balancing responsibility, risk and return...balancing responsibility, risk and return | 3...
TRANSCRIPT
Valerie S. Grant SVP—Senior Portfolio Manager, Responsible Investing
Harvard Business School Social Enterprise Initiative
Balancing Responsibility, Risk and Return
December 14, 2018
1|Balancing Responsibility, Risk and Return
Responsible investing is growing globally, across asset classes.
Growth is likely to continue, driven by demand from institutional asset owners and high net worth
individuals
Responsible investing can be implemented in a variety of ways, from screening to impact
investing, based on investor’s objectives and preferences for responsibility, risk and return.
Responsible investing is inherently more complex than traditional investing because it requires
attention to three dimensions rather than two.
A combination of strategies is often required to accomplish an investor’s goals within a particular
asset class or sub-asset class.
Summary and Conclusions
2|Balancing Responsibility, Risk and Return
Balancing Responsibility, Risk and ReturnAgenda and Overview
Responsible Investing: Definition and Market Dynamics
Strategies for Implementing Responsible Investing
Role of Active Management in Balancing Responsibility, Risk and Return
Unintended Consequences of Restrictions and Exclusions
Relationship between ESG Ratings and Risk
Value of Fundamental Investment Research
Product Example
Q&A
3|Balancing Responsibility, Risk and Return
Responsible Investing is Global and Encompasses All Asset Classes
Sustainable, responsible and impact investing (SRI) is an investment discipline that considers
environmental, social and corporate governance (ESG) criteria to generate long-term competitive
financial returns and positive societal/environmental impact.
Source: Forum for Sustainable and Responsible Investment (US SIF); Global Sustainable Investment Alliance 2016 Global Sustainable Investment Review
Europe, 53%
US, 38%
Canada, 5%
Australia / New
Zealand, 2%
Asia, 2%
100% = $23 trillion
~26% of Managed Assets
Bonds, 64%
Equities, 33%
PE / VC / Other Alts,
3%
100% = $23 trillion
~26% of Managed Assets
Note: Data on AUM by asset class is estimated based on data reported by Canada and Europe. The US and other markets have not reported data on asset
allocation for SRI investing.
4|Balancing Responsibility, Risk and Return
Passively Managed Investments
Assets Under Management, $US trillions
Global Socially Responsible Investments
Assets Under Management, $US trillions
$10
$14
$17
2012 2014 2016
$13
$18
$23
2012 2014 2016
Responsible Investing is Growing Rapidly and is Larger than Passive
Investing
Source: Broadridge FundFile, McKinsey & Company, Inc., Global Sustainable Investment Alliance Global Sustainable Investment Review 2016 and 2014
15%
CAGR
14%
CAGR
Europe
and ROW
North
America
Europe
and ROW
North
America
5|Balancing Responsibility, Risk and Return
Asset Owners are Committed to Responsible Investing
Strongly Agree, 44%
Agree, 33%
Neither Agree
Nor Disagree,
10%
Disagree
Somewhat, 7%
Disagree Strongly,
6%
To what extent do you agree or disagree with the following statement: “Asset owners have a
responsibility to address global sustainability issues through their investments”
Belief that Addressing Sustainability Issues is A Responsibility
100% = 116 Respondents
Source: Morgan Stanley, Sustainable Signals: Asset Owners Embrace Sustainability (2018). Based on a survey of 118 public and corporate pensions, endowments,
foundations, sovereign wealth entities, insurance companies and other large asset owners globally.
6|Balancing Responsibility, Risk and Return
Future Growth Likely to be Driven by Private Equity and Hedge Funds
6
7%
36%
37%
50%
65%
24%
26%
37%
34%
20%
0% 10% 20% 30% 40% 50% 60% 70% 80% 90%
Hedge Funds
Private Equity
Fixed Income
Real Assets
Public Equities
In your experience, in which sectors has your organization been able to find quality sustainable investing strategies / managers? (n=74)
Source: Morgan Stanley, Sustainable Signals: Asset Owners Embrace Sustainability (2018). Based on a survey of 118 public and corporate pensions, endowments, foundations,
sovereign wealth entities, insurance companies and other large asset owners globally.
Yes
Sometimes
Unmet Demand by Asset Owners for Quality SRI Strategies and Managers
7|Balancing Responsibility, Risk and Return
Responsible Investing Requires an Active Approach
Responsibility Introduces
a Third Dimension
Corporate social responsibility
introduces investment
considerations beyond
investors’ goals for return and
risk.
Mechanical Approaches Have
Inherent Shortcomings
Conventional, rules-based
approaches fall short in
managing trade-offs, improving
corporate behavior, and
identifying investment
opportunities.
Investing Responsibly
Adds Complexity
Financially motivated decisions
by corporations can impact
society and the environment.
Similarly, decisions by
corporations to behave
responsibly can impact financial
performance and investment
outcomes.
8|Balancing Responsibility, Risk and Return
RESPONSIBILITY
▪ Recognizes three dimensions instead of
two
▪ Helps uncover investment opportunities
and risks
▪ Offers tools to manage trade-offs and
engage constructively with management
on important ESG issues
▪ Exploits inefficiencies in ESG data and
reporting
▪ Enables shareholders to influence
companies to behave more responsibly
RISK
RETURN
Responsible Investing is Inherently More Complex than Traditional
InvestingActive Management Can Balance Objectives on All Three Dimensions
9|Balancing Responsibility, Risk and Return
Responsible Investing Includes Diverse Strategies That Can be Used Alone
or In Combination
9
Corporate Engagement
and Shareholder Action$8T
Impact / Community
Investing$248B
Thematic Investing$331B
ESG Integration$10T
Negative
Screening$15T
Norms-based
Screening$6T
Positive
Screening$6T
“Table Stakes”
Expected even in
non-SRI portfolios
“High Growth”
Greatest opportunity
for differentiation
in public and
private markets
“Big but Mature”
Approaches to Responsible Investing
Global Assets Under Management, $US
Source: Global Sustainable Investment Alliance 2016 Global Sustainable Investment Review
Strategies are not mutually exclusive
10|Balancing Responsibility, Risk and Return
Responsible Investing Strategies Address Different Objectives
Achieve
Positive
Outcomes
Align with
Mission
or Values
Influence
Corporate
Behavior
Avoid Bad
Actors
Manage Risk
or Volatility
Generate
Excess
Returns
Thematic Investing
Impact/Community
Investing
Negative Screening
Positive Screening
Norms Based
Screening
Corporate Engagement
and Shareholder Action
ESG Integration
Alignment with Investor’s Goals for Responsibility, Risk and Return is Critical
Objectives of Commonly Used Responsible Investing Strategies
Source: Global Sustainable Investment Alliance 2016 Global Sustainable Investment Review, AB Analysis
11|Balancing Responsibility, Risk and Return
6.7% 7.2%
Screening Remains Popular, but Can Have Unintended Consequences
Source: Standard & Poor's, AB analysis
All data shown from January 2007 to January 2017. Screens exclude companies with any exposure to tobacco, alcohol, defense, gambling, guns, Sudan,
pornography, fossil fuels and nuclear power
Broad Screens Typically Add Risk While Detracting from Returns
Percent of Universe Excluded with Broad Screens
16.3%15.1%
Annualized Cap Weighted Returns Annualized Volatility
Restricted
Portfolio
S&P
500
Market
Capitalization
39%
Number
of Stocks
25%
Restricted
Portfolio
S&P
500
12|Balancing Responsibility, Risk and Return
Dimension Metric Broad Screen*Targeted
Screen**S&P 500
% of Universe Excluded 39% 10% 0%
ReturnAnnualized return
(cap-weighted)6.7% 7.2% 7.2%
Risk Annualized volatility 16.3% 15.2% 15.1%
Risk Adjusted ReturnReturn/Risk Ratio
0.41 0.48 0.48
ResponsibilityESG Score
(equally-weighted)4.45 4.50 4.50
Tracking Error 2.5% 0.6% N/A
Targeted Screens Limit Negative Impact on Risk and ReturnsImpact of Broad vs. Narrow Screens on Return, Risk and Responsibility
Past performance does not guarantee future results. There can be no assurance that any investment objectives will be achieved.
January 2007 to January 2017
*Broad Screens include companies with any exposure to the 9 most common exclusions imposed on US responsible equity funds
**Narrow Screens excluded only those companies with material involvement in these business activities
Source: MSCI, AB Analysis
13|Balancing Responsibility, Risk and Return
Research Can Be Used to Find Improvers, not Just Top Performers
Forward returns for the next 12 months following a change in rating
January 1, 2017 through December 31, 2016
Source: MSCI, S&P and AB analysis
Excess Forward Return vs. Equal-Weighted S&P 500
Basis Points
Excess Forward Returns for Stocks with Two-Notch ESG
Upgrade vs. Equal-Weighted S&P 500
Upgrades for Poorly Rated Firms Are Rewarded Most
93
-34-60
-40
-20
0
20
40
60
80
100
Upgrades No Change
+127
basis
points
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
CCC B BB BBB
“The Redemption
Effect”
ESG Rating at
Time of UpgradeWorst Best
14|Balancing Responsibility, Risk and Return
ESG Ratings Are A Useful Indicator of Risk…
January 2007 to July 2017
Source: MSCI, S&P and AB analysis
Risk Premium for CCC vs. AAA Rated Stocks
= 2.83%
16%
17%
18%
19%
20%
21%
22%
CCC B BB BBB A AA AAA
Stock Specific Risk by ESG Rating CohortS&P 500
15|Balancing Responsibility, Risk and Return
Thematic Investing Can Uncover Growth OpportunitiesUN Sustainable Development Goals + Deep Fundamental Research is a Powerful Combination
Investing in Clean Water Aligns with UN Sustainable
Development Goals
CLEAN WATER AND
SANITATION
ZERO
HUNGER
GOOD JOBS AND
ECONOMIC GROWTH
INDUSTRY, INNOVATION
AND INFRASTRUCTURE
Leading to Differentiated
Investment Insights
16|Balancing Responsibility, Risk and Return
Portfolio Summary
Designed for clients seeking to invest responsibly
in their ‘core’ large cap equity allocation
Derived from the highest conviction holdings in
AB’s equity strategies and optimized for return, risk
and responsibility*
Balanced and persistent exposure to multiple
factors with long-term premia
Seeks to invest responsibly across multiple
environmental, social and governance parameters
Transparency in reporting performance on the
dimension of responsibility using key performance
indicators
Responsible US Equities (RE-USE)
Past performance does not guarantee future results. All portfolio statistics, characteristics and holdings are subject to change.
*Source portfolios include US Strategic Value, Relative Value, Large Cap Growth, Concentrated Growth, Strategic Core, Select Equities, Core Opportunities, Sustainable Thematic and US
Equity Income
**Based on 2008-2017 back test.
Portfolio Characteristics**
Holdings
Number of Holdings ~ 85
Annual turnover = 35-50%
Return and Risk Metrics
Target return premium: 1.0 – 1.5%
Tracking error: ~ 3.5%
Information Ratio: 0.4
Benchmark
S&P 500
Using Quantitative and Fundamental Approaches to Balance Return, Risk and Responsibility
17|Balancing Responsibility, Risk and Return
Implementing Multiple Strategies to Incorporate Responsibility
For illustrative purposes only. There can be no assurance that any investment objectives will be achieved.
*Screening eliminates from the investment universe companies that generate >5% of total revenues from tobacco, defense, guns, pornography and nuclear power. For fossil fuels, the exclusion is
based on revenue-adjusted carbon emissions (T CO2 / $M in revenue) > median for all companies that have any exposure to fossil fuels.
Screening*
ThematicUses AB’s US Sustainable Thematic Research as
Source Portfolio
ESG Integration
Active Ownership
RE-USE team engages with portfolio companies on ESG
issues and collaborates with investment and governance
teams on proxy voting
+ Fundamental evaluation of ESG issues conducted
by portfolio teams
+ ESG Momentum added to traditional quantitative
factors like Value, Growth, Size, etc.
+ RE-USE team conducts additional due diligence
on controversial stocks
Targeted screens minimize exposure to Tobacco,
Guns, Pornography, Defense, Fossil Fuels, Nuclear
Responsible US Equities (RE-USE)
18|Balancing Responsibility, Risk and Return
Responsible US Equities (RE-USE)
All metrics are reported
in absolute terms and
then measured vs. the
S&P 500
Qualitative measures,
including the efficacy of
our ESG engagements
with companies will be
monitored and reported.
As data on corporate
social responsibility
improves, we may add
new ESG metrics
ESG Momentum
For illustrative purposes only.
*CO2 emissions / $M Sales
**CO2 emissions / $M Invested
Climate Change
Diversity and Inclusion
Good Governance
% of Holdings with
ESG Ratings Upgrades
Average Board Tenure
% of Women on
Board of Directors
Carbon Emissions*
Carbon Intensity**
Transparency and Accountability on ESG Metrics
19|Balancing Responsibility, Risk and Return
Responsible investing is growing globally, across asset classes.
Growth is likely to continue, driven by demand from institutional asset owners and high net worth
individuals
Responsible investing can be implemented in a variety of ways, from screening to impact
investing, based on investor’s objectives and preferences for responsibility, risk and return.
Responsible investing is inherently more complex than traditional investing because it requires
attention to three dimensions rather than two.
A combination of strategies is often required to accomplish an investor’s goals within a particular
asset class or sub-asset class.
Summary and Conclusions
20|Balancing Responsibility, Risk and Return
Questions and Answers