SinCo briefing on Institutional Investors, Sustainable Investment and ESG in Capital Budgeting

Institutional Investors,
Sustainable Investment and
ESG in Capital Budgeting
Graham Sinclair

Principal, SinCo

@esgarchitect

graham.sinclair@sincosinco.com

"1
sustainable investment consulting ERM Client Day: Capital Budgeting and Sustainability
SinCo does not hold copyright to this image Wikicommons license.
© 2013 SinCo. All rights reserved.

Understanding the growth of ESG
Sustainable investment by institutional investors
1. Institutional investment is a competitive global industry. professionals manage portfolios across asset
classes, project and company types; financing/investing in stages of companies/projects business cycles.

2. Increasing materiality of environmental, social and governance (ESG) factors is driving investors, and
their end-clients, to integrate sustainability concepts. $13.6 trillion globally, $229 billion in Africa reports
proactively using ESG in investment policy or process.

3. Increasing quality of coverage of ESG flowing from professional ratings agencies and sharper focus. with
more coverage, opportunity to use of new ESG valuation models. Pursuit of "sustainability alpha"
continues; ESG benchmarking and performance attribution growing.

4. Improving African investment context is attracting capital. Benefit from making the sustainable
investment case for the positive outcomes, or reduction in negative impacts. South Africa is 5th largest
investor in Africa; 1-in-2 investment dollars in private equity in Sub-Saharan Africa is DFI-linked.
"2
sustainable investment consulting

What do investors want?
"3
SinCo does not hold copyright to this image Wikicommons license.

What do investors want?
Investors are seeking net-of-fees, net-of-inflation, risk-adjusted positive investment returns, for
example equity (dividends market price increases) or fixed income (coupon payments and principal
repatriation). Investors value diversity, non-correlation and liquidity.

Investors have a sense of long-term investment, but investor behavior may be irrational, herd-driven
on the fear-greed spectrum. Limits on scale, information and operational efficiency are parameters to
universal investment.

Investors want to reduce their buy/hold/sell decision to 2 pages describing the investment structure
(debt/equity), competitive advantages of firm and its products/services, quality of its management,
operational efficiency and strategic prospects. investors always want to buy their investments for the
lowest price, at the bottom of the J-curve (buy low-sell high).
"4@SinCoESG I sincosinco.com I info@sincosinco.com

"5
Key developments in sustainable investment theme
• $13.6 trillion (21.8%) of professionally managed assets reporting
incorporating environmental, social and governance (ESG) factors
into investment selection and management (Jan 2013 on 31 Dec
2011 data). Positive/best-in-class screening stands at just over
$1.0 trillion, while impact investing ($89 billion) and sustainability-
themed investments ($83 billion) are comparatively small.
• Investment in Africa reporting proactively investing using ESG
factors $228 billion AuM. Integration of ESG is $198 billion AuM.
South Africa is 95% of Africa investment market; ESG-branded
investment products make up just 1% AuM.
• According to Bloomberg ESG, "in 2010, 5,000 investors in 29
countries accessed more than 50 million ESG indicators in the
Bloomberg platform— a 29 percent increase over 2011."
• 40 percent of shareholder resolutions in 2012 in the USA
pertained to environmental and social concerns, up from 30
percent during the prior proxy season. SinCo research reﬂects
RSA share owner activity increasing off low base, with examples
of global best practice using online reporting of proxy votes.
• ESG performance studies
reﬂect sustainability may
increase returns. ESG tilts
in listed equity perform
best for buying ESG
"improvers" and shorting
"laggards" *2008-12
• $10 billion annual
savings on U.S. electric
bills from new lightbulb
standards. 59%
proportion of emissions-
reductions efforts pay for
themselves in 3 years.
• 67% return from listed
equity portfolio based on
the Carbon Disclosure
Leadership Index since
2006. 31% return of by
CDP Leadership Index's
Global 500 peers during
the same period.
@SinCoESG I sincosinco.com I info@sincosinco.com © 2013 SinCo. All rights reserved.

Rationale for sustainable investment
Global pension investment best practice from Africa
Regulation 28 of Pension Funds Act 24/1956 effective 1 January 2012

PREAMBLE "A fund has a fiduciary duty to act in the best interest of its members whose
benefits depend on the responsible management of fund assets. This duty supports the
adoption of a responsible investment approach to deploying capital into markets that will
earn adequate risk adjusted returns suitable for the fund’s specific member profile,
liquidity needs and liabilities. Prudent investing should give appropriate
consideration to any factor which may materially affect the sustainable long-term
performance of a fund’s assets, including factors of an environmental, social and
governance character. This concept applies across all assets and categories of assets
and should promote the interests of a fund in a stable and transparent environment."
"6

Reputations and rules: ESG acts throughout the
investment life cycle. Plays out regardless of rules.
Driven by regulator pressure, client demand,
increased exposure, and intangible value impacts.
Investors prefer legislation and regulation
(hard rules). But with weak regulations
and changing ESG issues, moving to
voluntary initiatives (soft rules).
"7
SinCo does not hold copyright to this image

Material ESG factors impacting valuations now 1/2
CARBON

From SinCo research for Navigating Muddy Waters research series commissioned by WWF with
SinCo, Trucost and Carbon Tracker, using GEPF's fixed income and equity portfolio as worked
example. Confirmed that investors attitudes to carbon & water scarcity risks ranged from ambivalent
to concerned.

Previous studies of the development of institutional investor approaches to sustainable investment in
South Africa identified 1/3 had no knowledge of a carbon tax pricing scenario, another 1/3 had zero.

*2015 carbon tax shifted valuations - Arcelormittal lost 6% on budget speech

*Learn more about Navigating Muddy Waters project at http://www.sincosinco.com/portfolio-climate-
risks.php
"8

Material ESG factors impacting valuations now 2/2
WATER

Analyst note from Standard Bank Equity Research on 14 resources companies: Most mining and industrial
operations in RSA in water-stressed areas: Waterberg and Witbank Coal fields, Witwatersrand gold
complex, and Bushveld PGM igneous complex. Lonmin and SASOL have lowest scores on their
proprietary ratings for water management. "Anglo Platinum has the highest score, implying the lowest risk,
it is still without IWUL at its key operations, based on public information available at date of
publication...SA Resource sector is still only about one year into setting fixed targets and monitoring them"

*Lonmin $LMI online self-reporting ".... The market price for PGMs can fluctuate widely... geological
formations, unanticipated ground and water conditions"
*Learn more about Navigating Muddy Waters project at http://www.sincosinco.com/portfolio-climate-
risks.php
"9

Investment case is sum of all operations and investments. ESG issues are
material, but methods for valuing differ. Timing, shocks and impacts differ.
"10
WHAT ESG ISSUES? All the the companies' strategy,
operational plans and realities are tested in the harsh light
of investment analyst presentations, and a public forum
where stakeholders have a voice

Integrating ESG factors leans on company insights
How will the least possible ESG data delivered as information on sustainability lead
to the maximum knowledge on the current value and future expected value of the
and its franchise with consumers, employees, policymakers, regulators, investors,
and other stakeholders?

Investors do not want a list of "material issues" for sector or generic firm. Investors
need the firm to explain the business critical sustainability issues, and ow the firm
with map and monitor and mitigate ESG risks, and maximize ESG opportunities.
"11

Modeling equity in mining companies in Africa 1/2
• VALUATION 101. A typical equity valuation in the mining sector in South Africa will
seek to build a valuation/price comparison based on financial data and "future
prospects". Mining firms are typically valued using a discounted cashflow (DCF)
model with an adjusted terminal value of zero at the end of the mine life, net of
closure costs. The sum-of-the-parts DCF model will price the sum of the above
ground and below ground operations and future projects, using this methodology
to value the firm in isolation and against sector and/or regional peers.
• DISCOUNTING FOR CAPITAL AND TIME-VALUE. The nominal weighted average
cost of capital (WACC) applied to cash flows is estimated using the investment
analysts views of future commodity prices and inflation, with a multiple applied to
the DCF-derived net asset value reflecting the investment analysts’ views on the
company, especially relative to the cross-rates of the mining firms operational
costs and dollar-based commodity prices. Academic research has tested for
improved WACC for firms with better sustainability performance, some evidence to
support.
"12@SinCoESG I sincosinco.com I info@sincosinco.com © 2013 SinCo. All rights reserved.

Modeling equity in mining companies in Africa 2/2
• RISKS AND ASSUMPTIONS. The model will include some risks to the target
price/s, typically including the increase in exploration, sustaining and development
capital expenditure plans. Assumptions about trends in commodity pricing,
success in above- and below-ground operational management, taxes (on average
30% across regions in the medium-to-long term), and input costs, such as labor.
Risks include assumptions about productivity, and work-safety stoppages related
to accidents and fatalities in operations.
• INTEGRATING ESG. ESG issues typically enter the modeling as costs and/or
risks, for example environmental remediation. But may also reasonably be
modeled as governance factors, for example the license to operate being granted
or renewed based on offering a non-corrupt, transparent and community-validated
approach to managing stakeholder relationships. Environmental issues may also
bring mining exploration or operating to a halt: for example where mines
contravene the National Environmental Management Act or the National Water
Act. In South Africa, courts are increasingly siding with civil society and consumers
where rights are threatened by state or private sector.

HEADLINE RISK TO INVESTORS
ESG is a factor throughout
investment life cycle
Impacts of all investor portfolio
companies/securities/projects
sums to portfolio-level ESG.
"14
SinCo does not hold copyright to this image. All rights beyond to Zapiro, purchase at www.zapiro.com

ESG data supply for investors
Inputs to institutional investor decisions 1/2
• ESG analysis must balance top-down thematic issues with bottom-up company context. analysis starts
with an overarching view. What is an accurate point-in-time, retrospective and prospective qualitative
value of firm sustainability? Companies have influential and persuasive role in making the case to
investors for materiality of ESG risks and opportunities.
• All analysis is also a competitive struggle for fastest, freshest and most accurate data offering
information interpreted for knowledge of current and future value of investment opportunity. ESG data
availability has ramped up since 2000, but still issues of frameworks (GRI vs integrated reporting vs
SASB), availability, reliability, verification, auditing, comparability.
• ESG
• Social - Child Labor, Consumer Product Safety, Diversity, Labor Relations
• Environmental - Environmental Performance, Global Sanctions, Superfund sites, Toxic Chemicals
• Tracking framework - Spills, Fines, Sites. Relative and absolute measures - for example, sites / $10
billion domestic company revenue, lbs / $1,000 domestic company revenue, Spills / $10 billion
domestic company revenue

ESG data supply for investors
Inputs to institutional investor decisions 2/2
WORKED EXAMPLE - MINING & MINERALS SECTOR - Industry Trends flagged by MSCI ESG, Jan 2013
• Social licenses to operate, obtained through community engagement and sustainability management, are
ever more essential to mining companies’ ability to run a successful mine.
• The industry is faced with many tough decisions. Management at many companies must choose
between layoffs or profits. Others are forced to choose between ramping up production of low grade
mines – the result could mean higher carbon emissions, wastes, and costs - or move operations deeper
into regions with high uncertainty due to risks of corruption, social changes, or sensitive environments
that can block projects from going forward.
• The increasingly scarce high grade projects are also often in regions where safety and environmental
standards need to be drastically upgraded to meet international standards. Poor social and
environmental performances also significantly raise risks of resource nationalization and higher payment
demands.
• Labor cost inflation reaches double digits for many companies and diminishes long term confidence that
high margin mines in areas of unrest will remain strong investments. Mining companies face additional
risks of cost hikes through increased regulatory pressure, expanding carbon regulations, and higher costs
for energy and supplies

Investor approaches - modeling investment case in mining
companies in Africa 1/2: ESG in multi-asset boutiques
• 1. Macro thematic issues relevant to mining or extractives - for example water scarcity, carbon
taxes, labour relations. Themes inform sense of "investment conviction" about how sector,
industry and firm may manage key issues in strategy and operations. Differs according to
investment philosophy, views of ESG, sense of long term investment holding periods
• 2. Key value creators/destroyers - at sector and company levels, filters for best/worst in class;
tempers financial data with sense of prospects. for example, firm may be estimated to have 35%
upside but be worst performer vs peers on key issues, implies portfolio management approach
to change weighting or company engagement seeking changes. Scenario and sensitivity
analyses will cHeck assumptions effects on models, for example work stoppages, mine
closures, or water shortages. May need to update model with additional valuation line items and
review assumptions.
• 3. Active ownership over time - using ESG information as active shareholder to steer company
away from high-risk, low-reward situations or binary issues with negative reputation impacts.
Investor uses all available tools, and wants to be seen to be acting. voluntary initiatives like
CRISA, PRI, EITI, Equator Principles or CDP play a role.

Investor approaches - modeling investment case in mining
companies in Africa 2/2: ESG in listed Africa equities
• Approach of active investment manager is to drill down to fundamental value - key factor is 'social
license to operate', without which the firm or mine does not have a business. Sustainability
performance through ESG factors all impact on the single biggest risk for mines - title risk, bigger
than above/below ground risks. 50-year mine in geological terms may be expropriated after 2 years?
• In Africa fewer data points and harder to compare to peers in context. Some ESG metrics may help
improve context for financial valuation, for example % of local labour (including mine management),
tax contribution to local fiscus, extent of beneficiation, net socio-economic footprint (job creation),
long-term infrastructure value added (potable water, energy, roads, telecoms, schools), displacement
of people and how this is managed, biodiversity impact (receiving environment), sustainability
practices (pollution control, mitigation for tailings dam contamination of soil and surface and
groundwater courses), ethical backbone of management team (zero tolerance of bribes and
corruption in securing title), or sustainability practices (rehabilitation of mine footprint, off balance
sheet legacy liabilities).
• Investor is paid to return net-of-fees, net-of-inflation, risk-adjusted investment performance.
Sustainable investment practice tends to factor material ESG factors in more aggressively, potentially
leading to very different fair value versus investment management competitors.

Frameworks for ESG - global and local
Future ﬁlled with "high context" business relationships; investing in multi-polar world
"19@SinCoESG I sincosinco.com I info@sincosinco.com

Understanding the growth of ESG
Sustainable investment by institutional investors
1. Institutional investment is a competitive global industry. professionals manage portfolios across asset
classes, project and company types; financing/investing in stages of companies/projects business cycles.

2. Increasing materiality of environmental, social and governance (ESG) factors is driving investors, and
their end-clients, to integrate sustainability concepts. $13.6 trillion globally, $229 billion in Africa reports
proactively using ESG in investment policy or process.

3. Increasing quality of coverage of ESG flowing from professional ratings agencies and sharper focus. with
more coverage, opportunity to use of new ESG valuation models. Pursuit of "sustainability alpha"
continues; ESG benchmarking and performance attribution growing.

4. Improving African investment context is attracting capital. Benefit from making the sustainable
investment case for the positive outcomes, or reduction in negative impacts. South Africa is 5th largest
investor in Africa; 1-in-2 investment dollars in private equity in Sub-Saharan Africa is DFI-linked.
"20

Graham Sinclair

Principal, SinCo

@esgarchitect

graham.sinclair@sincosinco.com

"21

www.africasif.org

@AfricaSIF

africasif@gmail.com

www.sincosinco.com

@SinCoESG

info@sincosinco.com

SinCo acknowledges the input and research by Old Mutual
Investment Group South Africa, Sustainable Capital, IFC,
Bloomberg ESG and MSCI ESG used in this presentation.
Analysis and opinions are solely SinCo.

All rights reserved. March 2013.
Thank you.

About SinCo

SinCo - sustainable investment consulting
- is a boutique sustainable investment
advisory ﬁrm specializing in environment,
social and governance (ESG) architecture
in frontier and emerging markets. Since
2006 SinCo has delivered sustainable
investment architecture globally to
pension funds, asset managers, private
equity funds, stock exchanges and
international organizations integrating
ESG factors into investment practice for
sustainable long-term investment
performance.

Learn from our experience at

sincosinco.com/portfolio-of-work.php

www.sincosinco.com | @SinCoESG |
info@sincosinco.com

SinCo is a Massachusetts Limited Liability Company (General Laws, Chapter 156C)
incorporated in February 2007 registered with the Secretary of State of the
Commonwealth of Massachusetts USA. 1009795 #1208. In 2013, SinCo is
undergoing the B Corp Certiﬁcation Process to formally recognize our mission-
driven business model in sustainable investment. B.Corp is used by the world’s
leading social entrepreneurs to assess, compare, and to improve the company’s
social and environmental performance.

"22

Indemnity and disclosures
This ESG research by SinCo includes funds, firms, securities and initiatives that may be clients of SinCo, or the parent of, or
affiliated with, a client of SinCo. SinCo ESG research reports, articles and profiles have not been submitted to, nor received
approval from, the United States Securities and Exchange Commission or any other regulatory body. While we have
exercised due care in compiling the information, we make no warranty, express or implied, regarding the accuracy,
completeness or usefulness of the information and assume no liability with respect to the consequences of relying on the
information for investment or other purposes. In particular, SinCo ESG research is not intended to constitute an offer,
solicitation or advice to buy or sell securities.
This material is provided for informational purposes only and should not be construed as investment advice or an offer or
solicitation to buy or sell securities. The economic and market forecasts presented herein have been generated by SinCo for
informational purposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved.
This information discusses general market activity, industry or sector trends, or other broad-based economic, market or
political conditions and should not be construed as research or investment advice.
Without limiting any of the foregoing and to the maximum extent permitted by law, in no event shall SinCo have any liability
regarding any of the Information for any direct, indirect, special, punitive, consequential (including lost profits) or any other
damages even if notified of the possibility of such damages. The foregoing shall not exclude or limit any liability that may not
by applicable law be excluded or limited.
The views and opinions expressed in this body of work are the author's own and may not reflect the views and opinions of
SinCo unless the author is authorized by SinCo to express such views or opinions on its behalf.
"23
@SinCoESG I sincosinco.com I info@sincosinco.com

About AfricaSIF.org
Africa Sustainable Investment Forum
is an independent,Pan-African, not-for-
proﬁt network, knowledgebase and
advocate promoting investment in
sustainable development across the
continent. Launched in June 2010, the
AfricaSIF.org Project is run by volunteers
building a network of institutions and
individuals promoting sustainable
investment in Africa by investors in
public, private and philanthropy sectors
across asset classes, countries and
stakeholders from our platform at
www.africasif.org.

"24

www.africasif.org I @AfricaSIF I. africasif@gmail.com

SinCo briefing on Institutional Investors, Sustainable Investment and ESG in Capital Budgeting

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