ASSET MANAGEMENT

P.3 | News

WILL BREXIT PUT THE BRAKES ON CLIMATE POLICIES?

N° 13 - June 2017

P.4 - 5 | From an academic point of view

INVESTING IN ESG PAYS FINANCIALLY

THE SRI CHRONICLES

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A presidential term focused on responsible investing?

Emmanuel Macron described his position on sustainable finance and his future commitments to the Forum for Responsible Investment when he was running for President. And yet his contribution remained virtually unnoticed.

In a letter dated March 27 20171, he declared that it was vital to put social and environmental issues at the heart of an economic model and said he was determined to promote this message to Europe as a whole. In his view, finance has a major role to play in addressing the long term challenges of sustainable development. To do so, France’s future president suggested investing EUR 50bn, with EUR 15bn going on ecological transition.

He also suggested any bank or French life assurance product should necessarily include at least one socially responsible investment fund, an efficient idea that would not prove costly for government finances. A similar obligation was introduced for employee savings schemes 15 years ago and it helped increase SRI assets more than tenfold. They now represent 25% of a market with more than EUR 100bn under management and all the stakeholders are happy with the results.

When he was campaigning, Emmanuel Macron showed he was very keen on sustainable finance. The appointment of Green activist Nicolas Hulot as Minister of State for ecology, the third most important member of the new government, is an encouraging signal. The ball, Mr President, is now in your court.

1. http://www.frenchsif.org/isr-esg/wp-content/uploads/LettreOuverteFIR_Re%CC%81ponseMacron.pdf

Edmond de Rothschild Asset Management is a co-sponsor of the Sustainable Finance and Responsible Investment Chair which is co-managed by Ecole Polytechnique and the Toulouse School of Economics, under the aegis of the Association Française de la Gestion financière (AFG).

Jean-Philippe DesmartinHead of the Responsible Investment Team

EDITORIALE

Sustainable Finance and Responsible Investment Chair

3 ASSET MANAGEMENT - THE SRI CHRONICLES

WILL BREXIT PUT THE BRAKES ON CLIMATE POLICIES?Any mention of the word ‘climate’ was entirely absent from the UK’s farewell letter to the European Union and 12 months after the UK voted to leave there are still doubts over the future of climate policies.

The issue is of paramount importance as predictability and stability are essential for investment decisions and efforts to reach climate targets. This is why the Institutional Investors Group on Climate Change (IIGCC), which represents 140 European institutionals, has published a report urging the UK government to adopt an ambitious decarbonisation strategy1.

It is difficult to say precisely how much European environ-mental legislation exists but it is certainly substantial. The UK is therefore expected to transpose community acquis like treaties, rules, directives and the European Court of Justice’s decisions and judgments when it draws up its Great Repeal Bill2. Repatriation of environmental policies is seen by some as an opportunity to go even further while others fear a move to turn the clock back.

UNCERTAINTIES

FOR THE EU- Maintaining the UK within the European energy market has

raised doubts over interconnections and funding.- The UK has confirmed that it wants to exit Europe’s atomic

energy community (Euratom). This has triggered worries over the nuclear industry’s stability and raises questions over (i) how to replace Euratom inspectors with a new inspection framework acceptable to the International Atomic Energy Agency and (ii) the renegotiation of certain agreements.

- Brexit may also mean the UK leaving the EU’s emissions trading system. Note that following the Brexit referendum result, CO2 prices slumped.

FOR THE UK- The UK Climate Change Levy was supposed to increase in

2019 but its future is now unclear.- The UK could miss its 2020 renewable energy targets3, and

accompanying measures could be called into question. - Freed from any European Court of Justice pressure, the UK

may well prove less inclined to harmonise legislation.

STABILITY AND OPPORTUNITIES

FOR THE EU- The European Commission will continue to play a core

role in rolling out legislation, notably by providing advice, guidelines and interpretations and sharing information. At the same time, the European Court of Justice will oversee effective compliance with legislation in environmental areas thanks to its ability to impose financial penalties and possible reputation risk.

- International conventions like Berne and Basel which the UK has ratified will continue to count.

- Access to the single market will still require compliance with EU product regulations and legislation like REACH (chemical products) and Ecodesign (energy efficiency).

- The UK was the 111th country to ratify the Paris Agreement, a move that investors and companies took as an important signal. And it is still expected to announce its own contribution, called Nationally Determined Contributions (NDC).

FOR THE UK- Some observers expect the UK’s agricultural policy to better

integrate environmental aspects. - The UK has its own climate laws. They aim to reduce

greenhouse emission by 80% by 2050. There is also a 10-year climate plan which can be readjusted every 5 years. The UK government raised its sights in July 2016 in its 5th carbon budget (2028-2032). The objective is to reduce greenhouse emission by 57% by 2030 compared to 1990 levels4.

1. Abandoning fossil fuels in favour of renewable and cleaner energy sources. March 2017.

2. Abrogation of the 1972 law which incorporated European legislation into British law, and translation of European laws into national laws.

3. 15% of energy requirements from renewable energy sources by 2020.

4. https://www.theccc.org.uk/tackling-climate-change/reducing-carbon-emissions/carbon-budgets-and-targets.

NEWSN

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INVESTING IN ESG PAYS FINANCIALLYESG AND FINANCIAL PERFORMANCE : AGGREGATED EVIDENCE FROM MORE THAN 2000 EMPIRICAL STUDIES

The search for a relation between environmental, social, and governance (ESG) criteria and corporate financial performance (CFP) can be traced back to the beginning of the 1970s. Scholars and investors have published many empirical studies and several review studies on this relation since then. The largest previous review study analyzes just a fraction of existing primary studies, making findings difficult to generalize. Thus, knowledge on the financial effects of ESG criteria remains fragmented. To overcome this shortcoming, this study extracts all provided primary and secondary data of previous academic review studies. Through doing this, the study combines the findings of about 2000 individual studies.

ALL CLASSES ARE WINNERS, PARTICULARLY BONDS AND REAL ESTATE

The results show that the business case for ESG investing is empirically very well founded. Roughly 90% of studies find a non-negative ESG-CFP relation. More importantly, the large majority of studies reports positive findings. Promising results are obtained when differentiating for portfolio and non-portfolio studies, regions, and young asset classes for ESG investing such as emerging markets, corporate bonds, and green real estate.

Non-equity asset classes both for bonds and real estate display a considerably higher share of positive findings over equities. More than two-thirds of studies uncover significant positive performance relations to ESG criteria. The share of positive votes for the 36 analyzed bond studies stands at 63.9% – with 13 neutral or mixed findings (36.1%). The relatively young research field of green real estate studies is reflected with seven studies in the total sample. Five studies (71.4%) find a positive and the other two a neutral relation.

STRONG GOVERNANCE MATERIALITY

For our sample of vote-count studies with identifiable ESG categories in 644 studies, we determine a relatively even positive relation for E, S, and G. The highest proportion is found in G with 62.3% of all cases. Governance-related aspects, on the other hand, demonstrate also the highest percentage of negative correlations with 9.2%. If the share of negative findings is deducted from positive ones, environmental studies offer the most favorable relation (58.7-4.3%).

Studies with a social focus show 55.1% (5.1%) positive (negative) outcomes, hence the weakest relation. When reviewing studies with various combinations of ESG criteria, 35.3% report positive (respectively 7.1% negative) findings. The downside bias

FROM AN ACADEMIC POINT OF VIEW

is Professor of capital markets and management at the University of Hamburg, Faculty of Business, Economics and Social Science, Germany. He is a member of the German Council for Sustainable Development - advisory body of the German Federal Government, co-chair of the UN PRI Academic Network Steering Committee, member of the corporate governance commission and the investor relations commission of the Society of Investment Professionals Germany (DVFA) and member of the Commission on Environmental, Social & Governance Issues (CESG) of the European Association of Financial Analysts Societies (EFFAS).

Alexander Bassen

ASSET MANAGEMENT - THE SRI CHRONICLES

of positive outcomes over developed markets. Excluding the proportion of portfolio studies, the ratio increases further to 70.8%. Based on 52 single studies in Emerging Markets solely focused on equity-linked studies, the spread to developed markets is considerable.

POSITIVE CORRELATION STABLE OVER 4 DECADES

ESG outperformance opportunities exist in many areas of the market. In particular, we find that this holds true for North America, Emerging Markets, and in nonequity asset classes. Our results propose that capital markets so far demonstrate no consistent learning effects regarding the ESG-CFP relation.

Since the mid-1990s, the positive correlation patterns in primary studies have been stable over time.The orientation toward long term responsible investing should be important for all kinds of rational investors in order to fulfill their fiduciary duties and may better align investors’ interests with the broader objectives of society. This requires a detailed and profound understanding of how to integrate ESG criteria into investment processes in order to harvest the full potential of value-enhancing ESG factors. A key area for future research is to better understand the interaction of different ESG criteria in portfolios and the relevance of specific ESG sub-criteria for CFP. These insights will shed further light on the ESG determinants for long-term positive performance impacts.

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primarily arises from a high proportion of portfolio-based studies in this section (39.1%). If all these studies were excluded, the positive (negative) rate stands at 51.7% (4.8%) which is nonetheless lower than pure E, S, and G approaches.

ALL GEOGRAPHIES BENEFIT FROM ESG FACTORS

Developed markets excluding North America exhibit a smaller share of positive results. This contrast is most apparent between North America (42.7% positive) and developed Europe (26.1% positive). Developed Asia/Australia possess a positive share of 33.3%, though with the largest share of negatives as well at 14.3%. The total sample excluding North American stands at 27.8% positive share. A check of the underlying studies reveals a larger share of portfolio-based studies within the European and Asian/Australian sample that potentially biases the data. However, when omitting all portfolio studies for the developed market samples, the positive ratio for North America increases to 51.5%, and for Europe and Asia/Australia combined to 45.6%. This implies that the previous gap between the two samples shrinks considerably – from 14.9 to 5.9 percentage points.

The Emerging Markets sample shows, with 65.4%, a considerable higher share

ESG outperformance opportunities exist in many areas of the market

METHODOLOGY: We chose a two-step research method to analyze existing review and primary studies. First, we include findings from so-called vote-count studies. Vote-count studies count the number of studies with significant positive, negative, and non-significant results and “votes” the category with the highest share as winner (Light and Smith 1971).

These studies provide interesting insights, but are less sophisticated from a methodological point of view. The shortcomings are well documented in the literature. Second, we aggregate the findings of econometric review studies – so-called meta-analyses – to derive a second-order meta-analysis. Study published in 2015.

ESG-CFP RELATION IN MAIN ASSET CLASSES (vote-count studies sample), n = 334 net studies.

80%

70%

60%

50%

40%

30%

20%

10%

0%

52.2%

4.4%

Equities

positive

negative

63.9%

0.0%

71.4%

0.0%

Bonds Real Estate

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SCASvenska Cellulosa AB (SCA) is a Swedish industrial group set up in 1929. Industrivärden, a local financial holding, is its biggest shareholder.

The group went through major repositioning after 2000, moving from its historic role in the paper industry to a more diversified company to focus on everyday cellulose-based personal hygiene products like lavatory paper and nappies. These new segments now represent around 85% of sales.

RECOMMENDED READING

COMPANY MEETINGS

LES VOYAGEURS DE L’EAULionel Goujon, Gwenaël Prié

Edition Dunod, 2010 (192p, EUR 22)

© istockphoto.

The information on individual stocks should not be construed as Edmond de Rothschild Asset Management (France) expressing an opinion on the prospective performances of these same stocks, and if applicable, on the expected price of the financial instruments issued by the companies. This information should not be construed as a recommendation to buy or sell these stocks as per article 621-30-1 of the “Code Monétaire et Financier”.

SCA is also Europe’s biggest private forest owner (15% of group sales). 50% of the group’s raw materials come from SCA forests which have ISO 14001, Forest Stewardship Council (FSC) and Programme for the Endorsement of Forest Certification (PEFC) certification. All other raw materials used are close to 100% certified. Biomass derived from forest and factory residues provides a large amount of the energy SCA uses.

Like many Nordic companies, SCA enjoys a social and environmental ecosystem which favours sustainable development initiatives. 65% of its employees are covered by collective agreements, the age pyramid is balanced and training effort is high. The group also stands out because of its stringent business ethics, as evidenced in its CEO’s resignation in 2015. In recent news, SCA announced that it was to spin off its forestry and hygiene units with each business listed separately.

“Water will become more valuable than oil”1.This is not yet another alarmist message from an NGO but the opinion of Jean-Louis Chaussade, CEO of Suez. In Les voyageurs de l’eau, two French civil engineers travel the world, encountering all the benefits water brings and the hurdles that have to be cleared to preserve it.The book covers colossal projects from China’s North-South transfer via everyday struggles to obtain drinking water in Uganda to South America’s problematic private management of water. With the authors, we tour the world and realise how accurate Jean-Louis Chaussade’s comment really is.

1. Source: Financial Times. 19/03/2017.

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THE SRI TEAM IN ACTION

AN AMBITIOUS 2020 ROADMAP10 years after embracing SRI with the launch of strategy focused on renewable energies, Edmond de Rothschild Asset Management has capitalised on progress made in 2013-2016 to validate its responsible investing strategy for 2017-2020.

The SRI team was closely involved in drawing up this strategy, especially as concerns specialist SRI offers, ESG integration and coordination with all businesses within the Edmond de Rothschild Group.

All equity and bond

investment teams will

work together on 10 ESG integration forums in

2017-20 to produce

hard and fast results

KEY FIGURES

USD 1bn Total new subsidies from 6 EU countries to the coal industry since 2015 despite their commitments to the Paris Agreement (Overseas Development Institute).

year when we improved our proprietary model, primarily so as to provide better coverage of social and environmental impact criteria. We were also delighted when the Group’s private banking division launched an SRI mandate1 which will essentially call on our experienced team.

ESG integration is a major part of the 2017-20 roadmap which has our signature of the UN’s Principles for Responsible Investment in 2010 as its bedrock.

Our approach seeks to gradually cover 85% of assets under management

1. At the end of 2016.

43%The percentage of French jobs that could be automated by 2030 according to three McKinsey analysts (Harvard Business Review).

Our specialised SRI range, including mandates and open-ended funds, represented 15% of assets managed by Edmond de Rothschild Asset Management (France) as of end 2016. The SRI team plays a key part in producing ESG research (essentially in the European investment universe), helping with SRI fund and mandate management, providing support to other investment teams and advising clients on how to meet their often very diverse SRI needs. We took a big step forward at the beginning of this

beyond our specialised SRI range. It is based on traditional top-down and bottom-up principles and also seeks to raise awareness among different posts and teams, formalise internal policies, improve information and reporting tools and link compliance, internal and external audit functions. Our top-down approach is rounded off by bottom-up initiatives. In practice, this means all equity and bond investment teams will work together on 10 ESG integration forums in 2017-20. These innovative efforts have been validated by our fund managers and aim to produce hard and fast results. These forums cover precise areas with strong financial implications like impacts on asset valuations, energy transition (both as a risk and an opportunity), executive management quality, intangible asset valuations and shareholder dialogue and engagement.

We intend to share the points raised in these discussions with all our teams so that they end up benefiting all investment divisions under the Edmond de Rothschild Group umbrella.

CONCORDIA - INTEGRITAS - INDUSTRIA

June 2017. Non-binding document. This document is for information only.

Disclaimer: The data, comments and analysis in this bulletin reflect the opinion of Edmond de Rothschild Asset Management (France) and its affiliates with respect to the markets and their trends, their regulation and tax treatment, on the basis of its own expertise, economic analysis and information currently known to it. However, they shall not under any circumstances be construed as comprising any sort of un-dertaking or guarantee whatsoever on the part of Edmond de Rothschild Asset Management (France). All potential investors should consult their service provider or advisor and exercise their own judgement independently of Edmond de Rothschild Asset Management (France) on the risks inherent to each investment and its suitability to their own personal and financial circumstances. To this end, investors must ac-quaint themselves with the key investor information document (KIID) that is provided before any subscription and available at http://funds.edram. com or on request from the head office of Edmond de Rothschild Asset Management (France). Main investment risks: capital loss risk, risk linked to discretionary management, equity risk, risk linked to the SRI selection, risk from investing in small and mid-caps.

Publication director: Philippe Uzan – Photo credit: Istock by Getty images

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