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Sustainable Investment: Opportunities for Mainstream Investors CFA Ireland

Steven A. Falci, CFA Vice President-Sustainable Investment KBC Asset Management Ltd. January 21 st 2009. Sustainable Investment: Opportunities for Mainstream Investors CFA Ireland. Evolution of SRI. Terms Mercer Emphasis Broad Vehicles Primary Market Focus Examples.

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Sustainable Investment: Opportunities for Mainstream Investors CFA Ireland

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  1. Steven A. Falci, CFA Vice President-Sustainable Investment KBC Asset Management Ltd. January 21st 2009 Sustainable Investment: Opportunities for Mainstream InvestorsCFA Ireland

  2. Evolution of SRI Terms Mercer Emphasis Broad Vehicles Primary Market Focus Examples

  3. SRI ↔ Sustainable Investment 1st Generation SRI Sustainable investing Criteria Focus ESG / Investment Process Time Orientation Ethical Materiality Exclusionary Inclusionary Separate Integrated Historical Future

  4. Global Market Size • Hard to precisely define – But various Indicators point to a Large and Growing Market • Eurosif – €5 trillion • European Social Investment Forum • Begin to distinguish approaches (Core and Broad) • UNPRI – $14 trillion • 380 Asset Owners and Asset Managers • Assert intention to integrate Environmental, Social and Governance Factors into investment process

  5. Global Growth SRI Source: Eurosif

  6. Sustainable Investment Strategies • Thematic Strategies • Investment opportunities in companies providing solutions to our most pressing global challenges • Renewable Energy, Water, Climate Change • ESG Integration • Material risks and opportunities related to Environmental, Social and Governance factors are an integral part of investment analysis • Companies with strong sustainability and financial profiles

  7. Global Mega Trends Innovation to meet challenges to our environment are driven by 3 Global Mega Trends. • World’s changing demographic profile • The combination of population growth, industrialization, economic growth and urbanization will continue to test the limits of our eco–system and will require investment in innovation and infrastructure in the developed and developing world to meet the needs of growing, more affluent global population. • Natural resource supply/demand imbalance • A growing, more affluent global population has and will continue to put increasing pressure on the supply of natural resources. Meeting the needs for energy, water and food is a major challenge of the 21st century. • Climate change -and operating in a carbon constrained world • Sustained pressure for lower carbon economies continue to gain momentum through efforts to mitigate and adapt too combat the effects of climate change. The growing demand for energy will need to be met through less reliance on the historically dominant carbon emitting sources of oil and coal and with more reliance on renewable alternative energy and energy efficiency.

  8. Alternative Energy Investment Thesis • Global Energy Demand – Population & Industrialization • Limited Supply of Fossil Fuel Energy • Falling Costs of Renewable Energy – Technology & Investment • Security of Fuel Supply – Local Source Necessary • Climate Change – Political & Regulatory Support

  9. Renewables as % of Energy Mix International Energy Agency: 30% of all energy related Investments in next 30 years will be in renewables • Renewable Energy • •Wind • •Solar •Biofuels • • Fuel Cells • Waste to Energy Renewable electricity capacity, share of 2005 electricity production Source: Renewables Global Status Report 2006 Update, REN 21

  10. Renewable energy actual cost of production — cents/kWh Expected cumulative reduction in costs of renewable technologies by 2020 Falling Costs of Renewables Source: United Nations Economic and Social Council

  11. Alternative Energy Portfolio Summary Source: KBCAMData as at 31.12.08.

  12. Water Investment Thesis • Demand – Population growth / Demographics • Supply problems – Availability, Infrastructure & Pollution • Regulatory Drivers • Technological Advancements

  13. 1% of Water Useable Less than 1% of all water is available for human consumption There is no substitute for water; that’s why it is rapidly becoming such a valuable resource.

  14. Water and Population Growth Chart Standard of Living Population Growth Economic Growth Sources: US Census Bureau / German Ministry of Environment

  15. Population/Water Divergence Asia has 36% of the world’s water supply and 60% of the population Source: UNESCO

  16. Investment Required Source: Boenning & Scattergood

  17. Water Portfolio Summary Source: KBCAM, Data as at 31.12.08.

  18. Climate Change Investment Thesis • Growing Population, Industrialization and Urbanization has led to increased carbon emissions. • Immediate action required to mitigate long term human, environmental and economic costs • Demand for Cleaner Energy, Energy Efficiency & Waste Management • Technological Advancements • Political, Regulatory & Popular Support

  19. Regulatory and Policy Initiatives continue to support increasing investment

  20. Energy Efficiency Multiplier Effect Fuel = Coal 65% Loss Power Plant 10% Loss Every 1 unit of energy saved at home or business represents up to 4 units saved at the power plant Transmission Lines Source: Sustainable Energy, Choosing Among Options (Tester, Drake, Driscoll, Golay, Peters), UBS Research

  21. 2/3 of Projected Co2 emission savings to come from energy efficiency Source: International Energy Agency

  22. Climate Change Portfolio Summary Source: KBCAM.Data as at 31.12.08.

  23. ESG Integration Environment Social GHG Emissions Eco Efficiency Environmental Management Systems Environmental Products Environmental Liability Water Consumption Human Capital Practices Health and Safety Issues Consumer Markets Labor Markets Supply Chain Management Human Rights • Costs and Revenues • Cost of Capital • Balance Sheet Risk • Brand and Reputation Risk • Competitive Advantage • Valuation Governance • Executive Comp Tied to Performance • Board Structure and Accountability • Transparency

  24. ESG Integration – Opportunities and Challenges • Opportunities • Capture sources of Intangible Value • Approximately 80% of market value driven by intangibles - Prof Baruch Lev, NYU Stern School of Business • Opportunities and Risks • Underpriced in market place • Challenges • Assessing materiality over time • Assessing materiality across industries / sectors / regions • Quantification and measurement

  25. Goldman Sachs Sustain - Integrated Process

  26. GS Sustain – ESG Weightings Management Quality (ESG) Social Source: Goldman Sachs Research

  27. Relative Carbon Exposure Source: CFA Magazine / Sept-Oct 2008

  28. Strategic Governance Environment Human Capital Stakeholder Capital Innovest Sustainability Matrix 10 9 8 7 6 5 4 3 2 1 0 Performance of Company 0 1 2 3 4 5 6 7 8 9 10 Alpha Intensity of Sub-Factor Source: Innovest Strategic Value Advisors

  29. Proposed DCF framework for integration of ESG Factors Exposure to ESG issues Strategy, policies, management systems Transmission Factors Financial value drivers Valuation components Risk premiums WACC Costs Shareholder value Revenues Free cash flows Others (tax, reinvestment rates) Source: Expanding the Investment Frontier – The Conference Board

  30. ESG Ratings Development • Materiality of ESG Factor for Sector • Comparative Ranking • Support Wide Array of Implementation Options • Top Quintile ESG & Top Quintile • ESG Tilt • ESG Beta • Hybrid Strategies – Quant / Fundamental Blend

  31. Performance Studies –Definitional Challenges • SRI vs Sustainable Investment • Risk characteristics in individual strategies • Time period, market conditions, geographic markets • Performance impact of specific ESG factors

  32. SRI vs Sustainable Investment • Cary Krosinsky –The Rise of Sustainable Investing in Sustainable Investing the Art of Long Term Investing – 2008 • Time Period 2002-2007 • 135 mutual funds • Meir Statman – The Wages of Social Responsibility –December 2008 Time Period 1992-2007 • KLD Research Scores • Tilt toward stocks with positive SRI scores – Positive Return Impact • Exclusionary practices detracted from returns

  33. Performance Reviews • Demystifying Responsible Investment Performance • 2007 UNEP-FI Asset Management Working Group / Mercer Consulting • Compilation of 20 Academic Studies and 10 Broker Research • 13 positive • 10 neutral • 4 neutral / positive or neutral / negative • 3 negative • Lloyd Kurtz-Answers to Four Questions • SRI Performance and Risk • Positive ESG Alpha • Environment – 13 studies • Governance – 7 studies • Employment Practice – 6 studies

  34. Studies on ESG Factors • Environment • Derwall, Guenster, Baver, Koedijk “The Eco-Efficiency Premium Puzzle” 2005 • Gluck and Becker “ Can Environmental Factors Improve Stock Selection” 2004 • Social • Edmans “ Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices” 2008 • Governance • Gompers, Ishii, Metrick “Corporate Governance and Equity Prices” 2003

  35. Conclusion • As with all active management what matters most • Rigorous Investment Process • Unique Insights • Innovation • Vision

  36. Reading - Sustainability, Investing and Business • Matthew Kiernan Investing in a Sustainable World (2008) • Cary Krosinsky and Nick Robbins, eds. Sustainable Investing: The Art of Long Term Performance (2008) • Thomas Friedman Hot Flat and Crowded (2008) • Holiday, Schmidheiny, Watts Walking the Talk: The Business Case for Sustainable Development (2002) • Mark Epstein, Making Sustainability Work (2008)

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