msci.commsci.com
TBLI 2013: Application of ESG Signals in
Portfolio Construction
June 18, 2013
Olga Emelianova
MSCI ESG IV...
msci.com 2msci.com
Current trends in ESG investment
• Do we see any growth in SRI or ESG integration?
• What drives invest...
msci.com
Increased Focus on ESG Integration by Investors
 Asset Owners are increasingly interested in incorporating long ...
msci.com
The Evolution of ESG Investment Mandates
Socially Responsible Screening
• Supports screening on religious, ethica...
msci.com
Identifying Systemic Risks through Macro Trends
5
Population, economic
growth outstrips natural
capacity
Richer E...
msci.com 6msci.com
ESG assessment: company level
• Are there implications of ESG performance on
companies’ capacity for lo...
msci.com
Examples: ESG Events and Performance
7
0
1
2
3
4
5
6
Aug-11 Feb-12 Aug-12
Aquarius Platinum Limited
May 2012: wor...
msci.com
Examples: ESG Factors and Financial Performance
8
2013 Q1 Results
Same Store
Sales
Operating
Profit
-50%
-40%
-30...
msci.com 9
Level of
Exposure
Management
Capacity
 Type of operations
 Location of operations
 Size of operation, etc.
...
msci.com
Example: Assessment of Health & Safety in Mining
1. Geographic Location
2. Mine Production Type
1. H&S Strategy a...
msci.com
Calculating Key Issue Scores (0-10): Risks
How Well Is the Company Managing the Issue, Given Its Specific Risk Le...
msci.com
Example: Company Performance on H&S Key Issue
12
= 10,000 employees
Alcoa
BHP Billiton
Norsk Hydro
Boliden
Cameco...
msci.com
Darden
Domino's
McDonalds Corp
Chipotle Mexican
Grill
Starbucks Corp
Yum! Brands
0
1
2
3
4
5
6
7
8
9
10
0 1 2 3 4...
msci.com 14msci.com
ESG assessment: portfolio level
• Can ESG factors be integrated in portfolios?
• Z. Nagy, D. Cogan, an...
msci.com
“ESG Factors in Portfolio Construction”:
Three ESG-tilt Strategies
 Approach
 Use case: Asset owner seeks to ra...
msci.com
Performance Analysis: Comparing the Three ESG Tilt Strategies
 During the sample period all three strategies sho...
msci.com
About MSCI ESG Research
 The leading provider of tools to measure and manage ESG Risk for asset owners, investme...
msci.com 18msci.com
MSCI ESG Global Client Service
Americas + 1.212.804.5299
Asia Pacific + 612.9033.9339
Europe,MiddleEas...
msci.com 19msci.com
Notice and Disclaimer
 This document and all of the information contained in it, including without li...
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Olga emelianova tbli2013

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TBLI CONFERENCE™ is the prime annual global networking and learning event on Environment, Social, Governance (ESG) and Impact Investing.

TBLI CONFERENCE USA New York 2013
Monday and Tuesday, June 17-18, 2013

Speakers:
Paul Rose
Vice President of the Royal Geographical Society
Richard L. Kauffman
Chairman for Energy Policy and Finance for the State of New York - Governor of New York's Office and Cabinet - United States of America
Martin Rapaport is chairman of the Rapaport Group and founder of the Rapaport Diamond Report

Published in: Economy & Finance, Business
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Olga emelianova tbli2013

  1. 1. msci.commsci.com TBLI 2013: Application of ESG Signals in Portfolio Construction June 18, 2013 Olga Emelianova MSCI ESG IVA Rating Research
  2. 2. msci.com 2msci.com Current trends in ESG investment • Do we see any growth in SRI or ESG integration? • What drives investment strategies? • What tools are available?
  3. 3. msci.com Increased Focus on ESG Integration by Investors  Asset Owners are increasingly interested in incorporating long term sustainability issues and scrutinizing the ESG performance of asset managers  7% of the total global investable market is subject to PRI ESG integration  Asset owners and managers increasingly finding ESG to be a material topic for engagement: tripling of ‘FOR’ votes on E&S proxy proposals since 1999 3 7.4% 7.6% 8.7% 9.4% 12.0%12.1% 9.8% 12.5% 15.0% 14.0% 16.3% 18.3% 20.6% 0% 5% 10% 15% 20% 25% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: ISS Checklist Average Vote Results for All E&S Proxy Proposals Source: UNPRI 2011 Report on Progress UN PRI Signatories & AUM
  4. 4. msci.com The Evolution of ESG Investment Mandates Socially Responsible Screening • Supports screening on religious, ethical, and divestment criteria (e.g. weapons, tobacco, Sudan, etc.) ESG Ethical Evaluation • Analyzes & monitors ‘ESG controversies’ and violations of global norms such as the UN Global Compact ESG Integration • Identifies ESG related investment risks and opportunities not often captured by conventional analysis 4
  5. 5. msci.com Identifying Systemic Risks through Macro Trends 5 Population, economic growth outstrips natural capacity Richer EM, Aging DM Rising temperatures, sea level Digitalization of all assets Macro Trends Systemic Risks Cost to Companies
  6. 6. msci.com 6msci.com ESG assessment: company level • Are there implications of ESG performance on companies’ capacity for long-term growth? • Can we anticipate ESG-related events or assess long- term performance risks?
  7. 7. msci.com Examples: ESG Events and Performance 7 0 1 2 3 4 5 6 Aug-11 Feb-12 Aug-12 Aquarius Platinum Limited May 2012: work stoppages ordered by Government March 2012: Rated ‘CCC’ Bottom quartile ranking on ‘Health & Safety’ 0 20 40 60 80 100 120 Oct-10 Feb-11 Jun-11 Oct-11 Feb-12 Jun-12 Oct-12 Monster Beverage Oct 23rd FDA probe of five reported death linked to Monster Energy Drink 2011 B 2012 CCC June, 2012: Downgrade to ‘CCC’ Bottom quartile ranking on ‘Nutrition & Health’ Other examples: Massey Energy, Sun Hung Kai Properties, Carnival, Zijin Mining, Foxconn Disclaimer: Examples only. Past performance is not indicative of future performance BB 2011 CCC 2012 CCC
  8. 8. msci.com Examples: ESG Factors and Financial Performance 8 2013 Q1 Results Same Store Sales Operating Profit -50% -40% -30% -20% -10% 0% 10% China US -41% -20% Yum! Brands 2011 IVA Profile: ”the company's high exposure (to food safety problems) compared to peers does not appear to be adequately countered by strategies to reduce food safety incidents” Source: Data from Yum! Brands Investor Presentation May 8, 2013 2010 B 2011 CCC 2012 CCC 0 10 20 30 40 50 60 Corrupt Officials Gap between Rich & Poor Food Safety %Respondents 2008 2012 Top Three Issues Cited by Chinese Respondents as a ‘Very Big Problem’ Source: Pew Research Project, Global Attitudes Survey China 2012
  9. 9. msci.com 9 Level of Exposure Management Capacity  Type of operations  Location of operations  Size of operation, etc.  Unlike traditional SRI ratings, MSCI ESG IVA ratings examine companies’ exposure to ESG-related risks and the management capacity to mitigate such risks  Companies with higher risk profiles are expected to demonstrate stronger mitigation systems MSCI ESG IVA Rating Model  Policies & commitments  Programs & initiatives  Performance indicators  Controversies
  10. 10. msci.com Example: Assessment of Health & Safety in Mining 1. Geographic Location 2. Mine Production Type 1. H&S Strategy and Targets  Reduction Targets 2. H&S Management Systems  OHSAS 18001 certification 3. H&S Performance Metrics  Injury Frequency Rates and Fatalities  Y-o-Y Improvement Trends 4. Management of H&S Incidents  Impact Size, Pattern of Events, Company’s Response, etc. 10 Risk Management & Performance Risk Exposure Country Fatalities per 100,000 miners Australia 11.16 India 31.33 Indonesia 23.50 Mine Characteristic Average Death per 100,000 Average Injury per 100,000 Underground Coal 42.91 7,253.03 Underground Metallic 28.18 5,393.02 Surface Metal, Stripping 7.04 3,265.51 Surface metal 6.89 3,193.01 Surface Coal, Stripping 14.32 2,263.64 Surface Coal 13.73 2,249.95 Mine Characteristic Average Death per 100,000 Average Injury per 100,000 Underground Coal 42.91 7,253.03 Underground Metallic 28.18 5,393.02 Surface Metal, Stripping 7.04 3,265.51 Surface metal 6.89 3,193.01 Surface Coal, Stripping 14.32 2,263.64 Surface Coal 13.73 2,249.95 Risk levels are tied to mining operation characteristics
  11. 11. msci.com Calculating Key Issue Scores (0-10): Risks How Well Is the Company Managing the Issue, Given Its Specific Risk Level? 11  When risk exposure=0 and risk management=0, the KI score=5  When risk exposure=10, the highest KI score is capped at 7 (because there are risks that can’t be fully managed even if company is doing everything possible)  When risk management<5, it is not possible to get KI score=10 even if exposure is very low (we set a minimum for ‘management’ attention) 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 RiskManagement Risk Exposure Key Issue Score = 10 Key Issue Scores = 0 Key Issue Score = 2 Key Issue Score = 10 Source: MSCI ESG Research
  12. 12. msci.com Example: Company Performance on H&S Key Issue 12 = 10,000 employees Alcoa BHP Billiton Norsk Hydro Boliden Cameco Anglo AmericanRio Tinto Xstrata Freeport-McMoRan Sumitomo Metal Peabody Energy Inmet ENRC Glencore KGHMGrupo Mexico CONSOL Energy Arch Coal Ivanhoe Mines LynasCorp Coal India MMC Norilsk China Shenhua Energy Kazakhmys Vedanta Res. Sterlite (India) South. Copper First Quantum Alpha Natural 0 5 10 4 5 6 7 8 9 10 Top Quartile Second Quartile Third Quartile Bottom Quartile RiskManagement Risk Exposure Moderate Management (Safety management structure average for industry, some improvement, average performance) Strong Management of Key Issue (Regular audits, strong improvements, leading performance) Poor Management (Average to poor safety metrics, lack of stringent management systems and programs) Moderate Risk (Regions with higher safety standards and metrics such as Australia, lower risk operations such as surface mining) High Risk (High risk countries such as China and high risk operations such as primary processing or underground coal mining)
  13. 13. msci.com Darden Domino's McDonalds Corp Chipotle Mexican Grill Starbucks Corp Yum! Brands 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 13 Finding Value in ESG Analysis: Benchmarking Exposure and Management of Food Safety Risks High Risk Exposure, Poor Risk Management •higher % revenues from products prone to recalls, high health impact •Larger, more complex operations Low Risk Exposure, Strong Risk Management •Traceability •Testing •Employee Training •Franchisee Training •Certification •Etc. Risk Management Risk Exposure Source: MSCI ESG Research IVA Industry Report; Restaurants, 2012
  14. 14. msci.com 14msci.com ESG assessment: portfolio level • Can ESG factors be integrated in portfolios? • Z. Nagy, D. Cogan, and D. Sinnreich “Optimizing ESG Factors in Portfolio Construction” (December 2012)
  15. 15. msci.com “ESG Factors in Portfolio Construction”: Three ESG-tilt Strategies  Approach  Use case: Asset owner seeks to raise ESG profile of global portfolio without incurring large tracking error Combine MSCI ESG IVA Ratings with Barra Global Equity Model to build optimized portfolios with higher ESG scores Keep risk, performance and structural characteristics equivalent to benchmarks like the MSCI World Index (risk reducing or index enhancing, rather than alpha seeking)  Strategy 1: ESG exclusion  Worst-in-class approach excludes low-rated (‘CCC’) companies  Strategy 2: ESG tilt  Best-in-class approach overweights higher-rated ESG companies, underweights lower- rated ones  Strategy 3: ESG momentum  ‘Best-effort’ approach overweights companies with ESG ratings upgrades over the preceding 12-month period and underweights companies with ratings downgrades  Time series: Feb. 2007 – Dec. 2012 for ESG Exclusion & ESG Tilt; Feb. 2008 – Dec. 2012 for ESG Momentum 15
  16. 16. msci.com Performance Analysis: Comparing the Three ESG Tilt Strategies  During the sample period all three strategies showed potential to improved ESG characteristics of a portfolio while limiting tracking error, impact on risk-adjusted returns  The best active returns and highest information ratio during the sample period came with companies showing ESG momentum – i.e. their IVA ratings improved over a recent time period Comparison of ESG Strategies, February 2008 – December 2012 16 ESG strategy ESG Exclusion ESG Tilt ESG Momentum Active return (annual, %) 0.10 0.05 0.35 Common factor contribution (annual, %) 0.06 0.03 0.08 Asset specific contribution (annual, %) 0.05 0.01 0.27 Tracking error (ex-post, annual %) 0.45 0.46 0.36 Information ratio 0.23 0.10 0.97 Average improvement in ESG score 1.27 1.21 0.46 Average relative improvement in ESG score (%) 23 22 8 Disclaimer: Past performance is not a predictor of future results
  17. 17. msci.com About MSCI ESG Research  The leading provider of tools to measure and manage ESG Risk for asset owners, investment managers, and consultants  Over 60 asset owners with $2.3 trillion in assets depend on MSCI ESG Research  Over 500 clients with $15 trillion in assets globally  ESG ratings and research expertise produced 100% in-house  Signatory to the Principles for Responsible Investment (www.unpri.org)  Direct successor to IRRC (1972), KLD (1988) and Innovest (1998)  Staff of 140+, including more than 90 in ESG research  Americas: New York, Boston, San Francisco, Toronto, Ann Arbor, Rockville  EMEA: Paris, London, Geneva  APAC: Tokyo, Sydney, Manila, Mumbai, Hong Kong, Beijing  Products and services:  ESG research and ratings  Screening data  Custom research  Indices 17
  18. 18. msci.com 18msci.com MSCI ESG Global Client Service Americas + 1.212.804.5299 Asia Pacific + 612.9033.9339 Europe,MiddleEast and Africa + +44.207.618.2510 esgclientservice@msci.com www.msci.com/esg
  19. 19. msci.com 19msci.com Notice and Disclaimer  This document and all of the information contained in it, including without limitation all text, data, graphs, charts (collectively, the “Information”) is the property of MSCI Inc. or its subsidiaries (collectively, “MSCI”), or MSCI’s licensors, direct or indirect suppliers or any third party involved in making or compiling any Information (collectively, with MSCI, the “Information Providers”) and is provided for informational purposes only. The Information may not be reproduced or redisseminated in whole or in part without prior written permission from MSCI.  The Information may not be used to create derivative works or to verify or correct other data or information. For example (but without limitation), the Information may not be used to create indices, databases, risk models, analytics, software, or in connection with the issuing, offering, sponsoring, managing or marketing of any securities, portfolios, financial products or other investment vehicles utilizing or based on, linked to, tracking or otherwise derived from the Information or any other MSCI data, information, products or services.  The user of the Information assumes the entire risk of any use it may make or permit to be made of the Information. NONE OF THE INFORMATION PROVIDERS MAKES ANY EXPRESS OR IMPLIED WARRANTIES OR REPRESENTATIONS WITH RESPECT TO THE INFORMATION (OR THE RESULTS TO BE OBTAINED BY THE USE THEREOF), AND TO THE MAXIMUM EXTENT PERMITTED BY APPLICABLE LAW, EACH INFORMATION PROVIDER EXPRESSLY DISCLAIMS ALL IMPLIED WARRANTIES (INCLUDING, WITHOUT LIMITATION, ANY IMPLIED WARRANTIES OF ORIGINALITY, ACCURACY, TIMELINESS, NON-INFRINGEMENT, COMPLETENESS, MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE) WITH RESPECT TO ANY OF THE INFORMATION.  Without limiting any of the foregoing and to the maximum extent permitted by applicable law, in no event shall any Information Provider 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, including without limitation (as applicable), any liability for death or personal injury to the extent that such injury results from the negligence or willful default of itself, its servants, agents or sub-contractors.  Information containing any historical information, data or analysis should not be taken as an indication or guarantee of any future performance, analysis, forecast or prediction. Past performance does not guarantee future results.  None of the Information constitutes an offer to sell (or a solicitation of an offer to buy), any security, financial product or other investment vehicle or any trading strategy.  You cannot invest in an index. MSCI does not issue, sponsor, endorse, market, offer, review or otherwise express any opinion regarding any investment or financial product that may be based on or linked to the performance of any MSCI index.  MSCI’s indirect wholly-owned subsidiary Institutional Shareholder Services, Inc. (“ISS”) is a Registered Investment Adviser under the Investment Advisers Act of 1940. Except with respect to any applicable products or services from ISS (including applicable products or services from MSCI ESG Research, which are provided by ISS), neither MSCI nor any of its products or services recommends, endorses, approves or otherwise expresses any opinion regarding any issuer, securities, financial products or instruments or trading strategies and neither MSCI nor any of its products or services is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.  The MSCI ESG Indices use ratings and other data, analysis and information from MSCI ESG Research. MSCI ESG Research is produced by ISS or its subsidiaries. Issuers mentioned or included in any MSCI ESG Research materials may be a client of MSCI, ISS, or another MSCI subsidiary, or the parent of, or affiliated with, a client of MSCI, ISS, or another MSCI subsidiary, including ISS Corporate Services, Inc., which provides tools and services to issuers. MSCI ESG Research materials, including materials utilized in any MSCI ESG Indices or other products, have not been submitted to, nor received approval from, the United States Securities and Exchange Commission or any other regulatory body.  Any use of or access to products, services or information of MSCI requires a license from MSCI. MSCI, Barra, RiskMetrics, IPD, ISS, FEA, InvestorForce, and other MSCI brands and product names are the trademarks, service marks, or registered trademarks of MSCI or its subsidiaries in the United States and other jurisdictions. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and Standard & Poor’s. “Global Industry Classification Standard (GICS)” is a service mark of MSCI and Standard & Poor’s. © 2013 MSCI Inc. All rights reserved. Apr 2013

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