Axel Hesse


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TBLI CONFERENCE™ EUROPE 2012 - Zurich - Switzerland

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Axel Hesse

  1. 1. TBLI and Standardization of Key Performance Indicators SD-KPI Standard 2010-2014: How to Systematically Integrate Relevant ESG Factors for Financial Performance (Fiduciary Duty) Zurich, 8 November 2012 Dr Axel Hesse Managing Director, SD-M® GmbH; www.SD-M.deThe SD-KPI Standard 2010-2014 and all its aspects are protected by copyright. All rights are reserved. Any commercial use of any aspects of theSD-KPI Standards for financial products/services of any kind, e.g. for investment funds or stock indexes/benchmarks, research, engagement orinformation services is subject to the prior consent of Dr. Axel Hesse (SD-M® GmbH) and/or licensing of the registered trademarks SD-KPIndex® orSD-KPInvest® from Dr. Axel Hesse (SD-M® GmbH). Any unauthorised use of the SD-KPI Standard will be prosecuted under copyright and criminal laws.However, companies are permitted and encouraged to use the SD-KPI Standard for their management and reporting systems at no charge. The use ofthe registered trademarks SD-KPIndex® or SD-KPInvest®, however, in any case remains subject to a license from Dr. Axel Hesse (SD-M® GmbH). © SD-M® GmbH, 2012, Page 1
  2. 2. Two faces of the same coin: Fiduciary duties of institutional investors andRELEVANT sustainability indicators in annual reports of companiesFreshfields Bruckhaus Deringer,A legal framework for theintegration of environmental,social and governance issues EU accounting directivesinto institutional investment, 78/660/EEC, consolidated versionOctober 2005: 2009-07-16:CONCLUSIONS SECTION 9Conventional investment analysis focuses on Contents of the annual reportvalue, in the sense of financial performance. As Article 46we note above, the links between ESG factors and 1 (b) To the extent necessary forfinancial performance are increasingly being an understanding of therecognised. On that basis, integrating ESG companys development,considerations into an investment analysis so as performance or position, theto more reliably predict financial performance analysis shall include bothis clearly permissible and is arguably required in financial and, where appropriate,all jurisdictions. […] Provided that all RELEVANT non-financial key performanceconsiderations have been taken into account, the indicators (KPIs) RELEVANT toweight that the decision-maker gives to each the particular business, includingconsideration or category of consideration is left to information relating tothe discretion of the investment manager alone. environmental and employee matters; © SD-M® GmbH, 2012, Page 2
  3. 3. Examples for the relevance of SD-KPIs for the financial performance 2006 2007 Automobiles: Fleet consumption (SD-KPI 1) KPMG: Fuel efficiency the most important factor for the consumer‘s purchase decision Standard&Poor’s: € 600-3.000 per vehicle to meet A study by Dr. Axel Hesse (SD-M) for Deloitte and the German Federal upcoming EU emission standards Ministry of the Environment Energy utilities: Greenhouse gas intensity (SD-KPI 1) S&P downgraded RWE from A- to BBB+ (July 2012) € 2 billion costs per year for the purchase of emission rights from 2013 2008 Proportion of renewables (SD-KPI 2): Energy transition after Fukushima Pharmaceuticals: Access to Medicine Index (SD-KPI 1): Meeting demand for basic medicines, a huge potential market Oil & Gas: Emissions of hazardous waste and toxic materials or oil spills (SD-KPI 3, published January 2010): BP lost US$ 67 billion of market capitalisation (1 June 2010) Banks: Sub-Prime risks integrated in SD-KPI 2 in October 2006 published January 2007: Hesse, A., “Sustained Added Value”, edited by Deloitte © SD-M® GmbH, 2012, Page 3
  4. 4. A global reporting and investment standard: SD-KPI Standard 2010-2014SD-KPIs: 3 most relevant SD-KPIs for the financial performance of the next five years for 68 industries on behalf of the German Environment Ministry: SD-KPIs “minimum reporting requirement” in annual reports (2009) consensus among global investors and analysts who influence sustainable assets of € 2 trillion transparent reporting and investment standard (weighting according to the relevance for the financial performance) database for evaluation of SD-KPIs for more than 3000 companies worldwide finished at the end of 2011 „Big Four“-accounting firms Deloitte, Ernst&Young and KPMG use SD-KPIs © SD-M® GmbH, 2012, Page 4
  5. 5. Return and performance goals are more Focused sustainability research willimportant than sustainability goals lead to risk-adjusted outperformance Survey of 1= very important leading unimportant = 6 European pensions funds Assets: € 460 billion Under- performance ABP AP1 AP4 BTPS (Hermes) Ethos ERAFP FRR MetallRente PGGM USS Source: Hesse (2008). Outperformance © SD-M® GmbH, 2012, Page 5
  6. 6. Option 1:SD-KPInvest®: SD-KPI-usage for conventional actively managed mandatesIn conventional actively managed mandates (specialised funds) components1. can be selected from the investment universe as usual and2. be over- or under-weighted according to their SD-KPI-PerformanceModerate over-/under-weighting e.g. according to this transparent system: SD-KPI-performance 0% - 20% ---> red ---> underweighting 10% SD-KPI-performance 20% - 40% ---> light red ---> underweighting 5% SD-KPI-performance 40% - 60% ---> yellow ---> no change SD-KPI-performance 60% - 80% ---> light green ---> overweighting 5% SD-KPI-performance 80%-100% ---> green ---> overweighting 10% © SD-M® GmbH, 2012, Page 6
  7. 7. Option 2:SD-KPInvest®: SD-KPI portfolio analysis and regrouping of specialised funds financial performance = risk-return-relationreturn (Sharpe ratio) SF1 SF5 SF4/8 SF3/7 SF2 SF6 SF1/5 SF2/6 SF4 SF8 SF3 SF7 benchmark benchmark risk SD-KPI- performance risk / return position of several financial performance / SD-KPI conventional specialised funds (SF) performance position of several conventional specialised funds (SF) optimisation path first-order optimisation path (conventional) second-order optimisation path (more sustainable) © SD-M® GmbH, 2012, Page 7
  8. 8. Option 3:SD-KPInvest®: SD-KPI integration in mainstream research / portfolio analysisThe asset manager can:• integrate only the three SD-KPIs, which are most important for the financialperformance and the mainstream research• analyse the impact of particular SD-KPIs on the financial performance• use SD-KPIs in quant analysis for the generation of long-term alphaThe asset owner can:• evaluate the SD-KPI performance of investees companies via a portfolio check.This also shows the SD-KPI performance compared with that of peers. © SD-M® GmbH, 2012, Page 8
  9. 9. Option 4:Passive investment/benchmark (Comparison of three sustainability indices) DJSI World STOXX ESG Leaders Enhanced-β-SD-KPIndex®, e.g. STOXX Global 1800 SD-KPIndex®, STOXX Europe 600 SD- KPIndex®, EURO STOXX 50 SD-KPIndex®, STOXX Europe 50 SD-KPIndex®, MSCI World SD-KPIndex® (customized)Reduction in the 86% (342 out of 2500 83,5% (297 out of 0-2% of leading conventional financialinvestment universe components) 1800 components) indices: 20-30 exclusions: production anti-personnel mines cluster bombsVoting/ Engagement ownership rights for ownership rights for ownership rights for 98%-100% of the the 14% “best-in- the 16,5% “ESG components of the conventional class”-components of leader-”components of indices; focused engagement regarding the conventional index the conventional index SD-KPIs possibleBased upon a standard - o KPIs for ESG + SD-KPI StandardsNumber of indicators c. 100 c. 40-50 3 SD-KPIsused per sectorTransparency for - o +indicators/weightingsFocus on the most - - +relevant KPIs for the (components are 0%/5%/10% over- orfinancial performance under-weighted according to SD-KPI-Performance)Derivatives - - + conventional option/futures useable © SD-M® GmbH, 2012, Page 9
  10. 10. Backcasting: „Buy and Hold“ EuroStoxx50 vs. EuroStoxx50 SD-KPIndex®5/10% over-/underweighted according to SD-KPI performance Performance-Entwicklung Performance development a) over-/underweighting from -10% until +10% a) Über-/Untergewichtungen von -10% bis +10% +10% +5% 0% +0.49% 0% Tracking Error: -10% -5% 0.34% p.a. -20% -10% -30% -15% -40% -20% -50% -25% -60% -30% Sep Dez Mrz Jun Sep Dez Mrz Jun Sep Dez Mrz Jun Sep Dez Mrz Jun Sep Dez Mrz 07 07 08 08 08 08 09 09 09 09 10 10 10 10 11 11 11 11 12 SD-KPI SD-KPI Portfolio EuroStoxx50 Vgl.-Portfolio SD-KPI Portfolio vs. SD-KPI Portfolio vs. Vgl.-Portfolio (rechte Achse) Portfolio Portfolio EuroStoxx50 Portfolio (right axis) Source: SD-M GmbH and HSBC © SD-M® GmbH, 2012, Page 10
  11. 11. Backcasting: „Buy and Hold“ EuroStoxx50 vs. EuroStoxx50 SD-KPIndex®25/50% over-/underweighted according to SD-KPI performance Performance-Entwicklung Performance development b) over-/underweighting from -50% until +50% c) Über-/Untergewichtungen von -50% bis +50% +10% +5% +2.57% 0% 0% Tracking Error: -10% 1.74% p.a. -5% -20% -10% -30% -15% -40% -20% -50% -25% -60% -30% Sep Dez Mrz Jun Sep Dez Mrz Jun Sep Dez Mrz Jun Sep Dez Mrz Jun Sep Dez Mrz 07 07 08 08 08 08 09 09 09 09 10 10 10 10 11 11 11 11 12 SD-KPI SD-KPI Portfolio EuroStoxx50 Vgl.-Portfolio SD-KPI Portfolio vs. SD-KPI Portfolio vs. Vgl.-Portfolio (rechte Achse) Portfolio Portfolio EuroStoxx50 Portfolio (right axis) Source: SD-M GmbH and HSBC © SD-M® GmbH, 2012, Page 11
  12. 12. Thank you for your attention!SD-M® GmbHDr Axel HesseManaging DirectorHesse@SD-M.dewww.SD-M.deTel +49 511 6968 4581Mobile +49 173 64 222 11 © SD-M® GmbH, 2012, Page 12