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Components of Sustainability

Components of Sustainability. Gail Doolin, CFA Dec. 8, 2010. Agenda. Overview of Sustainability ASSET4 ESG Data at Thomson Reuters Correlation of ESG scores with CDS spreads & Earnings Surprises ESG scores as Predictor of Future Returns Combining ESG with Earnings Quality Model Q&A.

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Components of Sustainability

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  1. Components of Sustainability Gail Doolin, CFA Dec. 8, 2010

  2. Agenda Overview of Sustainability ASSET4 ESG Data at Thomson Reuters Correlation of ESG scores with CDS spreads & Earnings Surprises ESG scores as Predictor of Future Returns Combining ESG with Earnings Quality Model Q&A

  3. Sustainability - Finally Moving Mainstream? “Are all Components of ESG Scores Equally Important?” The Financial Professionals Post, July 14, 2010 “Asset Managers Find New Sources Of Alpha – Responsible Investing” Institutional Investor, November 2010 “A Quant’s Take on ESG” responsible-investor.com, September 17, 2009 “Quants and Do-Gooders Unite” The Wall Street Journal, November 2, 2010

  4. Concept of Sustainability Sustainable development “meets the needs of the present without compromising the ability of future generations to meet their own needs” (The Brundlant Commission, 1987)

  5. ESG: The Corporate View • According to an Issue of The McKinsey Quarterly: 80% of CFOs and CIOs believe that ESG information can serve as a proxy for the quality of a company’s management. • An 2009 IBM Survey of business leaders revealed: More than 2/3 of organizations surveyed “focus on CSR as part of an integrated business strategy to grow new revenue streams and control costs.” Source: The McKinsey Quarterly, Feb. 2009

  6. Key Sustainability Concerns Environmental • New environmental regulations • Reputation damage from waste, pollution, spills, • Continued access to natural resources • Physical property damage from climate change Financial Impact • Higher raw material costs • Increased legal costs • Fines and legal judgments • Supply chain interruption • Higher insurance costs • Revenue impact due to consumer backlash • Higher costs to attract talent • Increased cost of capital Social • Ability to hire & retain talent • Labor related controversies • Product related complaints • Human rights Governance • Reputation damage & legal costs • Shareholder controversies Economic • Supply Chain risk • Customer loyalty

  7. What are the Characteristics of ESG Content? Reporting is largely voluntary so it is heavily skewed to large, publicly traded companies Despite the GRI’s efforts, what is reported and how it is reported still lacks standardization from firm to firm even within the same country/industry. Trend is toward more industry specific measures Europe has highest concentration of reporting companies, followed by U.S. In Asia, Australia has greatest interest. CSR reports are updated annually There is a limited amount of history

  8. Corporate Reporting Continues to Grow Source: CorporateRegister.com

  9. Asset4’s Content Attributes • Content collection practices • Rely on publicly available sources • Link back to source document for verification • Standardization methodology • Calculate KPIs from raw data points • Multiple levels of ratings • Coverage • Cover >3,000 companies globally including coverage for MSCI World, MSCI Europe, DJ Stoxx 600, Russell 1000 and FTSE 350 • History • History back to 2002 (approx 950 companies) • Minimum of 3 years of history • Dynamic ratings • Factor in the impact of news controversies

  10. ASSET4 ESG Data Sources and Products Data Collection News Monitoring Data Analysis Objective ESG Database Data Feeds Excel Add-in Negative Screening Annual Reports Company Websites NGO Websites Stock Exchange Filings CSR Reports News Sources

  11. Economic Performance Environmental Performance Social Performance Corporate Governance Performance Pillars • Client Loyalty • Performance • Shareholders Loyalty • Employment Quality • Health & Safety • Training & Develop. • Diversity • Human Rights • Community • Product Responsibility • Board Structure • Compensation Policy • Board Functions • Shareholders Rights • Vision and Strategy • Resource Reduction • Emission Reduction • Product Innovation Categories More than 250 indicators (calculated from data point values) Indicators ESG Data and Framework Overall performance Company overview Link to public data sources (Raw Data) DataPoints More than 750 data points 11

  12. Data Roll-up Example

  13. Standardization Allows for Peer Comparison

  14. Asset4 Coverage Growth by Region

  15. Access to ESG Related News Stories

  16. Dynamic Ratings Accounting Anti-Competition Biodiversity Business Ethics Child Labor Consumer Critical Countries Diversity and Opportunity Employee Health & Safety Freedom of Association FDA Warning Letters General Shareholder Rights Human Rights Indigenous People Insider Dealings Intellectual Property Management Compensation Product Impact Media Product Quality and Responsibility Public Health Social Exclusion Spills and Pollution Tax Fraud Wages or Working Conditions (Company) Wages or Working Conditions (Contractor) News stories pertaining to specific types of controversies impact KPIs so ratings can change due to events throughout the year. The types of controversies that can change ratings include:

  17. TR Studies Related to ESG Data

  18. Examination of ESG Performance &CDS Spreads • CDS Spreads measure the cost of ensuring against default and the riskiness of a bond • Examined the relationship between CDS spreads and ESG scores • Segregated ESG performers into 4 quartile groupings • 2005-2007 • 2008-present • Hypothesis: Higher ESG performers should have lower CDS spreads

  19. CDS Spreads vs. ESG Performance 2005-2007

  20. CDS Spreads and ESG Scores 2008-present

  21. Examination of Reported Earnings vs. Estimates and ASSET4 ESG scores • ESG as proxy of management quality • Greater awareness of business performance • Transparency with investors on information • Should be reflected in better earnings results • Examination of I/B/E/S estimates vs. actuals • Companies with higher ESG scores should out-perform those with lower scores

  22. Methodology of Study • Actual earnings announcements compared to I/B/E/S estimates for companies in the ASSET4 Universe • Placed into quartile groupings corresponding to the ASSET4 scores at the time • Percentage of announcements above or below the estimates within each ASSET4 scoring group compared • Annual announcements examined 2005-present • Quarterly announcements examined 2008-present

  23. Frequency of US Annual Earnings Above Estimates

  24. Frequency of US Annual Earnings Below Estimates

  25. Gap between ESG leaders and laggards – Annual earnings above estimates

  26. Gap Between ESG Leaders and Laggards –Annual Earnings Below Estimates

  27. Information Coefficient of ESG Factors

  28. Combining ESG with Earnings Quality Model

  29. Filtering with ESG Improves Risk-Adjusted Returns

  30. Observations & Conclusions Like KPIs, interest in industry specific ESG measures will continue to grow Events will become more embedded in sustainability ratings, allowing them to evolve more quickly As more companies report, large cap bias will weaken As expected, ESG scores are positively correlated with earnings surprises and negatively with CDS spreads Starmine’s research shows that ESG scores add value on an absolute and risk-adjusted basis

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