TRENDS IN ESG INVESTING

Benjamin Colton, Head of APAC, Asset Stewardship, State Street Global Advisors (Japan) Co., Ltd.

Transcript

1. State Street Global Advisors Trends in ESG Investing S&P Dow Jones Indices 11th Japan ETF Conference Benjamin Colton 3 April 2019 1
2. Agenda: Five Trends Shaping the ESG Investing Landscape in 2019 2 1. Investors are moving from purely exclusionary to ESG integrated strategies 3. Increasing demand to understand ESG performance of the portfolio will drive the need for enhanced reporting 2. ESG investment strategies will be powered by multiple sources of data 4. Climate solutions will evolve to include adaptation alongside mitigation 5. Mainstreaming of ESG will drive investments in talent and infrastructure
3. ESG Investing is Growing Rapidly 25% ESG AUM Sustainable Investing represents > ¼ of all professionally managed global assets. 17% Integration is Accelerating Portfolio integration is growing rapidly. 2X ESG Fund Launches Double The number of funds created in 2017 was twice that of 2014. 73% ESG is Growing Assets grew dramatically from 2012 to 2016. 3 1. McKinsey, ”From ‘why’ to ‘why not’: Sustainable investing as the new normal”, October 2017 2. Global Sustainable Investment Alliance. Reviews for 2014, 2016 3. Bloomberg, Global ESG 2018 Mid-year Outlook, June 2018
4. Academic Evidence Recent aggregated academic evidence is largely supportive of the ESG investment thesis 4 90% of studies on cost capital show that high ESG scores lowers cost of capital Cost of Capital Operating Performance 80%of studies show positive correlation between high ESG and superior stock performance Stock Prices 88%of studies show that strong ESG performance yields better operating performance of firms (e.g., ROA, Tobin’s Q) “We find that firms with strong ratings on material sustainability issues have better future performance than firms with inferior ratings on the same issues.” “Corporate Sustainability: First Evidence on Materiality” Khan, Serafeim, Yoon (2016) Source: From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance, March 2015, University of Oxford and Arabesque Partners. Retrieved 20 January 2016. The authors reviewed 29 cost of capital studies, 51 operating performance studies, and 41 stock price studies, respectively. Past performance is not a guarantee of future results. For illustrative purposes only and not intended as investment advice.
5. Understanding ESG Investment Styles 5 Exclusions Common Objectives Exclusions Inclusions Add Exposures Community investing Gender diversity investing Low carbon investing Exclusions Exclusionary Screening Excludes companies, sectors or countries involved in activities that do not align with global standards or investors’ moral values Align portfolios with moral and ethical values Mitigate ESG risks Influence companies to change business models or stop certain practices Positive Screening Tilts portfolio toward: • Best companies on ESG; companies with strong ESG momentum • Companies solving specific ESG Themes Impact Investing Targets a measurable positive social and/or environmental impact. Investments are generally project specific. Mitigate ESG risks Achieve higher returns Support business models solving sustainability issues Improve or maximize a portfolio’s ESG score` Mitigate ESG Risks Achieve higher returns Generate and measure specific social and/or environmental benefits that aligns with purpose Introduces tracking error and potentially impacts performance Securities selection is based predominantly on ESG scores/ratings — sourcing quality ESG can be a challenge Investments may be illiquid and investment returns could aim to be below or at/above the market rate Sourcing quality ESG data. Securities selection is based on quantitative and qualitative assessment of ESG factors, requiring analyst expertise. Long-term mindset is necessary. Influence company strategy for long-term value creation Help management capture value and reduce risk Enhance ESG disclosure and practices A significant ownership stake is needed to exert influence. Resource intensive. Active ownership is crucial for index strategies. Investment Considerations Source: SSGA, “Understanding & Comparing ESG Terminology: A Practical Framework for Identifying the ESG Strategy That is Right for You”, September 2017 Active Ownership/ Stewardship Voting company shares and engaging with companies on a variety of ESG issues to effect changes in behavior or company practices and policies ESG Integration Incorporates ESG data, alongside traditional financial analysis, into the securities selection process 5
6. ESG Data Landscape 6 Sustainalytics MSCI RobecoSAM Bloomberg Sustainalytics 1.0 0.53 0.76 0.66 MSCI 1.0 0.48 0.47 RobecoSAM 1.0 0.68 Bloomberg 1.0 • Governments do not formally require companies to report on material ESG data • Companies need to determine for themselves which ESG factors are “material” and what information should be disclosed to capital markets • Asset Owners and Managers need this data to help properly allocate capital to companies creating long- term sustainable value ESG Scores Are Different Across Providers (Cross Sectional Correlation for Constituents of the MSCI World Index, June 30, 2017) Source: “A Blueprint for Integrating ESG into Equity Portfolios”, Journal of Investment Management, Bender, Bridges, He, Lester, and Sun • Data Providers, driven by their own ESG views, have different sourcing methods, scoring methodologies, and weighting schematics—with varying degrees of transparency
7. Trend 1: Investors are Moving from Purely Exclusionary to ESG Integration Strategies • The proliferation on ESG data providers in the 2000s means that more historical ESG data is available for research, which increasingly shows that material ESG information can be a value driver • Market infrastructure development such as the Sustainability Accounting Standards Boards Framework has encouraged companies to report on their ESG activities that are material to investors • Regulatory action, particularly in Europe, will mandate investors to consider ESG information in their investment process* Source: ESG Pushes for Benchmarks with 2oC scenario analysis., Responsible investor, December 14, 2018 7
8. Trend 2: ESG Investment Strategies Powered by Multiple Sources of Data • Historically, Investors have been reliant on a single source of ESG data to inform their investment processes. • This data typically comes for third-party providers, employing their own proprietary methodologies, leading to: • Low correlation of ESG scores from different data providers for the same universe of companies • Investors adopting the philosophy of a third-party data providers, with no fiduciary responsibility. As a result, investors are increasingly embracing multiple sources of ESG data to build their investment solutions 8
9. Trend 3: Increasing Demand to Understand ESG Performance of the Portfolio will Drive the Need for Enhanced Reporting • With investors looking at ESG as a value-based dimension in their investment process, they increasingly want to understand ESG performance along with traditional financial measures • Beneficiaries and multiple stakeholders are looking for greater insights into the ESG profile of their investments. • Greater interest in robust ESG reporting along dimensions such as carbon emission, controversy exposure and overall ESG profile 9
10. Trend 4: Climate Solutions will Evolve to Include Adaptation Alongside Mitigation • Historically, climate-aware investors aimed to: • Reduce GHG exposure • Increase exposure to “green” energy companies. • Increasing economic impact of climate change on companies leads investors to evaluate company management’s adaptation strategies. • With increasing commitments to The Task Force on Climate-related Financial Disclosures (TCFD) by investors, management and boards will need to fully incorporate climate change in their long-term strategy. 10
11. Trend 5: Mainstreaming of ESG will Drive Investments in Talent and Infrastructure ESG investing no longer lives in a silo, and increasingly ESG is being integrated into the routine of investment processes of asset managers, leading to:  An acute demand of experienced professionals with interdisciplinary knowledge and a variety of capabilities: deep investment expertise, strong policy and strategic analysis, and the ability to communicate to all stakeholders  The need to build out ESG capabilities, including investments in data, analytics and reporting infrastructure 11
12. ESG Investment Approach 12
13. A Focus on Performance. 13 Stewardship. Pushing portfolio companies to focus on material ESG issues • Using our Voice • Using our Vote Solutions. Next-generation of ESG investing solutions • Designing precision indexes • Creating custom client solutions • Enhancing integration Scoring. Developing a respected set of performance- oriented goals and data • Built a transparent, multi-source data architecture
14. Our Core Stewardship Beliefs Companies embracing ESG best practices have strong, effective, independent boards and incorporate sustainability into their long-term strategy across these two issues. 1 (TCFD) Task Force on Climate-related Financial Disclosures Source: SSGA Asset Stewardship Team Incorporating sustainability into long-term strategy Strong, effective, independent boards of directors Board Leadership Board Response to Activism Diversity Board Refreshment Corporate Governance Principles ESG Shareholder Rights SSGA Sustainability Tiered Framework Climate Change Disclosure Pay Strategies Water Management Incorporation of TCFD1 Principles Corporate Culture
15. Stewardship Fearless Girl: A Symbol of Using Our Voice and Vote. 15
16. Fearless Girl Global Campaign 16 1Markets with Voting Guidelines: United States, UK, and Australia 2Markets with Voting Guidelines: United States, UK, Australia, Canada, EMEA, and Japan Source: State Street Global Advisors Engagement Tracking Database Concluding its second year, the Fearless Girl campaign continues to drive impact globally. Since the start of the campaign, approximately 35% (445/1,265 companies) of the companies identified by State Street Global Advisors responded to our call by either adding a female director or committing to do so. 1,265 Number of Companies Adding First Woman to Board or Addressing the Issue Main Message Companies Identified Voting Action 423 22 Added a female director Committed to add a female director in the near term 512 667 Year 1 of Campaign1 Year 2 of Campaign2
17. Fearless Girl in Japan 17 Source: State Street Global Advisors Engagement Tracking Database • Our Fearless Girl campaign has been a catalyst for action in Japan. We are pleased with the early success of the campaign with approximately 19% (54/281 companies) of companies identified already taking action. • Based on engagement, we question whether this pace of progress can be sustained as several companies highlighted a lack of diverse candidates in their pipelines as a concern. 281 Number of Companies Adding First Woman to Board or Addressing the Issue Main Message Companies Identified Voting Action 43 11 Added a female director Committed to add a female director in the near term N/A 181 March 2017- Feb. 2018 March 2018- Feb. 2019
18. SHE: SPDR® SSGA Gender Diversity Index ETF 18 The Impact of Gender-Diverse Leadership Teams Observed in an MSCI Study Source: MSCI, Women on Boards: Global Trends in Gender Diversity on Corporate Boards, November 2015. * MSCI defined strong female leadership as having a board of directors with at least three women or a higher percentage of women than the average in the company’s country. ^ Companies with less than three women on their board of directors or a lower percentage of women than the average in the company’s country. SHE seeks to contribute to greater gender diversity in corporate America with: ・Leadership SHE invests in US large-capitalization companies that rank among the highest in their sector in terms of gender diversity within their senior leadership positions. ・ Influence By investing in companies with gender-diverse senior leadership, SHE may inspire conversation and action to increase gender diversity in company leadership teams. ・ Impact State Street Global Advisors launched SHE with a charitable component. SHE Impacts — a donor-advised fund — contributes a portion of the advisor’s proceeds from SHE to support national charities that focus on STEM (Science, Technology, Engineering and Math) programs for young women.
19. 19 R-Factor: The Transparent ESG Scoring Methodology R-Factor Score •Systems –level Framework Aligned •Best in Class Data •Industry Specific Models •Asset Stewardship Expertise •Materiality Weighted SASB Alignment, Data Mapping, Scoring CorpGov Code Alignment, Data Mapping, Scoring ISS Governance •CorpGov KPI Metrics Asset Stewardship • National Governance Codes R-Factor Scores SASB Materiality Map™ Issues: Environment Social Capital • GHG emissions • Human rights & community relations • Air quality • Access and affordability • Energy management • Customer welfare • Fuel management • Data security & customer privacy • Water & wastewater management • Fair disclosure & labeling • Waste & hazardous materials management • Fair marketing & advertising • Biodiversity impacts Human Capital Leadership and Governance • Labor relations • Systemic risk management • Fair labor practices • Accident & safety management • Employee health, safety & wellbeing • Business ethics & transparency of payments • Diversity & inclusion • Competitive behavior • Compensation & benefits • Regulatory capture and political influence • Recruitment, development & retention • Materials sourcing Business Model and Innovation • Supply chain management • Lifecycle impacts of products and services • Environmental, social impacts on assets & operations • Product packaging • Product quality and safety Sustainalytics •ESG KPI Metrics ISS-Oekom •ESG KPI Metrics Vigeo Eiris •ESG KPI Metrics 26 Materiality Map Topics 11 Sectors 77 SICS Sub- Sectors Sources: Sustainability Accounting Standards Board (SASB), SSGA. For illustrative purposes only. Figures not drawn to scale. 77 Industry Models 17 Regional Models
20. R-Factor Powers New Client Solutions Deeper Integration Across Asset Class 20 New Indexes & Funds In 2019, R-Factor will power a series of indexes and funds including exposures to the US and global equity markets and US fixed income markets. Custom Solutions R-Factor enable us to create tailored solutions for clients to meet their investment objectives and regulatory commitments. Enhanced Integration Our active managers will now use the proprietary ESG scoring system powered by R-Factor to incorporate into their investment management processes.
21. R-Factor Powers Reporting Gives Clients Transparency Into Holdings 21 Quarterly reports provided to clients are synchronized with a full scope of ESG-related metrics, including: • ESG Scores, Positions and Holdings. Revealing a fund/portfolio’s ESG profile, with best and worst ESG positions and scores. • ESG Momentum Profile. Showcasing the evolution of a fund/portfolio’s ESG rating across the previous two years. • Carbon Intensity Profile. Shows how fund/portfolio carbon emissions have changed over a 12 mo. period. • Stewardship Profile. Including votes and engagements on issues such as gender diversity, climate. Source: SSGA
22. A Spectrum of Investment Solutions: Navigating the Climate Challenge Target Net Carbon Emission Reduction Reduce exposure to carbon intensity & Fossil fuel reserves Increase exposure to Companies generating revenues from low carbon opportunities (Green revenues) Exclusionary Mitigation + Adaptation Mitigate & Adapt in a risk-controlled way Reduce exposure to worse than average carbon emission, fossil fuel assets (Carbon Reserves) & Brown Revenues Increase exposure to Companies generating revenues from low carbon opportunities (Green revenues) Resiliency (Adaptation) Screen out Worst Polluters Fossil Fuel Reserves Coal Source: SSGA, MSCI, FTSE, S&P Trucost Mitigation A Range of Options 22
23. Balancing Risk and Carbon Reduction Choice: Target Carbon Reduction 90% 80% 70% 60% Choice: Target Tracking Error Thresholds 1 2 Carbon reduction targets Pre-stated level of Tracking Error Resulting % Carbon Reduction1 0.5% 1.0% 1.5% 74.88% 83.95% 88.61% 23 1 % reduction in carbon reflects back-tested results and is for illustrative purposes only. The results shown were achieved by means of a mathematical formula, and are not indicative of actual future results which could differ substantially. Source: SSGA.
24. Appendix 24
25. Benjamin Colton Head of APAC, Asset Stewardship 25 Benjamin Colton is Vice President, Head of Asia-Pacific on the Asset Stewardship Team of State Street Global Advisors (SSGA). Mr. Colton and his colleagues on the Asset Stewardship Team are responsible for developing and implementing SSGA's global proxy voting policies and guidelines across all investment strategies, and managing SSGA's proxy voting activities and issuer engagement on environmental, social and governance (ESG) issues. Prior to joining SSGA in 2018, Mr. Colton served as a member of the Active Ownership Team at Norges Bank Investment Management (NBIM) based in Oslo, Norway and later in New York City, USA. Mr. Colton earned an Executive Global Master of Science in Management (Distinction) from the London School of Economics & Political Science (LSE), a Master of Science in Economics from the University of Nevada, and a Bachelor of Science (Distinction) in Economics from The University of Nevada.
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