Royal London Asset Management (RLAM) is committed to being a responsible investor. This means being a good steward of assets and promoting responsible investment with other stakeholders. The aim is to generate sustainable, risk-adjusted returns that reflect a wider understanding of what will drive economic performance in the future.

As part of that commitment RLAM seeks to understand environmental, social and governance risks and opportunities within the investment process. To achieve this we engage with companies and industry regulators to understand the issues and to promote best practice.

RESPONSIBILITYMATTERS

Royal London Asset Management Responsible Investment Quarterly Review • Q2 2016 ASSET MANAGEMENT

Despite the muted year so far for the equity market, which largely reflects the ongoing uncertainty in the global economy, these are exciting times. The pace of innovation from the companies we invest in is increasing rapidly, something which we believe will be both socially positive and financially rewarding.

The pace of innovation is accelerating for three key reasons. Firstly the availability of computing power continues to grow. Smartphones are becoming more powerful, cheaper and readily available. Secondly the amount of digital data is growing exponentially. Data is the raw material for innovation. Finally the amount being spent on research & development (R&D) by major corporates is at record levels. This combination of computing power, data and R&D spend is creating fertile ground from which innovation can grow.

We have always been of the view that innovation is, on the whole, socially positive. Step changes in living standards have often been accompanied by a technological development, such as the internet or new medicines to cure disease. This is not to say that there are not issues, such as data privacy, that are created as the innovation process progresses, but these are offset by far greater positives. This observation is important as we are on the cusp of perhaps the next big innovation of our lifetime: Artificial Intelligence (AI).

Most people will have at least a general awareness of what AI is. The more formal definition is that it is the name of the academic field which studies how to create computers and computer software that are capable of intelligent behaviour. Previously computers had to be programmed to become more intelligent and useful, what if a machine could actually learn as it goes along and be able to become more intelligent by itself ?

As computers are universal in society AI has the potential to become a general purpose technology, one capable of profoundly changing all aspects of society in the way the internet or electricity did. According to leading AI researchers, industry players are likely to have invested more in the development of AI over the last five years than the total since the inception of the field.

Both the benefits and problems with AI will take time to become clear. It may be possible to enhance the pace of drug development in areas of cancer, improve the diagnosis of medical patients and make cities smarter and more environmentally friendly. Equally AI has the potential to render a number of careers, particularly those which are low paid, unnecessary.

The Trust invests in the world leaders in AI: Google, Microsoft and Amazon. Each of these companies was invested in for different reasons but each over time has used innovation as a way towards social improvement. As AI develops we will continue to ask the question of each of these companies: does it have a net positive benefit to society?

FUND MANAGER VIEW

Mike Fox Head of Sustainable Funds

Much like Shakespeare’s Richard III, Britain’s public companies are experiencing a season of discontent and conflict precipitated by growing disquiet amongst their shareholder base. It began with the revolt over Bob Dudley’s pay package at the BP AGM and has continued most recently with Ladbrokes and Man Group receiving substantial votes against their executive pay packages of 42% and 37% respectively.

Executive pay has not received this much attention since the ‘Shareholder Spring’ of 2012 when shareholder revolts led to some high profile executive resignations. So what is different in 2016? I believe tension has been building for some time between companies and shareholders and the vote results we are seeing are the result of a few key trends at play.

First, financial performance overall in 2015 was not great. This was particularly the case in the commodities sector, but is equally true of many others. At the same time, companies have been privately asking their shareholders for permission to increase executive pay packages. We have received dozens of requests over the past year from companies seeking to increase either base salaries, annual bonuses or long-term incentive schemes, known as ‘LTIPs’. Some companies have even proposed increasing all three. The story in each case is similar. Boards perceive their executives are underpaid relative to their peers, increases have been modest or non-existent since the recession, and the boards feel they need to ‘catch up’ or risk a resignation. Only one out of 31 companies that wrote to us in the last 18 months was actually proposing to reduce executive pay.

In some cases the increases were warranted, for example where the company had materially grown in size or pay had truly not kept pace with the market. But in our view, many companies simply did not have a justifiable case for proposing large increases, yet many of them went ahead with them anyway.

The second trend is an increasing scepticism amongst many city investors about whether

the current model of remuneration is fit for purpose. Royal London Asset Management has been voting against pay schemes that it considers too complex for several years now. The Investment Association recently published an interim report looking at the issue of complex pay schemes and called for the move to simplify how executives are rewarded.

As the Telegraph recently reported, pay complexity has played well into the hands of remuneration consultants that are paid substantial sums to advise companies on how to structure their schemes and present them to shareholders. While there are some legitimate uses for consultants, over reliance on their advice and their mathematical pay models can lead to disastrous results if they are not coupled with a healthy dose of director scrutiny and discretion.

Third, there is a growing unease with the pace at which executive pay has risen in comparison with that of the average worker and pension saver. Although many companies are now astute enough to limit executive salary increases to an amount commensurate with their wider workforce, bonuses and LTIPs continue to go up. Not to mention executive pensions, which for many provide a cash top up of 25 to 30% over and above base salary. Don’t get me wrong, we are not afraid to pay well for exceptional performance. But one cannot make decisions about executive pay in a social vacuum and it is hard to ignore or discount the growing concerns about pay inequality, particularly in light of recent lacklustre financial performance.

The final trend is the looming triennial vote on remuneration policy, which for many companies will happen next year. In the UK, shareholders get a binding vote on pay policy which takes place every three years. So unlike most of the votes in 2016 which were annual advisory votes, next year’s votes must receive at least 50% support to pass. Failure to receive majority support from shareholders will send boards back to the drawing board to find more suitable pay schemes that will meet the high expectations of shareholders. Arguably, the

discontent shown by investors this year serves as a warning shot to directors in advance of next year’s votes.

Despite an increase in public activity, RLAM’s approach to voting this year remains consistent with previous years. We have been voting against some of the most controversial pay packages for several years now, including at BP and Reckitt Benckiser. What’s different this year is that we are increasingly joined by our peers in exercising our vote. This is very much welcomed.

However, I have one note of caution. As investors become more willing to vote against executive pay packages, boards may, in turn, become more immune to receiving high votes against. While a 20% vote against a pay package was once considered a major embarrassment, remuneration schemes with opposition from 30% or 40% of shareholders may become the norm. The change in rhetoric from directors is a particular concern, as they increasingly take a ‘glass half full’ approach, emphasising that 80% of shareholder support is a sign of success, not failure. They certainly weren’t saying this in 2012, and I fear that wider shareholder and public angst is increasingly being dismissed by some as a minority view.

Even though this year’s votes are not binding and many of the pay packages being rejected have in fact already been paid, boards are not out of the woods yet. Unlike the optimism expressed by Richard III in his opening soliloquy, the sentiment amongst investors has yet to give way to a sunnier disposition. In fact, directors that ignore the spring of discontent may face higher votes against their re-election. Like many of England’s Kings and Queens, they could be facing an untimely end to their reign.

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THE VIEWFROM RLAM

Responsible Investment Quarterly Review • Q2 2016

ThE SpRING OF DISCONTENT

First published in the Telegraph on 15 May 2016.

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THE VIEWFROM RLAM

SUSTAINABLE INVESTMENT IN pRACTICE

Responsible Investment Quarterly Review • Q2 2016

Rewarding good corporate behaviour

One important element to our approach to sustainable investing is to support companies exhibiting leadership in managing the environmental, social and governance (ESG) issues they face. In our quest to support companies with a net benefit to society (which is our definition of sustainability) we look for those businesses with products and services, such as healthcare and technology, with a positive impact on society and for companies who in the responsible way they manage themselves also have a positive impact on society.

Showing leadership in the management of ESG issues is in our view a strong proxy for how well a business is managed. Those companies with best practice in this area are led by forward thinking, responsible and socially aware Chief Executives and Boards. Those characteristics are often a good indicator of positive future investment returns.

This twin track approach of products and services, combined with ESG leadership, has been the foundation of our approach to Sustainable investing since 2003. It has been fundamental in our delivery of strong investment returns over the last decade and we are optimistic it will be successful in the future.

The RL Sustainable Funds invest in a number of companies that are leaders in ESG management. Here are a couple of examples:

Case study:Unilever

Unilever is one of the most responsible businesses we have come across. Its products are resource intensive both at the point of manufacture and also at the point of use. Take shampoo for example. At the point of manufacture a range of chemicals are used to create both the product and its packaging. Also when it is used water availability is an issue, particularly in developing economies where water scarcity is a major problem. Unilever has developed hair care products which reduce the amount of resource to manufacture them and require minimal water at the point of use, thereby reducing its impact on the environment. We believe this, and the countless other initiatives Unilever has in place, shows leadership in ESG management and is why we invest in it.

Case study:Starbucks

Starbucks’ management of sustainability is structured around three key themes: community involvement, ethical sourcing, and environmental stewardship. What sets them apart is their aggressive approach to target setting and subsequent ability meeting them. Starbucks has published and consistently delivered on targets in relation to use of energy from renewable sources, water usage and recyclable packaging.

The procurement of coffee and cocoa in the supply chain is the most material risk for Starbucks but one that appears to be very well managed. They have, over a number of years, made great strides in use of fairtrade certified and Coffee and Farmer Equity (C.A.F.E) Practices verified coffee. As a result we consider Starbucks to be an ESG leader.

Performance

Asset class 1 year

3 years

5 years

10 years

Sustainable Leaders - £436.0m UK All Companies UK Equity 1st 1st 1st 1st

Sustainable World - £221.7m Mixed Investment 40-85% Shares Global Equity 1st 1st 1st -

Sustainable Diversified - £295.5m Mixed Investment 20-65% Shares Multi Asset 1st 1st 1st -

Sustainable Managed Growth - £59.8m Mixed Investment 0-35% Shares Fixed Income 1st - - -

Sustainable Managed Income – £28.1m 12 month income target 3.7% to 30/6/2016 Fixed Income 1.5% total return - - -

Source: Lipper as at 30/06/2016. Past performance is not a guide to future performance. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested.

ThE UK’S REMUNERATION VOTESIn the UK, shareholders are given two opportunities to vote on remuneration: an annual vote to approve pay awarded in the year, and a triennial vote to approve the forward-looking pay policy. The annual vote is advisory only, so effectively will have no impact on the pay-outs awarded in 2015. However, the pay policy vote is binding. If boards fail to receive a majority of support from shareholders then they must propose an alternative policy the following year.

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CORPORATEGOVERNANCE

STEWARDShIp & VOTINGThe 2016 proxy season has been stormy, with several high profile companies receiving significant opposition from shareholders to their executive pay reports.

BP received 59% votes against its pay report after the board approved a £14 million pay package for the CEO in a year when the company made record losses. RLAM objected publically to the pay-out, and in particular the annual bonus. The CEO received the maximum bonus last year of 250% of salary for meeting key operational targets. Although we acknowledge the management team was successful in the year in meeting key targets, we believe the board should have applied discretion to reduce the award to reflect financial performance.

Anglo American was another company in the headlines this quarter over pay. Only 52% of shareholders supported the remuneration vote with 37% voting against and 11% abstaining. It was the worst performing stock on the FTSE last year, yet executives received significant annual bonuses. RLAM voted against the remuneration report.

Health care firm Smith & Nephew also received significant opposition to its pay report, with only 43% opting to support the resolution. RLAM bucked the trend on this vote and after significant internal discussion, decided to support the company’s pay. We acknowledged the good performance of the company recently and felt the board had followed a robust process in making its decision to allow the long-term

awards to vest in full.

At Shire, RLAM also voted against the pay report due to our concerns about the 25% increase to the CEO’s salary and overall quantum of awards. We also abstained on the re-election of the chair of the remuneration committee to reflect the fact that we had voted against the pay at Shire for several years.

Finally, at WPP, RLAM also voted against the pay report due to our concerns about the size of the award granted to the CEO, Sir Martin Sorrell during the year. WPP received a 33.45% vote against. We also voted against the Chairman of the Remuneration Committee in light of our consistent votes against the pay at WPP over recent years, he received a 8.36% vote against.

Responsible Investment Quarterly Review • Q2 2016

Companymeetings

voted

391

Votes against

directors

6%

Companieswe met with

31

Resolutionsvoted

6,182

Pay consultation requests

10

Votes in support of management

93%

Votes against pay

26%

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3

8

t

5

Remuneration

Climate Change

Board Skills

Corporate Governance

Succession Planning

AGM Vote

Diversity

Culture

Reputational Risk

COmPANYENGAGEMENT

Responsible Investment Quarterly Review • Q2 2016

In the quarter we engaged with 31 companies on a range of topics:

DIVERSITyGKN, an engineering firm heavily involved in aerospace and manufacturing is in an industry that traditionally and unfortunately continues to struggle with diversity. We met with the company alongside other investors to gain their perspective on the issue and to understand steps that are being taken to address this. The company was clear, there is a lack of female candidates for the boardroom with the appropriate skill set but reassuringly there are the signs of a shift in the thinking of those responsible for recruitment. There are small but positive signs of improvement. The Company are trying to tackle the issue from the ground up. They are using initiatives such as mentoring; employees bringing their children into work; speaking at schools, colleges and universities, all in the hope of encouraging a more diverse range of people to apply for apprenticeships and graduate programs. This is an issue that will only be addressed through the combination of many smaller programs. We will continue to monitor and engage with the company on progress both inside and outside the boardroom.

SOCIAL hOUSINGThe social housing sector is currently undergoing a period of immense change. The government has decreased funding and capped the rent that associations are able to charge their tenants. An answer at which many providers have arrived is to increase their commercial exposure, building houses for sale to counteract the financial strain. For a sector traditionally focused on providing social benefit, this is new territory. A number of providers have also recently announced intentions to merge in order to further reduce operating costs. Recent examples are London & Quadrant with Hyde and East Thames and the merger of Affinity Sutton with Circle Housing; creating two of the largest providers. We are working on an ongoing project with the RLAM Fixed Income team, who are invested in a number of social housing providers, to better understand the changes facing the sector. By speaking to the companies we can gain an understanding of those that are better prepared to deal with these new challenges and particularly whether their governance structures are appropriately structured to deal with the progression towards commerciality.

SUCCESSION pLANNINGThis quarter we met with the Worldpay management team following their IPO in October 2015. We sought to engage further with the company addressing their corporate governance arrangements which currently fall below the levels of independence required of a FTSE 100 company. We were satisfied that there are systems in place to address these short comings. Plans are in place to appoint more independent directors to the board with skill-sets appropriate to the business and to move away from Private Equity backing necessary for an IPO. A full scale review is being undertaken and succession plans are in place both for the board and management, ensuring the smooth and successful operation of the executive pipeline. This will remain an ongoing engagement project until full compliance with the UK governance code is reached. We regard a formal succession plan as fundamental to the long-term resilience of a business and will be asking all companies we meet with this year about their succession plans.

VOTING ThEMES

Issued by Royal London Asset Management July 2016. Information correct at that date unless otherwise stated. For professional investors and advisors only. Past performance is not a guide to future performance. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. Royal London Asset Management Limited, registered in England and Wales number 2244297; Royal London Unit Trust Managers Limited, registered in England and Wales number 2372439. RLUM Limited, registered in England and Wales number 2369965. All of these companies are authorised and regulated by the Financial Conduct Authority. All of these companies are subsidiaries of The Royal London Mutual Insurance Society Limited, registered in England and Wales number 99064. Registered Office: 55 Gracechurch Street, London, EC3V 0RL. The marketing brand also includes Royal London Asset Management Bond Funds Plc, an umbrella company with segregated liability between sub-funds, authorised and regulated by the Central Bank of Ireland, registered in Ireland number 364259.

Registered office: 70 Sir John Rogerson’s Quay, Dublin 2, Ireland. Ref: NRLAMON0001

CONTACT

Royal London Asset Management

55 Gracechurch Street London EC3V 0RL

Tel020 7506 6754

Fax020 7506 6796

Emailbdsupport@rlam.co.uk

www.rlam.co.uk

Niall O’Shea

Head of Responsible Investment

Ashley Hamilton Claxton

Corporate Governance Manager

Gail Counihan

Responsible Investment Analyst

Sophie Johnson

Responsible Investment Analyst

For further information about our responsible investment capabilities, please contact:

RLAM’s Responsible Investment Team

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