strategy to identify and engage companies with the potential to improve financial performance through corporate sustainability. Hermes guidance to portfolio companies includes disclosure about the social, environmental and ethical matters affecting the company’s short and long term value, how these risks are being managed, and how the board gets information about these issues.

29 The Value–Sustainability Connection
The System Conditions to Drive Change Rules of the game consistently make doing the right thing economical Companies articulate how they are creating value through sustainability Investors have suitable means to incorporate sustainability into existing analysis Sustainability contributes to investment outperformance Becomes part of investors’ fiduciary duty

30 World Resources Institute
Pathways World Resources Institute We gratefully acknowledge the financial support of: The Surdna, Joyce and Olin Foundations & WRI’s Corporate Council and Partners And the support and contributions of the talented staff of WRI’s Sustainable Enterprise Program

31 Terms of Use Pathways is provided to help foster environmentally sound and socially equitable economic development. We request your compliance with the following terms of use: All materials contained in Pathways modules are believed to be property of World Resources Institute or to be in the public domain. The opinions and analysis contained herein is that of the authors and editors. Original sources are credited on the slides or in the notes to the best of our knowledge; please bring errors or omission of citation to our immediate attention. Please credit original materials to World Resources Institute. Materials may be copied and edited and revised for internal company use and for non-commercial, educational purposes. For commercial or other use of materials, please contact Don S. Doering at or (202)

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