Demystifying Responsible Investment Performance


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Xavier Desmadryl, SRI Financial Analyst - HSBC Asset Management - UK

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  • Mission: ALL levels of financial institution operation: Incl: Lending, asset management, insurance
  • Mission: ALL levels of financial institution operation: Incl: Lending, asset management, insurance
  • Mission: ALL levels of financial institution operation: Incl: Lending, asset management, insurance
  • Mission: ALL levels of financial institution operation: Incl: Lending, asset management, insurance
  • Mission: ALL levels of financial institution operation: Incl: Lending, asset management, insurance
  • Mission: ALL levels of financial institution operation: Incl: Lending, asset management, insurance
  • Mission: ALL levels of financial institution operation: Incl: Lending, asset management, insurance
  • Mission: ALL levels of financial institution operation: Incl: Lending, asset management, insurance
  • Mission: ALL levels of financial institution operation: Incl: Lending, asset management, insurance
  • Demystifying Responsible Investment Performance

    1. 1. Demystifying Responsible Investment Performance Paris, November 15th, 2007 TBLI Europe Xavier DESMADRYL HSBC Investments Global Head of SRI Research UNEP FI Asset Management Working Group Co-Chair
    2. 2. <ul><li>‘ Sustainable Bank of the Year’ in the Financial Times Sustainable Banking Awards 2006 </li></ul><ul><li>First major bank to go ‘Carbon Neutral’ </li></ul><ul><li>The HSBC Climate Partnership : US$100 million investment – one of the largest ever corporate donations </li></ul><ul><li>Founding signatory of the United Nations Environment Programme’s Finance Initiative, Climate Group </li></ul><ul><li>Implementation of CR committees that function within the main structures of the HSBC Group </li></ul><ul><li>Development of sustainable business through: Equator Principles, sector guidelines and policies, microfinance, SRI… </li></ul><ul><li>Our quality is recognised by major rating agencies and indexes </li></ul>HSBC: a leader of finance and sustainability
    3. 3. HSBC Group Investment Businesses – A global SRI footprint <ul><li>HSBC manages around $1.64bn of SRI assets globally * </li></ul>* Source: HSBC, figures as at 31/05/2007, relating to the assets of HSBC Investments, Halbis and SINOPIA Düsseldorf Paris London Hong Kong Vancouver Singapore Sao Paulo Mandates 1 Global Equity fund 2 UK Equity funds + Mandates 2 Pan-European Equity funds 1 Euro Bonds fund 1 Pan-European Balanced fund + Mandates 1 Brazilian Equity funds 1 Euro-Zone Balanced fund Mandates Mandates AUM by investment vehicle AUM by asset class Funds of funds Mandates Mutual Funds Balanced Equities Fixed Income
    4. 4. Reflected into the structure of our product range * Dedicated to UK charities ** See prospectus for more information <ul><li>The global SRI platform advises and supports the following funds…as well as a list of dedicated funds and mandates </li></ul><ul><li>2 SRI projects are being discussed : a domestic Indian Equities SRI fund and a Global Emerging Markets fund. </li></ul>Brazil United Kingdom United Kingdom German speaking countries France France France Worldwide** Worldwide** Available Ethical exclusion UK equities UK HSBC Common Fund for Growth* - - Ethical exclusion UK equities UK HSBC Ethical Charity Unit Trust* - - aa (Novethic) aa (Novethic) - - - SRI rating Best in class Best in class Best in class Best in class Best in class Best in class Best in class SRI process - -  (31/08/2007) - - - - S&P rating Brazilian equities Euro fixed income Euro fixed income European equities Global balanced (50/50) European equities Global equities Investment universe Brazil HSBC FI Acoes Sustentabilidade Empresarial - ISE France HSBC Mix Responsable Luxembourg HSBC Inik fonds France HSBC Euro Obligations Responsables France HSBC Valeurs Responsables Luxembourg HSBC GIF Sustainability Leaders Luxembourg HSBC GIF Global Equity SRI Domicile Funds
    5. 5. <ul><li>UNEP FI Asset Management Working Group in a nutshell : </li></ul><ul><li>A Strategic Alliance of leading asset managers : </li></ul><ul><ul><ul><li>ABN AMRO Banco Real Brasil Hermes Pensions Management </li></ul></ul></ul><ul><ul><ul><li>Acuity Investment Management HSBC Investments (Co-Chair) </li></ul></ul></ul><ul><ul><ul><li>BNP Paribas Asset Management Insight Investment Management </li></ul></ul></ul><ul><ul><ul><li>Calvert Group (Co-Chair) Mitsubishi UFJ Trust & Banking Corp. </li></ul></ul></ul><ul><ul><ul><li>ClearBridge Advisors, SAI Nikko Asset Management </li></ul></ul></ul><ul><ul><ul><li>Eurizon Capital Morley Fund Management </li></ul></ul></ul><ul><ul><ul><li>Groupama Asset Management Pax World Management Corp. </li></ul></ul></ul><ul><ul><ul><li>Henderson Global Investors RCM (UK) </li></ul></ul></ul><ul><ul><li>Mission : </li></ul></ul><ul><ul><li>Advance mainstream integration of environment, social and governance (ESG) issues </li></ul></ul><ul><li>into investment processes </li></ul>
    6. 6. Sustainable Development and SRI: Definitions <ul><li>People: consequences on employees, clients, suppliers, local communities </li></ul><ul><li>Planet: analysis of the impacts of companies and their products </li></ul><ul><li>Profit: financial performance, but also ability to contribute to economic development </li></ul>* Source: From the Brundtland Report to the United Nations World Commission on Environment and Development, 1987 What is Sustainable Development? What is CSR ? <ul><li>Development that meets the needs of the present without compromising the ability of future generations to meet their own needs (Bruntland Commission, 1987) </li></ul><ul><li>CSR = Corporate Social Responsibility </li></ul><ul><li>The implementation, on a corporate level, of the three pillars of sustainable development </li></ul>
    7. 7. SRI and its approaches <ul><li>SRI = Sustainable & Responsible Investment </li></ul><ul><li>An investment strategy that takes into account a company's performance in the three pillars of sustainable development, in addition to its financial performance, when selecting and managing investment portfolios </li></ul><ul><li>SRI includes numerous, varied approaches: </li></ul><ul><ul><li>Ethical </li></ul></ul><ul><ul><li>Negative screening </li></ul></ul><ul><ul><li>Positive screening </li></ul></ul><ul><ul><li>Best in class </li></ul></ul><ul><ul><li>Engagement </li></ul></ul><ul><ul><li>Shareholder activism </li></ul></ul><ul><ul><li>ESG integration </li></ul></ul>What is SRI ?
    8. 8. UN Principles for Responsible Investment : Institutional investors lead the way to mainstreaming PRI launched in April 2006 by UN Secretary General “ The Principles provide a framework for achieving better long-term investment returns, and more sustainable markets. They offer a path for integrating environmental, social and governance criteria into investment analysis and ownership practices. If implemented, they have tremendous potential to more closely align investment practices with the goals of the United Nations, thereby contributing to a more stable and inclusive global economy”. Significant and growing support : 245 signatories. Representing > US$10 trillion . September 2007
    9. 9. According to Markowitz Theory SRI should structurally underperform … <ul><li>1952 : Markowitz theory proposes </li></ul><ul><ul><li>How rational investors will use diversification to optimize their portfolios, </li></ul></ul><ul><ul><li>How an asset should be priced given its risk relative to the market as a whole. </li></ul></ul><ul><li>The basic concepts of the theory are the </li></ul><ul><ul><li>Efficient frontier </li></ul></ul><ul><ul><li>Capital Asset Pricing Model </li></ul></ul><ul><ul><li>Beta coefficient </li></ul></ul><ul><ul><li>Capital Market Line and Securities Market Line. </li></ul></ul>According to this theory If markets are efficient the CAPM model should demonstrate the underperformance of any restricted asset management style such as ethical or SRI investment approach. Indeed, a restricted investment universe should lead to a lower diversification potential, thus a higher risk exposure
    10. 10. But Moskowitz says SRI could lead to a “virtuous circle” According to this theory High level of information quality can improve investors’ decision making process thanks to a better understanding of companies issues and opportunities. <ul><li>1972 : Moskowitz states </li></ul><ul><ul><li>“ social performance of corporations can be influenced by capital markets responding to pressures from investors and customers who perceive new goal for their money.” </li></ul></ul><ul><ul><li>“ while corporations have long been under a variety of pressures to meet their social responsibilities, they are now faced with the possibility that their publicly traded shares will be bought or dumped on the basis of their actions or inactions on this front.” </li></ul></ul><ul><ul><li>“ socially investments need not, of course, be unsound financially. To the contrary, the argument has been made that the socially aware corporation possesses the special sensitivity that will enable it to surpass peers.” </li></ul></ul><ul><li>From intuition to theory </li></ul><ul><ul><li>The idea enhanced extra financial integration and stakeholders transparency provide investors with higher level of valuable information not yet identified by the market. </li></ul></ul>
    11. 11. And traditional “market icons” have different points of view <ul><li>CSR as a business opportunity driving a competitive advantage </li></ul><ul><ul><li>ESG positively seen as a caution for reputation protection </li></ul></ul><ul><li>« It takes 20 years to build a reputation and five minutes to ruin it. » Warren Buffet .  </li></ul><ul><li>CSR as an obstacle to capitalism, generating additional and useless costs </li></ul><ul><li>Milton Friedman . (The New York Times Magazine, 1970) shares these views, to say the least … </li></ul><ul><li>« The discussions of &quot;social responsibilities of business&quot; are notable of analytical looseness and lack of rigor. Businessmen who talk this way are unwitting puppets of the intellectual forces that have been undermining the basis of a free society… » </li></ul><ul><li>« There is one and only one social responsibility of business : to use it resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without fraud. » </li></ul>
    12. 12. This controversy generated huge academic research … Around 150 research pieces published since the early 70s Nehrt (1996 ), « Timing and intensity effects of environmental investments » Dowell, Hart & Yeung (2005 ), « Do corporate global environmental standards create or destroy value ? » Wolf & Curcio (1996 ), « Corporate environmental strategy : impact upon firm value » Capon, Farley & Hoenig (1990 ), « Determinants of financial performance : a meta-analysis » DiBartolomeo & Kurtz (1999 ), « Managing risk exposures of socially screened portfolios » Blank, Herbert & Carty (2002 ), « The eco-efficiency anomaly » Abramson, Lorne & Dan Chung (2000 ), « Socially responsible investing: viable for value investors ? » Derwall & Koedijk (2005 ), « The performance of socially responsible bond funds » Angel & Rivoli (1997 ), « Does ethical investing impose a cost upon the firm ? A theoritical examination » King & Lenox (2000 ), « Does it really pay to be green ? An empirical study of firm environmental and financial performance » Brown & Caylor (2004 ), « The correlation between corporate governance and company performance » Dimtcheva, Morrison & Marsland (2002 ), « Green with envy » Dimtcheva, Morrison & Marsland (2002 ), « Boxing against green shadows » Goyen & Beal (1999 ), « To invest or to donate – an investigation of the characteristics of some green investors » Feldman, Soyka & Ameer (1996 ), « Does improving a firm’s environmental management system and environmental performance result in a higher stock price? » Barth, McNichols & Wilson (1995 ), « Factors influencing firm’s disclosures about environmental liabilities » Fogler & Nutt (1975 ), « A note on social responsibility and stock valuation » Drobetz, Schillhofer & Zimmermann (2003 ), « Corporate governance and expected stock returns, evidence from Germany » Derwall, Guenster, Bauer & Koedijk (2005 ), « The eco-efficiency premium puzzle » Garz, Volk, Gilles (2002 ), « More gain than pain – SRI : sustainability pays off » Gond (2006 ), « Construire la relation (positive) entre performance sociétale et financière sur le marché de l’ISR : de la performation à l’autoréalisation ? » And this is just a small sample …
    13. 13. <ul><li>The Materiality of Environmental, Social and Governance issues to Equity Pricing , Launched in 2004 and Show Me The Money: L inking Environmental, Social and Governance Factors to Company Value , S econd Materiality Report, July 2006 </li></ul><ul><ul><li>Objective: Identify and quantify the potential impact of Environmental, Social and Governance (ESG) issues on stock pricing </li></ul></ul><ul><ul><li>Based upon research from major brokerage houses </li></ul></ul><ul><ul><li>Conclusion: Overwhelming evidence that ESG issues are material to portfolio investment value </li></ul></ul><ul><ul><li>Downloaded over 100,000 times </li></ul></ul>The broker community is publishing compelling ESG-related research
    14. 14. … Producing interesting but diversified results <ul><li>This is why UNEP FI AMWG and Mercer Investment Consulting have embarked into a meta analysis project. </li></ul><ul><li>The idea is to link broker and academic research on ESG factors in a report: </li></ul><ul><ul><li>Demystifying the Responsible Investment Performance . </li></ul></ul>
    15. 15. Demystifying Responsible Investment Performance : General outline of study <ul><li>Forewords </li></ul><ul><li>UNEP FI Asset Management Working Group & Mercer Investment Consulting </li></ul><ul><li>Introduction </li></ul><ul><li>large matrix of studies and template aspects </li></ul><ul><li>Research </li></ul><ul><li>20 academic and 10 broker studies </li></ul><ul><li>Conclusion </li></ul><ul><li>academic and broker/industry research connected </li></ul><ul><li>Future Research Opportunities </li></ul>
    16. 16. Demystifying Responsible Investment Performance : A good start, the Mercer foreword Foreword from Mercer’s Investment Consulting business There has long been a debate between those who regard environmental, social and governance (ESG) factors as being risk factors which can have a material impact on investment performance and those who regard them as exclusive social issues. However, the evidence of materiality with regard to ESG factors is beginning to take shape as more academic and practitioner research in this field emerges. Of the 20 academic studies reviewed in this report, it is interesting to see evidence of a positive relationship between ESG factors and portfolio performance in half of these, with 7 reporting a neutral effect and 3 a negative association. A combination of short data samples, variability in data sources and different geographical regions probably explains the divergence in results. Moreover, many of the academic studies are focused on examining the impact of screened versus traditional portfolio returns, which is not the approach that most mainstream investors now take in the integration of ESG factors into the investment process. Over time, as more resources are allocated to research in this field and data comparability improves, we anticipate that the evidence supporting ESG integration will become more robust. Indeed, we are already seeing evidence of materiality in the returns that ESG integrated strategies are producing amongst practitioners (as evidenced by the broker studies also reviewed in this report). At Mercer we will continue to help asset owners in their quest to integrate ESG factors into fiduciary processes and to encourage investment managers to seek innovative solutions for integrating ESG into their investment decisions.   Tim Gardener Jane Ambachtsheer Global Head Global Head, Responsible Investment Mercer’s Investment Consulting business Mercer’s Investment Consulting business
    17. 17. Demystifying Responsible Investment Performance : Two representative samples <ul><li>10 broker studies </li></ul><ul><li>Selected by the UNEP FI AMWG </li></ul><ul><li>Different research methods </li></ul><ul><li>Various sectors reviewed </li></ul><ul><li>Thematic bias reflecting brokerage industry’s current ESG research production … </li></ul><ul><li>… a smaller portion of quant ESG-integration research </li></ul><ul><li>20 academic studies </li></ul><ul><li>selected by Mercer Investment Consulting </li></ul><ul><li>approved by UNEP FI AMWG </li></ul><ul><li>representing almost all regions </li></ul><ul><li>applying diverse research methods </li></ul><ul><li>and the extent to which they measure the financial effect of E, S or G factors on portfolio performance. </li></ul>
    18. 18. Framework of Study : A common matrix enabling comparison
    19. 19. Academic studies : Detailed Results 1
    20. 20. Academic studies : Detailed Results 2
    21. 21. Academic studies : Key findings <ul><li>The breadth and depth of academic research on measuring the relationship with portfolio performance has expanded. </li></ul><ul><li>Of the twenty studies reviewed : </li></ul><ul><li>- 10 showed evidence of a positive relationship between ESG factors and portfolio performance, </li></ul><ul><li>- 7 reported a neutral effect </li></ul><ul><li>- and 3 a negative association. </li></ul><ul><li>Results vary depending on the research methods used, and some of the studies still refer to a relatively short sample period that makes statistical analysis difficult to interpret </li></ul><ul><li>While the results vary, the evidence suggests that there does not appear to be a performance penalty from taking ESG factors into account in the portfolio management process. </li></ul>
    22. 22. Brokers studies : Detailed results *While the authors of these thematic studies were generally positive on ESG factors explored, specific tests for correlations between these considerations and investment performance were not conducted. For this reason, a neutral rating was assigned.
    23. 23. Brokers studies: Key findings <ul><li>True scarcity of brokers ESG quantitative research: Goldman Sachs and WestLB being exceptions with noteworthy findings highlighting that good ESG management demonstrates superior risk management and subsequently superior management overall </li></ul><ul><ul><li>“ ESG performance as a proxy for management quality, in so far as it reflects the company’s ability to respond to long term trends and maintain a competitive advantage” (2007). Goldman Sachs </li></ul></ul><ul><li>Real hype about climate change, cleantechs, and Co2 related surveys seen as winning business case. But, there’s no free lunch. Some really original themes such as nanotechnology are also being reviewed ( Oddo ) </li></ul><ul><li>  </li></ul><ul><li>Still very difficult to find a clear link between mainstream financial criteria (e.g., share price volatility) and ESG factors: not yet been analysed long enough and in sufficient detail; and not yet been fully taken into account and priced in by many investors. </li></ul><ul><li>The studies suggest though there are important reasons to look at ESG factors more closely: </li></ul><ul><ul><li>“ ESG issues, specifically climate change, can “gradually but powerfully change the economic landscape” and cause “periodic sharp movements in asset prices.” (2007:1) Lehman Brothers . </li></ul></ul>
    24. 24. Linking Academic and Brokers research : 5 key messages <ul><li>ESG integration is not synonymous to a few simple automatic exclusions. </li></ul><ul><li>SRI, as a financial discipline, which can be successfully implemented in virtually any investment style </li></ul><ul><li>The argument that integrating ESG factors into investment analysis and decision-making will only lead to underperformance simply cannot be made (manager skill, investment style, time period, etc. are integral) </li></ul><ul><li>More rigorous quantitative ESG research is vital to improve data comparability </li></ul><ul><li>Long-term horizon needed to integrate ESG factors more effectively and for investors to act more responsibly. </li></ul>
    25. 25. Going forward: Lift off for a new research Odyssey <ul><li>New areas could be explored (e.g., ESG and emerging markets) </li></ul><ul><li>Systematically measuring ESG factors’ contribution on a sector by sector basis to: </li></ul><ul><li>- overall risk management policy: already embedded to some extent in large caps valuations </li></ul><ul><li>- opportunity generation: mainly considered for innovative small & midcaps </li></ul><ul><li>Next Step: UNEP FI AMWG initiating a second research project </li></ul><ul><li>The idea is obviously not to change the DCF model but to upgrade the discount rate valuation. </li></ul><ul><li>Our goal is to selectively mainstream ESG criteria but only if they deserve it. </li></ul><ul><ul><li>“ Not everything that counts can be counted and not everything that can be counted counts “ (Albert Einstein) . </li></ul></ul><ul><ul><li>But we must try at least! </li></ul></ul>