Patience, Persistence or Punishment - Matthew Weatherley White

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TBLI CONFERENCE™ EUROPE 2012 - Zurich - Switzerland

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Patience, Persistence or Punishment - Matthew Weatherley White

  1. 1. Vs.Patience, Persistence or Punishment?
  2. 2. “Level set” our conversation• US-centric experience > limited Euro/World• ESG screening is only one part of our work… and a relatively small part (<15% public equity exposure) – Internal tools in late beta to support ESG metrics – ESG discipline more challenging to apply in private and alternative investments due to lack of transparency, historical data and market comps• ESG in listed equities as analog for non-marketable assets• Question: does/should ESG offer alpha? – “value-added” vs. “values-added” discipline? – Beta as a value driver (institutional vs. individual)
  3. 3. Challenges of ESG Integration Social / Logistics Fiduciary Values Performance– Scoring – ESG Screened Universe– Exclusions and company scores– Inclusions – Minimize tracking error– Relativity to standard benchmark– Impact? – KPI’s for alternatives not standardized
  4. 4. Alpha vs. Beta: a question of timing?• Beta is always available… but sometimes undesirable.• Alpha is rarely available… and frequently misunderstood (and thus dangerous!).• Institutional behavior vs. the pursuit of alpha – Anyone who evaluates manager performance on a quarterly basis should be prohibited from using the word “alpha”!
  5. 5. Case Studies: Aperio and GEOS Using equity-based data to extrapolate a strategy for full ESG integration.
  6. 6. Aperio Capital• Pure beta: .99 historical correlation to selected benchmark(s)• No promise of outperformance. No potential for underperformance.• “managed passive” strategy = custom index fund – Low fee – Tax efficient – “Buying the market” – a royal pain in the ass… just ask your clients!
  7. 7. Ranges of Tracking Error 600 600 Active Tracking Error Typical Active Manager Typical Active Manager 400 400 Typical SRI Screens 200 Basis Points Basis Points 200 Index SRI Tracking Error SRI Screened Portfolio 0 0 -200 -200 -400 -400 -600 -600 Source for Expected Active Tracking Error: GMO survey of Callan Associates, Inc., Mercer Investment Consulting, Watson Wyatt Worldwide Source for Expected Index SRI Tracking Error: Aperio GroupAperio v. [Latin] to make 7clear, to reveal the truth
  8. 8. Impact of Screening on Tracking ErrorAperio v. [Latin] to make 8clear, to reveal the truth
  9. 9. It’s Just Math!Aperio v. [Latin] to make 9clear, to reveal the truth
  10. 10. Impact of Tracking Error on Portfolio RiskAperio v. [Latin] to make 10clear, to reveal the truth
  11. 11. Measuring the Impact of Screening on Risk and Return Estimated Incremental Risk (%)Negative Screens - eliminate companies involved in: Tracking Error (%) (Standard Deviation)Animal Testing (Pharma and Non-Pharma) 0.78 0.02Animal Testing (Non-Pharma Only) 0.59 0.01Tobacco 0.50 0.01Abortion, Contraceptives, Stem Cell Research, Tobacco, Alcohol 1.06 0.03Weapons and Firearms 0.41 0.00Weapons and Firearms & No DoD Contracting 2.84 0.20Positive Screens - emphasize companies with better:Environmental Record 0.85 0.02Corporate Governance 0.85 0.02 Tracking error is a measure of how closely a portfolio follows, or “tracks”, its benchmark index. Annual tracking error is a statistical measure that is defined as the standard deviation of the difference in annual returns between a portfolio and its benchmark. It is often described as a measure of “unsystematic” risk. Tracking error reflects a forecast estimate based on the Barra Aegis multifactor model. Incremental risk converts forecast tracking error to incremental portfolio standard deviation based on market standard deviation of 20%, converted to variance by squaring and then adding to squared tracking error, the sum of which is then converted back to standard deviation by taking square root. Source:Aperio v. [Latin] to make 11clear, to reveal the truth
  12. 12. Resources • www.kld.com • www.sustainalytics.com • www.iwfinancial.com • Bloomberg • Thomson Reuters/Asset4 12Aperio v. [Latin] to make clear, to reveal the truth
  13. 13. Essex GEOS• Pure alpha: .6 correlation to S&P 500• Concentrated portfolio: < 30 positions• Extremely focused: four primary themes• Global view• High volatility: gotta know what you own…. and why!
  14. 14. Energy Technology Transitions Are Now Faster… V. APPENDIX
  15. 15. …and Lower CO2V. APPENDIX
  16. 16. U.S. Primary Energy Flow by Sector V. APPENDIX
  17. 17. GDP Growth = BTU GrowthV. APPENDIX
  18. 18. China and India Will Drive Over 50% of Energy Demand Source: IEA 2011 World Energy Outlook V. APPENDIX
  19. 19. China Drives Coal Demand…“We will vigorously develop renewable energy and nuclear energy. We will endeavor to increase the share of non- fossil fuels in primary energy consumption to around 15% by 2020.” -Chinese President Hu Jintao, address at UN Climate Change Summit, September 22, 2009. V. APPENDIX
  20. 20. …and Oil Demand Yearly Data 12/31/1992 - 12/31/2010 Top World Petroleum Consumers (as a % of World Demand) Top Five Consumers 12/31/2010 = 44.1% 47 47 46 46 45 45 44 44 United States 12/31/2010 = 22.0% 25 25 24 24 23 23 10 China 12/31/2010 = 10.6% 10 9 9 8 8 7 7 6 6 5 5 8.0 Japan 12/31/2010 = 5.1% 8.0 7.5 7.5 7.0 7.0 6.5 6.5 6.0 6.0 5.5 5.5 Russia 12/31/2010 = 3.6% 6 6 5 5 4 4 4.2 Germany 12/31/2010 = 2.9% 4.2 3.9 3.9 3.6 3.6 3.3 3.3 3.0 3.0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010(ESX1083D) Copyright 2012 N D ed avis Research, Inc. Further distribution prohibited without prior perm ission. All Rights Reserved. See N R D D isclaim at er www.ndr.com /copyright.htm l . For data vendor disclaim ers refer to www.ndr.com/vendorinfo/ . V. APPENDIX
  21. 21. Where Is Food Grown?Sources: Early Warning; Proceedings of the National Academy of Sciences, ‘Trading carbon for food: Global comparison of carbon stocks vs. crop yields on agriculturalland, West et al, July 2010.Cropland distribution and average annual yield. Croplands cover ∼15 million km2 (8). The weighted average dry crop yields per unit area for 175herbaceous and woody crop types . V. APPENDIX
  22. 22. In Areas That Are Water Stressed Source: The United Nations World Water Development Report 3, World Water Assessment Programme; 2009 V. APPENDIX
  23. 23. Grain Demand > SupplyV. APPENDIX
  24. 24. The Economics of Climate Change Stern Review • Climate change threatens to be the greatest and widest-ranging market failure ever seen • The cost to avoid significant climate change would be significantly lower than the costs to combat it – Spend 1% GDP each year and remove most of the risk from climate change, staying below 550 parts per million of C02 – Or, expect an annual 5-20% GDP loss, from an increase in temperature and subsequent extreme weather, losses to food, water, and the ecosystem • Recommendations – Reduce consumer demand for carbon intensive goods and services – Improve grid efficiency and reliability – Promote cleaner energy and transportation technology – Create a global market for carbon pricingSource: Stern Review: The Economics of Climate Change, BBC NewsThe information is not intended to provide investment advice. V. APPENDIX
  25. 25. Leveraging Wedges for CO2 Stabilization • The wedge strategy applies a broad portfolio of measures to meet a stabilization level of 550 ppm CO2e • Each “wedge” is a strategy to reduce carbon emissions that grows from zero to 1.0 Gt(C)/yr in 50 years • Cumulatively, a wedge redirects the flow of 25 Gt(C) in its first 50 years. This is 2.5 trillion dollars at $100/t(C) – $100/t(C): $2.5t x 8 wedges = $20 trillion – $50/t(C): $1.25t x 8 wedges = $10 trillion • Fill the stabilization triangle with wedges – Energy efficiency – Fuel switching – Carbon capture & storage (CCS) – Nuclear – Wind – Solar – Biomass fuels – Natural carbon sinksSource: Carbon Mitigation Initiative, Princeton Environmental Institute, Princeton University, 2007 V. APPENDIX
  26. 26. Global Scientific Consensus – IPCC• Intergovernmental Panel on Climate Change 4th Assessment "Most of the observed increase in globally averaged temperatures since the mid-20th century is very likely (greater than 90%) due to the observed increase in anthropogenic greenhouse gas concentrations." Working Group I – February 2007 “Evidence from all continents and most oceans shows that many natural systems are being affected by regional climate changes, particularly temperature increases.“ Working Group II – April 2007 “…stabilization of greenhouse gas concentrations is possible at a reasonable cost, with stabilization between 445ppm and 535ppm costing less than 3% of global GDP.” Working Group III – May 2007 Source: IPCC, retrieved on November 19, IPCC 2007: WG1-AR4 2007 V. APPENDIX
  27. 27. Global Scientific Consensus – IPCCSource: IPCC, retrieved on November 19,2007. Fig2-1. V. APPENDIX
  28. 28. Essex GEOS Performance Composite Investment Returns SINCE INCEPTION SINCE INCEPTION Q2 2012 YTD 2012 (Cumulative) (Annualized) 4/1/12-6/30/12 1/1/12-6/30/12 7/1/09-6/30/12 7/1/09-6/30/12Total Portfolio (Gross) -10.76% 0.35% 19.29% 6.06%Total Portfolio (Net) -10.99% -0.15% 15.77% 5.00%MSCI World Index Total Return Gross -4.86% 6.29% 38.90% 11.93%Wilderhill Clean Energy Index (w/o income) -18.83% -11.23% -54.67% -23.20% • Gross performance results presented are net of transaction costs, withholding taxes and direct expenses, but before management fees, custody fees and other indirect expenses. • Net performance results are presented net of the maximum applicable management fees, transaction costs, withholding taxes and direct expenses, but before custody fees and other indirect expenses. • The performance of the portfolios comprising the composite may have been affected significantly by material market and economic conditions, including interest rates, market trends and general business conditions, which may or may not be repeated in the future. • Past performance is not indicative of future results. • Please see the attached fully compliant presentation that adheres to the Global Investment Performance Standards (GIPS®) • Benchmarks:. The MSCI World Index Total Return Gross is a global benchmark that includes reinvestment of dividends and it is quoted in USD. The index is a free-float weighted equity index composed of companies representative of the market structure of 23 developed market countries in North America, Europe, and the Asia/Pacific Region. It does not include emerging markets. An index is unmanaged and cannot be invested in directly. The Wilderhill Clean Energy Index is a modified equal dollar weighted index comprised of publicly traded companies whose business’s stand to benefit substantially from societal transition toward the use of cleaner energy and conservation. An index is unmanaged and cannot be invested in directly. III. ESSEX GEOS PERFORMANCE & HOLDINGS
  29. 29. Patience, Persistence or Punishment?• Patience? – Data inconclusive – too much noise and insufficient longitudinal evidence• Persistence? – A question of simply forcing the discipline until it has been proven successful?• Punishment? – Clear environmental value is not always reflected in stock prices – Even if we are right… will we be too late?
  30. 30. Alpha vs. Beta: full portfolio ESG integration• Beta = “values enhancement”• Alpha = “value enhancement”• Time frame for pursuing alpha must be explicitly understood… and explained to clients and fiduciaries• We must ask ourselves the hard question: If we truly believe that ESG offers the potential for meaningful alpha, are we willing/able to accept the volatility and time frame required to pursue it?

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