SinCo briefing on Institutional Investors, Sustainable Investment and ESG in Capital Budgeting

Institutional Investors, Sustainable Investment and

ESG in Capital Budgeting

Graham SinclairPrincipal, [email protected]@sincosinco.com

"1

sustainable investment consulting ERM Client Day: Capital Budgeting and Sustainability

SinCo does not hold copyright to this image Wikicommons license.

© 2013 SinCo. All rights reserved.

Understanding the growth of ESG Sustainable investment by institutional investors

1. Institutional investment is a competitive global industry. professionals manage portfolios across asset classes, project and company types; financing/investing in stages of companies/projects business cycles. 2. Increasing materiality of environmental, social and governance (ESG) factors is driving investors, and their end-clients, to integrate sustainability concepts. $13.6 trillion globally, $229 billion in Africa reports proactively using ESG in investment policy or process. 3. Increasing quality of coverage of ESG flowing from professional ratings agencies and sharper focus. with more coverage, opportunity to use of new ESG valuation models. Pursuit of "sustainability alpha" continues; ESG benchmarking and performance attribution growing. 4. Improving African investment context is attracting capital. Benefit from making the sustainable investment case for the positive outcomes, or reduction in negative impacts. South Africa is 5th largest investor in Africa; 1-in-2 investment dollars in private equity in Sub-Saharan Africa is DFI-linked.

"2

sustainable investment consulting


What do investors want?"3

SinCo does not hold copyright to this image Wikicommons license.

What do investors want?

Investors are seeking net-of-fees, net-of-inflation, risk-adjusted positive investment returns, for example equity (dividends market price increases) or fixed income (coupon payments and principal repatriation). Investors value diversity, non-correlation and liquidity. Investors have a sense of long-term investment, but investor behavior may be irrational, herd-driven on the fear-greed spectrum. Limits on scale, information and operational efficiency are parameters to universal investment. Investors want to reduce their buy/hold/sell decision to 2 pages describing the investment structure (debt/equity), competitive advantages of firm and its products/services, quality of its management, operational efficiency and strategic prospects. investors always want to buy their investments for the lowest price, at the bottom of the J-curve (buy low-sell high).

"4@SinCoESG I sincosinco.com I [email protected]



http://sincosinco.com


"5

Key developments in sustainable investment theme

• $13.6 trillion (21.8%) of professionally managed assets reporting incorporating environmental, social and governance (ESG) factors into investment selection and management (Jan 2013 on 31 Dec 2011 data). Positive/best-in-class screening stands at just over $1.0 trillion, while impact investing ($89 billion) and sustainability-themed investments ($83 billion) are comparatively small.

• Investment in Africa reporting proactively investing using ESG factors $228 billion AuM. Integration of ESG is $198 billion AuM. South Africa is 95% of Africa investment market; ESG-branded investment products make up just 1% AuM.

• According to Bloomberg ESG, "in 2010, 5,000 investors in 29 countries accessed more than 50 million ESG indicators in the Bloomberg platform— a 29 percent increase over 2011."

• 40 percent of shareholder resolutions in 2012 in the USA pertained to environmental and social concerns, up from 30 percent during the prior proxy season. SinCo research reflects RSA share owner activity increasing off low base, with examples of global best practice using online reporting of proxy votes.

• ESG performance studies reflect sustainability may increase returns. ESG tilts in listed equity perform best for buying ESG "improvers" and shorting "laggards" *2008-12

• $10 billion annual savings on U.S. electric bills from new lightbulb standards. 59% proportion of emissions-reductions efforts pay for themselves in 3 years.

• 67% return from listed equity portfolio based on the Carbon Disclosure Leadership Index since 2006. 31% return of by CDP Leadership Index's Global 500 peers during the same period.

@SinCoESG I sincosinco.com I [email protected] © 2013 SinCo. All rights reserved.



Rationale for sustainable investment Global pension investment best practice from Africa

Regulation 28 of Pension Funds Act 24/1956 effective 1 January 2012PREAMBLE "A fund has a fiduciary duty to act in the best interest of its members whose benefits depend on the responsible management of fund assets. This duty supports the adoption of a responsible investment approach to deploying capital into markets that will earn adequate risk adjusted returns suitable for the fund’s specific member profile, liquidity needs and liabilities. Prudent investing should give appropriate consideration to any factor which may materially affect the sustainable long-term performance of a fund’s assets, including factors of an environmental, social and governance character. This concept applies across all assets and categories of assets and should promote the interests of a fund in a stable and transparent environment."

"6





Reputations and rules: ESG acts throughout the investment life cycle. Plays out regardless of rules.

Driven by regulator pressure, client demand, increased exposure, and intangible value impacts.

Investors prefer legislation and regulation (hard rules). But with weak regulations and changing ESG issues, moving to voluntary initiatives (soft rules).

"7

SinCo does not hold copyright to this image

Material ESG factors impacting valuations now 1/2

CARBON From SinCo research for Navigating Muddy Waters research series commissioned by WWF with SinCo, Trucost and Carbon Tracker, using GEPF's fixed income and equity portfolio as worked example. Confirmed that investors attitudes to carbon & water scarcity risks ranged from ambivalent to concerned. Previous studies of the development of institutional investor approaches to sustainable investment in South Africa identified 1/3 had no knowledge of a carbon tax pricing scenario, another 1/3 had zero. *2015 carbon tax shifted valuations - Arcelormittal lost 6% on budget speech*Learn more about Navigating Muddy Waters project at http://www.sincosinco.com/portfolio-climate-risks.php

"8





Material ESG factors impacting valuations now 2/2WATERAnalyst note from Standard Bank Equity Research on 14 resources companies: Most mining and industrial operations in RSA in water-stressed areas: Waterberg and Witbank Coal fields, Witwatersrand gold complex, and Bushveld PGM igneous complex. Lonmin and SASOL have lowest scores on their proprietary ratings for water management. "Anglo Platinum has the highest score, implying the lowest risk, it is still without IWUL at its key operations, based on public information available at date of publication...SA Resource sector is still only about one year into setting fixed targets and monitoring them" *Lonmin $LMI online self-reporting ".... The market price for PGMs can fluctuate widely... geological formations, unanticipated ground and water conditions" *Learn more about Navigating Muddy Waters project at http://www.sincosinco.com/portfolio-climate-risks.php

"9





Investment case is sum of all operations and investments. ESG issues are material, but methods for valuing differ. Timing, shocks and impacts differ.

"10

WHAT ESG ISSUES? All the the companies' strategy, operational plans and realities are tested in the harsh light

of investment analyst presentations, and a public forum where stakeholders have a voice

Integrating ESG factors leans on company insights

How will the least possible ESG data delivered as information on sustainability lead to the maximum knowledge on the current value and future expected value of the and its franchise with consumers, employees, policymakers, regulators, investors, and other stakeholders? Investors do not want a list of "material issues" for sector or generic firm. Investors need the firm to explain the business critical sustainability issues, and ow the firm with map and monitor and mitigate ESG risks, and maximize ESG opportunities.

"11





Modeling equity in mining companies in Africa 1/2

• VALUATION 101. A typical equity valuation in the mining sector in South Africa will seek to build a valuation/price comparison based on financial data and "future prospects". Mining firms are typically valued using a discounted cashflow (DCF) model with an adjusted terminal value of zero at the end of the mine life, net of closure costs. The sum-of-the-parts DCF model will price the sum of the above ground and below ground operations and future projects, using this methodology to value the firm in isolation and against sector and/or regional peers.

• DISCOUNTING FOR CAPITAL AND TIME-VALUE. The nominal weighted average cost of capital (WACC) applied to cash flows is estimated using the investment analysts views of future commodity prices and inflation, with a multiple applied to the DCF-derived net asset value reflecting the investment analysts’ views on the company, especially relative to the cross-rates of the mining firms operational costs and dollar-based commodity prices. Academic research has tested for improved WACC for firms with better sustainability performance, some evidence to support.

"12@SinCoESG I sincosinco.com I [email protected] © 2013 SinCo. All rights reserved.



Modeling equity in mining companies in Africa 2/2

• RISKS AND ASSUMPTIONS. The model will include some risks to the target price/s, typically including the increase in exploration, sustaining and development capital expenditure plans. Assumptions about trends in commodity pricing, success in above- and below-ground operational management, taxes (on average 30% across regions in the medium-to-long term), and input costs, such as labor. Risks include assumptions about productivity, and work-safety stoppages related to accidents and fatalities in operations.

• INTEGRATING ESG. ESG issues typically enter the modeling as costs and/or risks, for example environmental remediation. But may also reasonably be modeled as governance factors, for example the license to operate being granted or renewed based on offering a non-corrupt, transparent and community-validated approach to managing stakeholder relationships. Environmental issues may also bring mining exploration or operating to a halt: for example where mines contravene the National Environmental Management Act or the National Water Act. In South Africa, courts are increasingly siding with civil society and consumers where rights are threatened by state or private sector.




HEADLINE RISK TO INVESTORS ESG is a factor throughout

investment life cycle

Impacts of all investor portfolio companies/securities/projects sums to portfolio-level ESG.

"14

SinCo does not hold copyright to this image. All rights beyond to Zapiro, purchase at www.zapiro.com

ESG data supply for investors Inputs to institutional investor decisions 1/2• ESG analysis must balance top-down thematic issues with bottom-up company context. analysis starts

with an overarching view. What is an accurate point-in-time, retrospective and prospective qualitative value of firm sustainability? Companies have influential and persuasive role in making the case to investors for materiality of ESG risks and opportunities.

• All analysis is also a competitive struggle for fastest, freshest and most accurate data offering information interpreted for knowledge of current and future value of investment opportunity. ESG data availability has ramped up since 2000, but still issues of frameworks (GRI vs integrated reporting vs SASB), availability, reliability, verification, auditing, comparability.

• ESG

• Social - Child Labor, Consumer Product Safety, Diversity, Labor Relations

• Environmental - Environmental Performance, Global Sanctions, Superfund sites, Toxic Chemicals

• Tracking framework - Spills, Fines, Sites. Relative and absolute measures - for example, sites / $10 billion domestic company revenue, lbs / $1,000 domestic company revenue, Spills / $10 billion domestic company revenue




ESG data supply for investors Inputs to institutional investor decisions 2/2

WORKED EXAMPLE - MINING & MINERALS SECTOR - Industry Trends flagged by MSCI ESG, Jan 2013

• Social licenses to operate, obtained through community engagement and sustainability management, are ever more essential to mining companies’ ability to run a successful mine.

• The industry is faced with many tough decisions. Management at many companies must choose between layoffs or profits. Others are forced to choose between ramping up production of low grade mines – the result could mean higher carbon emissions, wastes, and costs - or move operations deeper into regions with high uncertainty due to risks of corruption, social changes, or sensitive environments that can block projects from going forward.

• The increasingly scarce high grade projects are also often in regions where safety and environmental standards need to be drastically upgraded to meet international standards. Poor social and environmental performances also significantly raise risks of resource nationalization and higher payment demands.

• Labor cost inflation reaches double digits for many companies and diminishes long term confidence that high margin mines in areas of unrest will remain strong investments. Mining companies face additional risks of cost hikes through increased regulatory pressure, expanding carbon regulations, and higher costs for energy and supplies




Investor approaches - modeling investment case in mining companies in Africa 1/2: ESG in multi-asset boutiques

• 1. Macro thematic issues relevant to mining or extractives - for example water scarcity, carbon taxes, labour relations. Themes inform sense of "investment conviction" about how sector, industry and firm may manage key issues in strategy and operations. Differs according to investment philosophy, views of ESG, sense of long term investment holding periods

• 2. Key value creators/destroyers - at sector and company levels, filters for best/worst in class; tempers financial data with sense of prospects. for example, firm may be estimated to have 35% upside but be worst performer vs peers on key issues, implies portfolio management approach to change weighting or company engagement seeking changes. Scenario and sensitivity analyses will cHeck assumptions effects on models, for example work stoppages, mine closures, or water shortages. May need to update model with additional valuation line items and review assumptions.

• 3. Active ownership over time - using ESG information as active shareholder to steer company away from high-risk, low-reward situations or binary issues with negative reputation impacts. Investor uses all available tools, and wants to be seen to be acting. voluntary initiatives like CRISA, PRI, EITI, Equator Principles or CDP play a role.




Investor approaches - modeling investment case in mining companies in Africa 2/2: ESG in listed Africa equities

• Approach of active investment manager is to drill down to fundamental value - key factor is 'social license to operate', without which the firm or mine does not have a business. Sustainability performance through ESG factors all impact on the single biggest risk for mines - title risk, bigger than above/below ground risks. 50-year mine in geological terms may be expropriated after 2 years?

• In Africa fewer data points and harder to compare to peers in context. Some ESG metrics may help improve context for financial valuation, for example % of local labour (including mine management), tax contribution to local fiscus, extent of beneficiation, net socio-economic footprint (job creation), long-term infrastructure value added (potable water, energy, roads, telecoms, schools), displacement of people and how this is managed, biodiversity impact (receiving environment), sustainability practices (pollution control, mitigation for tailings dam contamination of soil and surface and groundwater courses), ethical backbone of management team (zero tolerance of bribes and corruption in securing title), or sustainability practices (rehabilitation of mine footprint, off balance sheet legacy liabilities).

• Investor is paid to return net-of-fees, net-of-inflation, risk-adjusted investment performance. Sustainable investment practice tends to factor material ESG factors in more aggressively, potentially leading to very different fair value versus investment management competitors.




Frameworks for ESG - global and local Future filled with "high context" business relationships; investing in multi-polar world

"19@SinCoESG I sincosinco.com I [email protected]



Understanding the growth of ESG Sustainable investment by institutional investors

1. Institutional investment is a competitive global industry. professionals manage portfolios across asset classes, project and company types; financing/investing in stages of companies/projects business cycles. 2. Increasing materiality of environmental, social and governance (ESG) factors is driving investors, and their end-clients, to integrate sustainability concepts. $13.6 trillion globally, $229 billion in Africa reports proactively using ESG in investment policy or process. 3. Increasing quality of coverage of ESG flowing from professional ratings agencies and sharper focus. with more coverage, opportunity to use of new ESG valuation models. Pursuit of "sustainability alpha" continues; ESG benchmarking and performance attribution growing. 4. Improving African investment context is attracting capital. Benefit from making the sustainable investment case for the positive outcomes, or reduction in negative impacts. South Africa is 5th largest investor in Africa; 1-in-2 investment dollars in private equity in Sub-Saharan Africa is DFI-linked.

"20



Graham SinclairPrincipal, [email protected]@sincosinco.com

"21


www.africasif.org@[email protected]

www.sincosinco.com@[email protected]

SinCo acknowledges the input and research by Old Mutual Investment Group South Africa, Sustainable Capital, IFC,

Bloomberg ESG and MSCI ESG used in this presentation. Analysis and opinions are solely SinCo.

All rights reserved. March 2013.

Thank you.

http://www.sincosinco.com

http://www.sincosinco.com

About SinCoSinCo - sustainable investment consulting - is a boutique sustainable investment advisory firm specializing in environment, social and governance (ESG) architecture in frontier and emerging markets. Since 2006 SinCo has delivered sustainable investment architecture globally to pension funds, asset managers, private equity funds, stock exchanges and international organizations integrating ESG factors into investment practice for sustainable long-term investment performance. Learn from our experience atsincosinco.com/portfolio-of-work.php www.sincosinco.com | @SinCoESG | [email protected] SinCo is a Massachusetts Limited Liability Company (General Laws, Chapter 156C) incorporated in February 2007 registered with the Secretary of State of the Commonwealth of Massachusetts USA. 1009795 #1208. In 2013, SinCo is undergoing the B Corp Certification Process to formally recognize our mission-driven business model in sustainable investment. B.Corp is used by the world’s leading social entrepreneurs to assess, compare, and to improve the company’s social and environmental performance.

"22

http://sincosinco.com/portfolio-of-work.php

http://sincosinco.com/portfolio-of-work.php

Indemnity and disclosures

This ESG research by SinCo includes funds, firms, securities and initiatives that may be clients of SinCo, or the parent of, or affiliated with, a client of SinCo. SinCo ESG research reports, articles and profiles have not been submitted to, nor received approval from, the United States Securities and Exchange Commission or any other regulatory body. While we have exercised due care in compiling the information, we make no warranty, express or implied, regarding the accuracy, completeness or usefulness of the information and assume no liability with respect to the consequences of relying on the information for investment or other purposes. In particular, SinCo ESG research is not intended to constitute an offer, solicitation or advice to buy or sell securities.

This material is provided for informational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities. The economic and market forecasts presented herein have been generated by SinCo for informational purposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved. This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice.

Without limiting any of the foregoing and to the maximum extent permitted by law, in no event shall SinCo 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.

The views and opinions expressed in this body of work are the author's own and may not reflect the views and opinions of SinCo unless the author is authorized by SinCo to express such views or opinions on its behalf.


"23


@SinCoESG I sincosinco.com I [email protected]



About AfricaSIF.org

Africa Sustainable Investment Forum is an independent,Pan-African, not-for-profit network, knowledgebase and advocate promoting investment in sustainable development across the continent. Launched in June 2010, the AfricaSIF.org Project is run by volunteers building a network of institutions and individuals promoting sustainable investment in Africa by investors in public, private and philanthropy sectors across asset classes, countries and stakeholders from our platform at www.africasif.org.

"24

www.africasif.org I @AfricaSIF I. [email protected]

http://www.africasif.org

http://www.africasif.org

Date post:	03-Jun-2015
Category:	Economy & Finance
Upload:	graham-sinclair
View:	134 times
Download:	0 times

SinCo briefing on Institutional Investors, Sustainable Investment and ESG in Capital Budgeting

Economy & Finance