responsible investment & governance annual report 2012

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Responsible Investment & Governance Annual Report 2012

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Page 1: Responsible investment & governance annual report 2012

Responsible Investment & Governance Annual Report • 2012

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Contents

Introduction: Responsible investment – sound business strategy and ownership approach

Identifying companies performing well

Engagements – a cornerstone for active investors

PRI initiatives for company engagement

Nuclear weapons policy

Corporate governance activities

Focus Brazil Focus Mexico

Focus Canada

Emerging Stars & Swedish Stars

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Responsible investment– sound business strategy and ownership approach

The past couple of years have been shaped by the finan-cial crisis and growing macro changes all over the world. The imbalances disclosed have in many ways demon-strated how critical active ownership is in the financial sector. The market economies dominating world markets are today facing significant pressure from civil societies, clients and interest groups. Questions are being raised as to whether shareholders should and could continue to benefit from their ownership right without also assuming the responsibility that comes with that right. As investors we are continuously striving for higher standards regarding transparency, disclosure and ac-countability for the companies we invest in. We believe that the industries we operate in as well as our actions need to move from a culture of formal ownership entitle-ment to a culture of responsible ownership.Our activities within the realm of responsible ownership have increased over the last couple of years, and results achieved have improved our ability to provide clients with long-term responsible investment solutions. Most investment managers act on behalf of millions of investors, mainly ordinary people, so it does not make sense to suggest that it is in their interest to invest in a company that destroys the environment and mistreats its employees, thereby encouraging the company to con-tinue what it is doing.

We clearly see some key trends shaping 2013. Slow and sluggish economic growth and downward pricing pressure caused by regulatory and fiscal con-straints will make it increasingly difficult for a number of industries in core developed markets. Longer term, growth will be determined by companies’ ability to tap into new markets targeting underserved demographics both domestically and abroad. Despite strong focus on the commercial potential of demographic shifts and Bottom-of-the-Pyramid strategies, opportunities remain largely unexplored even in sectors facing strong headwinds in existing markets.

We believe that companies able to tackle this key issue will be the long-term winners. Mass protests in China have risen dramatically over the past several years, culminating in a number of high profile protests in 2012 that have put a stop to plans for new industrial plants. At the heart of Chinese social discontent are a growing intolerance of corruption and concerns over the rising inequality. These shifts in policy focus could result in sweeping structural changes or simply a wave of high profile prosecutions, so investors should thoroughly consider investing in companies and sectors vulnerable to being targeted for corruption. Any upcoming corruption sweeps could impact investors in two ways: (i) through an immediate blow to a single stock or (ii) through longer-term erosion of competi-tive advantage due to loss of political access. According to Institutional Shareholder Services Inc. (ISS), more than 20% of shareholders voted ‘yes’ to proxy proposals last year involving environmental and social issues, an increase from 7.6% in 2000 and 9.8% in 2005. As in-vestors and other stakeholders put pressure on compa-nies to increase their attention to ESG issues, company reporting on these issues has been on the rise. However, in many cases the information provided does not help investors make insightful decisions about the key mate-rial risks associated with a business. Because companies are under pressure to address a wide variety of issues of concern to various stakeholders, they are often reporting on issues where they face little finan-cial impact while ignoring issues that pose significant risks to their core activities.

Sasja BeslikHead of Responsible Investment & Governance

Allan PolackHead of Asset Management

Introduction:

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Identifying companies performing well

The core of our Responsible Investment (RI) strategy is in-depth environmental, social and governance (ESG) analysis and engagement activities. Throughout our ESG analysis companies’ overall management practices re-garding key ESG issues are assessed together with their governance structure for dealing with these aspects. Based on the analysis, companies are selected for proac-tive engagement dialogues. The focus is on transferring knowledge and active participation in the development process. In 2010, we initiated our in-house environ-mental, social and governance (ESG) analysis and de-veloped our own criteria and methodology. Our analysis is based on a positive approach and aims at identifying best practices and companies that have implemented good management policies to address key risks and op-portunities. Our in-house research team focuses mainly on analysis of Nordic companies as well as on analysis

related to our enhanced RI funds: Swedish Stars and Emerging Stars (page 28).

Identifying new starsThe first and one of the most important parts of the ESG analysis process is to identify issues for each sector and for the company we are assessing. Our aim is to identify key issues that are of material relevance for the company to address, today and in the future. NGOs, external research providers, unions and media are important sources of information. We search not only for policies and management systems but also for concrete actions and results that indicate that the company has estab-lished policies and practices to manage the identified key issues. The company is informed about our rating but also about what improvements we need to see in order for us to rate the company differently.

We consider acting responsibly a prerequisite for a company to achieve long-term good returns. Our ESG analysis enables us to identify companies that operate in line with our policy and deliver long-term value.

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Engagements – a cornerstone for active investors

Nordea sees engagement as an active investor and the opportunity to contribute to positive changes as an important part of our work with responsible invest-ments. We engage with companies violating international norms and companies where we see significant room for improvement in relation to ESG issues.

Norm-based engagementsIn 2012 Nordea demonstrated active ownership in 14 international companies violating international norms. The breaches include violations of human rights (in-cluding indigenous people’s rights), violations of labour rights, severe environmental degradation as well as cor-ruption.

Ended engagements due to successful progressIn 2012 Nordea also successfully ended five company engagements because the companies’ norm-based behaviour had improved significantly since the dialogue was started. Among the companies were two oil and gas companies, a car maker, a utility company and a mining company.

The norm violations included environmental degradation through severe oil spills, human rights abuses in Burma, suppression of workers’ rights to unionise and violations of the indigenous people’s rights at a dam project in Pan-ama. Other examples were supply of military equipment to Sudan as well as environmental and human rights violations at mining facilities in India.

All the companies have developed and implemented sufficient policies and procedures to address the previ-ous norm violations. Furthermore, they have improved transparency and begun reporting on how they address ESG risks in their business operations. Another impres-sive development and change is how the companies now see sustainability as an important part of their strategy.

From being a laggard in its strategic approach to sustain-ability, the mining company now has sustainability as a core strategic pillar of its business strategy.

New engagements with norm-breaching companies Nordea initiated three new engagements in 2012. One engagement targets labour rights at a company’s sub-sidiary in Mexico, where labour rights in general are weak. The other two company engagements address indigenous people’s rights in relation to a dam project in Brazil. Often it takes time before we see real strategic change in the companies we engage with. But we know for a fact that the time and efforts we spend on engag-ing with companies discussing their norm violations and overall approach to sustainability do lead to progress. It is especially rewarding when the companies not only ad-dress their norm-breaching behaviour, but also start to look at sustainability as an important part of their overall business strategy.

We engage to change. Nordea initiates engagement dialogues to change behaviour and to enhance business performance by addressing the business practices used by companies we invest in.

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Examples of norm-based engagement activities in 2012

Case: Environmental violationsAn oil company has been responsible for severe water and soil pollution. The company has repeatedly failed to maintain corroded pipelines, resulting in at least eight registered oil spills since 2006. The most recent spill was in April 2010. Management is acknowledging the problems related to the oil spills. The company has been provided with a list of key issues to work on including pipeline monitoring and oil spills reduction systems, gas flaring as well as cleaning and remediation of areas con-taminated by oil spills. Management was also provided with a detailed road map for pipeline integrity manage-ment and other environmental issues, and it has com-mitted itself to work with us to make progress.

Case: Human rights violationsViolation of indigenous people’s rights in connection with a dam project in Central America. Previously, the company has been reported to be involved in trade union discrimination in Africa, constituting a breach of several ILO conventions on workers’ rights.Nordea put pressure on the company, requiring it to adopt adequate risk mitigation strategies that address the violations of the indigenous people’s rights. Among other things the company was provided with samples of leading peers’ work in this area.

We have achieved the main target of our engagement because the company has now implemented a risk mitigation strategy. Furthermore, effective reporting mechanisms are now in place, with increased transpar-ency as to the company’s operations. In early 2013 the company will publish an extensive CSR report on the key ESG risks related to its business operations. Nordea was allowed to preview the report, and we are satisfied with

the way the company now reports on and addresses its risks.Nordea also put pressure on the company, requiring it to do better in terms of honouring labour rights. We have now also seen a positive development in this respect. In Cameroon, where the company previously opposed any form of unionisation, workers are now represented by three different unions and the company has developed a strong culture for unionisation at its facilities. This is something that was quite unlikely a few years ago.

Following sufficient progress and with the targets met, Nordea ended this engagement in the autumn of 2012.

Case: Labour rights violationIn early 2012 Nordea initiated a dialogue with a Finnish company allegedly involved in labour rights violations in Mexico. The company had recently acquired a Mexican company that was suppressing unionisation.

Since we started the dialogue, the Finnish company has been very responsive and forthcoming towards Nordea, discussing ways to approach the labour controversies and to ensure that the rights of the workers are suffi-ciently safeguarded.

This autumn the company arranged a vote organised by a third party on union representation among its employ-ees. Nordea view this as a proactive and timely response by the company, demonstrating its willingness to ensure the workers’ right to union representation of their own choosing. The next step in the dialogue will be to ensure that the company has sufficient policies and processes in place to mitigate labour related controversies.

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Proactive dialogues and company engagementsNordea also prioritises proactive engagements. We initiate dialogue with the companies representing our largest holdings as well as companies identified for our RI enhanced funds during the ESG analysis process. As owners we would like the companies we invest in to ad-dress ESG risks as well as opportunities.The proactive dialogues and engagements are carried out by Nordea’s inhouse team for responsible investment and governance. In 2012 we met with 44 Nordic and global companies. It is our practice to engage in a direct face-to-face dialogue with the companies.

Three levels of interaction with companiesThe first level of interaction is the information request. The aim of this dialogue is to receive basic information from the company. The information is used in our ESG analysis for the RI enhanced funds and, where necessary, to encourage the company to improve transparency.

The second level is a dialogue initiated in order to un-derstand more about a specific key issue. The companies often have good reporting processes in place, but we may lack certain information in order to complete our assess-ment of the company. The dialogue is often conducted at face-to-face meetings or via conference calls.

The third level of interaction involves more intensive engagements conducted in order to improve a company’s ESG rating. In addition to contributing to a positive development in the company in terms of ESG, the goal of such interaction is to improve the company’s ESG profile so that we can invest in it through our RI enhanced funds.

This type of engagement has clear targets based on find-ings in our analysis and is a long-term activity lasting between six months and three years.

All three types of interaction are drivers of change and will result in improved transparency and better risk or opportunity management.

Examples of company meetings – 2012

Astra Zeneca

Axis Communication

BR Malls

Estacio Participacoes

Elextrolux

Getinge

H&M

Holmen

J.M.

Kappahl

Kungsleden

LLX

Lojas Americanas

Meda

Millicom

Mills

Multiplan

NCC

Nobia

Nordea

OGX

Oriflame

Petrobras

PRG Realty

Engagements - a cornerstone for active investors

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Mr Sasja Beslik is Heading Responsible Investment and Governance activities for Nordea Asset Manage- ment. Beslik joined Nordea in 2009. During his time at Nordea he has worked as CEO for Nordea Investment Funds in Sweden and is leading development of Responsible Investment concept, products and solutions within Nordea Group . Beslik has extensive international investment experience, before joining Nordea, working in Africa, Asia and former Soviet Union countries, Beslik worked also as Global Head of Engagement activities for ABN AMRO Asset Management. Appointed as most influential business individual in Sweden under age of 40 in 2007, Beslik have since then been awarded best ESG analyst in Sweden 2010 and Young Global Leader by World Economic Forum in 2011, one among 100 selected individuals globally.Aside of his work within Nordea Group Beslik chairs UNEP FI Water Work group addressing global water issues within the context of financial industry as well as participating in steering committee within UNPRI on shale gas and water issues.

Before joining Financial industry 2003, Beslik worked for multinationals in extractive industries in the CSR field all over the world.

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PRI initiatives for company engagement

Nordea also participates in company engagements and initiatives through the PRI Clearing House. This is a hub for signatories to PRI (United Nations-backed Princi-ples for Responsible Investment) where they can jointly support, drive and participate in different initiatives.

Nordea is currently involved in five PRI initiatives: sustainable fisheries and Global Compact reporting as well as three initiatives addressing oil sands production, water risk and fracking.

Sustainable fisheriesIt is increasingly recognised that overfishing and un-sustainable fishing practices could cause an irreversible decline in fish populations. This may lead to disruptions in company supply chains and represents a risk to both the companies and the investors that have invested in these companies.

The sustainable fisheries initiative was initiated and is backed by 18 investors and covers 41 companies. The goal is more sustainable fisheries practices in their busi-ness operations. Among the companies are Mitsubishi, Unilever, McDonalds, Wesfarmers and Nestlé.

This initiative was started in July 2011.

Global CompactNordea also supports the investor-backed initiative towards companies that have signed the UN Global Compact* but do not fulfil its reporting requirements. The goal of the initiative is to make the companies report on how they address and implement the ten principles to which they have signed up.

34 investors from over 12 countries and representing over USD 3 trillion are supporting this initiative through the PRI Clearing House. Together with the respective investors, Nordea has addressed 116 companies in total, 89 leaders and 27 laggards, on their Global Compact reporting.

This initiative was started in 2007.

Oil sands initiativeIn August 2012 Nordea joined a new initiative through the PRI that targets oil sands production and the key environmental and social impacts of such production. The initiative is run by PRI signatories in cooperation with COSIA**, an organization established by the 12 biggest oil sands producing companies operating in Canada. The aim of this initiative is a constructive dialogue focusing on how the industry may reduce the environmental and social impact of the companies’ oil sands production.

This initiative was started in 2012.

Water risk and fracking initiativesIn late 2012 Nordea was elected to participate in the steering committee of two new engagements through the PRI, focusing on water risks and fracking.

Water withdrawals are forecast to continue to grow significantly – according to the Water Resources Group demand for water will by 2030 exceed current available supply by 40%, leading to large areas with significant water scarcity around the world. This will most likely have a significant effect on future economic growth and is therefore likely to impact long-term investors.

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The aim of this initiative is to initiate a dialogue with water-intensive companies and sectors in order to address direct risks and supply chain risks related to water-demanding production and water scarcity.

The initiative on fracking aims at addressing several aspects of fracking operations, with a targeted group of companies. The focus of engagements varies from greenhouse gas emissions, water pollution and manage-ment to social and community concerns.

The water risk and fracking initiatives will run for three years.

*The UN Global Compact is a set of ten principles that busi-

nesses can sign up to regarding the protection of human rights,

labour rights and the environment and anti-corruption efforts.

Reporting on how the company is following up on the principles

is not required, but highly recommended so as to avoid so-called

blue-washing. Blue-washing is when a company signs up to the

UN Global Compact for branding reasons, but does not follow

up on the principles or report on how the principles are followed.

**COSIA stands for Canada`s Oil Sands Innovation Alliance.

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Nuclear weapons excluded from Nordea Funds

Nordea has decided to exclude companies that con-tribute to the production or development of nuclear programmes from our funds*. We regard nuclear weapons and their potential use as controversial, given their indiscriminate effects on human populations.

During the first months of 2012 ten companies were excluded from our funds due to their involvement in the production or development of nuclear programmes. That is, of the ten companies two were already excluded due to their involvement in anti-personnel mine and cluster munitions production.

Companies excluded from Nordea’s funds due to their involvement in the produc-tion or development of nuclear pro- grammes are:

• EADS• GoodrichCorp• Safran• BabcockInternationalGroup• BAESystems• HuntingtonIngalls• NorthropGrumman• Rolls-Royce• GeneralDynamics**• LockheedMartin**

* By production and development of nuclear programmes we mean companies’ contribu- tion to nuclear programmes in the develop- ment and production phase.

- In so-called nuclear weapons states as defined by the Non-Proliferation of Nuclear Weapons Treaty (NPT), constituting the following five countries: the United States, Russia, the United Kingdom, France and China. It therefore applies to all nuclear programmes apart from the programmes established before 1970 when the NPT entered into force.- It also involves all nuclear programmes outside the NPT. The NPT is an international treaty whose objective is to prevent the spread of nuclear weapons.

** Previously excluded from Nordea´s funds due to anti-personnel mine and cluster munitions production (2009).

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Aeroteh S.A. Involvement in cluster munitions

Alliant Techsystems Inc. Involvement in cluster munitions

Aryt Industries Ltd Involvement in cluster munitions

Doosan Corporation Involvement in cluster munitions

General Dynamics Corporation Involvement in cluster munitions & nuclear weapons

Hanwha Corporation Involvement in cluster munitions & anti-personnel mines

L-3 Communications Corporation Involvement in cluster munitions

Lockheed Martin Corporation Involvement in cluster munitions & nuclear weapons

Motovilikhinskive Zavody OAO Involvement in cluster munitions

Poongsan Corporation Involvement in cluster munitions

Singapore Technologies Engineering Ltd Involvement in cluster munitions & anti-personnel mines

Textron Inc. Involvement in cluster munitions

Potash Corporation of Saskatchewan Violation of human rights related norms

Babcock International Group Involvement in nuclear weapons

BAE Systems plc Involvement in nuclear weapons

European Aeronautic Defence and Space Company EADS N.V. Involvement in nuclear weapons

United Technologies Corporation Involvement in nuclear weapons

Huntington Ingalls Industries Inc. Involvement in nuclear weapons

Northrop Grumman Corporation Involvement in nuclear weapons

Rolls-Royce plc Involvement in nuclear weapons

Safran Group Involvement in nuclear weapons

List of companies excluded from Nordea’s funds:

If a company is not demonstrating a real commitment to changing its norm-breaching behaviour, Nordea’s Com-mittee for Responsible Investment may decide to exclude this company from all Nordea’s fund portfolios.Certain companies also produce specific products that make an engagement less feasible, for example compa-nies where the production of illegal weapons and com-

ponents to nuclear weapons constitutes an important part of their business operations.

Below the companies excluded from Nordea’s funds as of December 2012 are listed. These are companies where dialogue is not feasible or has led to insufficient progress.

Excluded companies – where engagement is not feasible

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Corporate governance activities

When exercising our role as an owner, we focus our rela-tively limited resources on companies where our owner-ship is of such a size that our decisions have significance for the company’s development. In a relatively large number of companies our shareholding is of signifi-cance. For example, at the end of 2012 we had hold-ings in 42 companies exceeding 5% of the outstanding shares, and in more than 95 companies we held more than 3%.

The absolute majority of these large holdings are con-centrated to Nordic companies, mainly Swedish compa-nies. Some examples of our largest holdings are Sigma, an information technology company in which we hold 20% of the capital, and Sectra, a company operating in the area of medical systems and secure communication systems in which we hold 19% of the capital.

Nomination committeesDuring the first half of 2012 Nordea Fundswas represented on 26 nomination committees ofthe companies; Alpcot Agro, Arise, Boliden, Bure Equity,Connecta, Dibs, Doro, East Capital Explorer, HiQ, JM,Kungsleden, Lagercrantz, Meda, MTG, NCC, Opus Prodox, Proffice, Rezidor, Saab, Sectra, Sigma, Studs-vik, Svedbergs, Swedol, Transmode and ÅF. The nomination committees normally consist of repre-sentatives from the 3-4 largest owners. It is their re-sponsibility, among other things, to evaluate the perfor-mance of the board and to propose new board members and auditors as well as their remuneration to the AGM.At the end of 2012 Nordea Funds was a member of 29 nomination committees.

During the year we have had dialogues with the boards of 16 companies regarding the design of remuneration programmes for executives and employees. We consider correctly designed incentive programmes as useful instruments for the creation of added value for the shareholders. This means for instance that participants in the incentive programme should be exposed to both increases and decreases in the value of the company’s stock. Incentive programmes should have a clear con-nection to performance at both individual and company level and should also aim at long-term ownership of shares. Provided that clearly operations-related goals or explicit and relevant reference measurements are achieved, the incentive programme may result in shares or options to the management and staff.

In one case during 2012 (Autoliv) we voted against the advisory resolution to approve the compensation of the company´s executives, among other things due to the lack of performance criteria for granting shares and op-tions.

At this season’s AGMs, proposals have in a number of cases been presented, mandating the boards to decide on rights issues against cash without pre-emptive rights for the shareholders. In our opinion rights issues against cash without pre-emptive rights could result in obvi-ous disadvantages for existing shareholders and in some cases destroy value.

We therefore normally act on such proposals. In a number of companies we have initiated a dialogue with the boards, resulting in the mandates being limited to

Nordea Funds is an active owner in the companies we invest in. A good long-term development of the companies will benefit shareholders, employees as well as other stakeholders.

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issues with pre-emptive rights. At some AGMs we have also made requests to the boards regarding the use of such mandates. One example is Finnish company Rapala where the suggested mandate was exceptionally exten-sive. In other cases, for example Consilium, we have voted against such a mandate.

We have focused on this type of mandate for a number of years and are happy to note that the number of requests for such mandates is decreasing. More importantly, we note that in no case where we have acted has the man-dates been used for rights issues against cash without pre-emptive rights for the shareholders.

At the AGM of Scania, together with eight other Swedish institutions we abstained from voting for the election of board members. We considered it to be the most suitable way to express our concerns. The reason was that the only representative on the nomination committee who was independent of VW and MAN did not support the proposed board on the grounds that it would not take the interests of minority shareholders sufficiently into account. At the AGM Nordea Funds requested that the majority owners’ representatives on nomination com-mittees should in future consider the interests of all shareholders.

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Focus Brazil

Rio The UN conference on sustainable development was held in Rio in June 2012. The event, known as Rio+20 marking the twentieth anniversary of the Rio Earth Sum-mit held in 1992, gathered 45,000 delegates from 188 countries to discuss the institutional framework and economics of sustainable development.

Company meetings in BrazilBefore the PRI conference, Nordea representatives took the opportunity to meet a total of 12 Brazilian com-panies which are all Emerging Stars holdings or potential holdings. The sustainability index (ISE) of the Brazil-ian stock exchange (BOVESPA) has been in place since 2005, and this has encouraged Brazilian companies to build strong ESG management systems and practices. Many Brazilian companies report far less than they are actually doing in terms of ESG management. This “doing instead of reporting” attitude is indeed a welcome devel-opment, and as a whole (with few exceptions) the ratings of the Brazilian companies are improving.

The future we wantThe large international development conferences nowa-days rarely produce binding international agreements, and while the Rio+20 conference as expected did not result in any new binding agreements, several business-related initiatives were included in the conference outcome document “The Future We Want”.

Corporate responsibility for sustainable development was wholeheartedly supported through for example the promotion of green economy, environmentally sound use of raw materials and corporate sustainability reporting.

During the conference many organizations and stock exchanges announced their ESG reporting initiatives. The UK Department for the Environment, Food and

Rural Affairs (DEFRA) announced that greenhouse gas emission reporting will be a mandatory part of the annual reporting of all companies listed on the London Stock Exchange as from 2013. DEFRA estimates that over time this will make it possible for the UK to reduce its annual carbon emissions by 4 million tonnes and thus meet the EU target by 2020. Nasdaq OMX announced that it will join the Sustainable Stock Exchanges initiative, requiring ESG reporting from all listed companies on a “comply or explain” basis.

The Nordea RIG team fully supports and endorses initiatives improving transparency on ESG issues. The “Stars” ESG research process relies on corporate trans-parency, and the LSE and NASDAQ OMX are welcome additions to the Sao Paolo, Johannesburg and Singapore exchanges, all key exchanges for Emerging Stars that already include some form of ESG disclosure in their listing requirements.

PRI conferenceShortly after the Rio+20 conference, the Principles of Responsible Investment initiative held its annual conference for PRI signatories in which the Nordea delegation including the Emerging Stars fund manager and analysts also participated.

Main conference topics addressed systemic risks and how the responsible investment community as a whole can respond. Among the key initiatives, the PRI secretariat will start consulting signatories on which policy issues to research and lobby, to identify policy responses on the key subjects identified for action.

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Focus Mexico Big Business hazards in the world’s most dangerous city

Mexico has in many ways become highly popular among investors and companies around the globe. From one coast the country offers access to the Pacific Ocean and Asia and from the other to the Atlantic Ocean and Europe. Also, sunny Mexico borders the US, the world’s largest and most attractive market with which it has a long-standing free trade agree-ment. Even so, the wide-spread corruption and high crime rates in Mexico often terrify even the most hardened market players, and many companies soon see themselves as pawns in a game where it is difficult to see what the real agenda is.

When the Finnish company PKC Group acquired activi-ties in Mexico some years ago, the strategy was fairly straightforward. The company wanted access to cheap and efficient labour in one of the most appealing geo-graphical areas in the world. Separated only by the once so mighty Rio Grande river, Mexico is only a stone’s throw away from the world’s most potent market in the US where for instance major car makers are willing ta-kers of the company’s products. PKC is not alone. Three out of four of the largest com-panies in the US have established production facilities here just south of the US border. Over the past 50 years the Mexican government has offered extremely lucrative conditions for production companies setting up busi-ness in the border region, the so-called “maquiladoras”. These companies have always been treated benevolently to ensure that the slow wheels of Mexico keep turning. Political changes in difficult times For almost 100 years Mexico was governed by the Institutional Revolutionary Party, the PRI. But in the early 2000s something happened. The Mexican people demanded changes, and the PRI president was ousted and replaced by a new candidate who pledged to fight corruption and crime. This president has now also been toppled and in 2013 the PRI returned to power. Unfortunately, the fight especially against the drug

barons became much bloodier than anyone dared ima-gine. During the second half of the 2000s and up to now the war between drug barons, the police and the mili-tary has claimed close to 60,000 lives. The epicentre of the war was the almost mythical border town of Juarez, which quite ironically is just across the border from El Paso, one of the safest places in the US. But Juarez also acts as a magnet to big companies looking for access to cheap labour and the US market at the same time. The production facilities of major global players are located along the border like pearls on a string, with most of them in Juarez. Even companies such as Swedish Electrolux, which is known for its soft Nordic values and an ethical rule book the size of the Bible, has more than 5000 people employed at its huge white goods factories in Juarez. The drug war is, however, far from the only serious issue in Mexico. For decades poverty and an almost totali-tarian regime has given free rein to corruption. Many companies have had to realise that principles were one thing, reality another. Recently, American supermarket giant Walmart, one of the largest retailers in the world, was caught in having systematically been paying bribes for years as a means to grow its activities. Today, Walmart is the second-largest employer in Mexico and the scandal remains front-page news in the media including New York Times. On the list showing the most corrupt countries in the world in 2012 Mexico is number 105. Topping the list as the world’s least corrupt countries are Denmark, Finland and New Zealand. Unions fighting to gain a foothold But the companies in Juarez and other border towns in the maquiladoras zones in Mexico are not only struggling with crime and corruption. One very hot topic these days is the Mexican trade unions.

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The Finnish company PKC recently found itself at the centre of one of these battles. In line with many other foreign companies in Mexico, it had not previously opened its doors to the trade unions because as so many other organisations in the complex Mexican society the unions are known to be deeply corrupt and engaged in power struggles with one another. And the outcome of these struggles is not always to the benefit of work-ers or employers. Some unions are even rumoured to be a source of funding for the ruling PRI party, with no transparency as to the many millions of pesos raised in this way. But most observers have long agreed that for companies in Mexico to climb up from the lowest level of the pro-duction ladder, the trade unions will have to be involved more and in a better way. Consequently, as one of few companies PKC arranged a vote among its employees on union representation. The employees were to choose between two unions competing for the exclusive right to represent the thousands of workers at PKC’s factories. The vote resulted in a tie, and the matter has now been transferred from the PKC factory floor to the Mexican courts. Meanwhile, PKC and many of its employees have become pawns in a game where so much more than col-lective agreements, overtime payment and training is at stake. A new era But despite the obvious hazards of the Mexican miracle, the country is no doubt moving in the right direction. The horrendous experiences of the past notwithstand-ing, the Mexican government has introduced new laws aimed at securing transparency in government and public administration – and it seems that the new laws may have the desired effect in terms of putting an end to corrosive corruption. Moreover, the drug war has turned less ferocious and far fewer people have been killed over the past year. Some think that the reason is that the most

dangerous drug cartels have lost, but others believe that the confrontations have merely declined following the election of a new president. But no-one can take away Mexico’s strategic geographi-cal location, and in fierce competition with Brazil Mexico has evolved into one of the greatest attractions for foreign direct investment in Latin America. The question is whether companies such as PKC and Electrolux will succeed in anchoring their own values in this complex, highly charged and dangerous society that Mexico is and will be for many years to come.

Focus Mexico

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On 1 December 2012 Mexico got a new president. The former president Mr. Felipe Calderon from the National Action Party (PAN) handed over the power to the new president Mr. Enrique Peña Nieto from The Institutional Revolutionary Party (PRI). Mr. Peña had won a clear victory in the election in July.

The PRI has more or less been running Mexico for most of the 20th century. However, in 2000 the PAN won the election and stayed in power through two presidents until 1 December 2012.

Mr. Peña is considered “new blood”, and he has clearly stated that he represents a change from the PRI that was in power before year 2000. He is a very good communi-cator and has a strong appeal among the Mexican public. Mr. Peña has very clearly stated that his top priority as president is to make the economy grow faster and to focus on reducing poverty. Some very interesting and important reform proposals will be up for voting soon, and we have become more optimistic about a positive outcome. The reason for our optimism is that there is actually a huge “overlap” in the reform agendas of the PRI and the PAN, which should make it relatively straightforward to get the reforms passed in Congress. Some of the reforms are quite significant and require constitutional changes. A two-thirds majority in Con-gress is needed to change the constitution. However, we are talking politics, and as we know things are not always straightforward.

Two key reforms in the short to medium term are an energy reform and a fiscal reform. An energy reform ob-viously contains many elements, but simply put, Mexico has huge reserves of oil and gas but they all remain in the ground because the state-run oil and gas company (Pemex) has been stripped of all its cash flows by the government to fund the government budget. So despite its huge reserves, Mexico ends up importing refined

products from the US and having subsidised prices at a cost for the government. An energy reform will im-prove the fiscal situation significantly over the long run, domestic energy structures will improve and the manu-facturing industry will receive a boost. As Pemex starts to restructure and increase production, we will see very positive industry developments in the full value chain around the energy sector, and job creation will surge.

Turning to the fiscal reform, it again involves many ele-ments, but simply put, tax collection needs to improve and the tax system needs to be simplified. Over the long term, these reforms may provide a strong boost to the economy and the budget and, in turn, the market.

A recent labour market reform may be seen as a good in-dicator of the potentially better times ahead for Mexico. During the period from September to November, ie after the election but before the PRI took office, the PAN and the PRI managed to agree on a new labour market reform.

Nordea’s RIG team visited Mexico in December to as-sess the effects of this new labour market reform. The conclusions we draw from this trip are generally on the positive side because from an ESG perspective we see important improvements. One aspect for which the Mexican manufacturing companies have been much criticised from an ESG perspective has been the fact that they made women do pregnancy tests before hiring them – which was totally legal. The new labour law does not allow this. We believe this is great news and an indication that this reform has positive ESG implications. However, much still remains to be done in Mexico in terms of ad-dressing ESG related issues.

Besides the much better outlook for economic reforms in Mexico, a number of other factors also contribute to our more positive view on Mexico from an economic growth

Mexico – new government and new opportunities

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perspective. The key driver here is the competitive strength that Mexico has gained over the past few years and the fact that this looks set to continue in the years to come. This will help Mexico attract investments, thereby lifting job creation and, in turn, consumption.

The improvement in competitiveness is well illustrated by the trend in average manufacturing wages. In 2000 the level in Mexico was USD 1.5 compared to USD 0.3 in China so there was a quite large gap in favour of Chi-na. Now data for 2011 show that manufacturing wages averaged USD 2.1 in Mexico and USD 1.6 in China. The gap has thus significantly narrowed in favour of Mexico. And if you add transportation costs, Mexico really starts to have a competitive edge over China in a number of areas seen from a US market perspective. Furthermore, in future Mexico will benefit from its huge domestic energy resources (assuming the energy reform is implemented), but in the meantime until domestic energy production picks up, Mexican manufacturers in the northern part of Mexico can increase their use of cheap shale gas from the US.

Another important advantage for Mexico for years to come is its attractive demographic profile. This not only has positive implications for the manufacturing sector, but also much broader structural economic implications for the trend rate of growth in the economy. We believe Mexico is getting closer to the point where as an econo-my and a society it can start to harvest the benefits of the so-called demographic dividend.

Big structural economic issues still have to be resolved in Mexico, and reforms are definitely needed in the years ahead to address them. Corruption is also a huge problem, which will take years to solve. Transparency International, a leading anti-corruption organisation, estimates that Mexican households spend a hefty USD 2.5bn on so-called “petty corruption” (ie payments

to ensure your rubbish is collected or your kids get the school books they need, or a sudden parking ticket by the local police officer etc). This is a huge economic waste. However, relative to other emerging market countries Mexico is not doing too badly. The World Bank ranks Mexico as one of the most straightforward places to do business in Latin America.

We are confident that Mexico is on the right track. We are quite optimistic about the economic outlook for Mexico in the years to come as we think the probability of successful reforms will generate some positive surprises for the economy. Consequently, we are starting to look more closely for new stock ideas in Mexico. However, in the past we have struggled a bit to find companies with both a good business model, strong ESG drivers and an attractive valuation. Hopefully we will be able to invest in a few new names relatively soon – we are working on some interesting cases, and the current political changes and potential implications for the longer-term growth outlook are making us more confident.

Mexico – new government and new opportunities

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Focus CanadaField visit March 2012, the tar sands, Alberta Province

The fight over Canada’s dirty oilThese years a regular fight on words, facts, feelings and not least over billions of dollars in potential earnings takes place in the old Indian territories in the Canadian Alberta province. Nordea went to Fort McMurray – the epicentre of what may be regarded as the world’s most controversial oil bonanza – to examine the environmental and social impact of a burgeoning industry.

At first sight, the idea of anyone wanting to start a new adventure here seems totally absurd. Fort McMur-ray, a former homely, tumbleweed-blown town in the middle of Canada, and its surroundings are now a truly depressing place to stay if you are not paid abundantly for it. Fort McMurray itself is not much bigger than a small country town located in the middle of nowhere, but as soon as you venture out into town where the money flows, all your senses are assailed by the heavy industrial haze overhanging the area. There is a constant, long line of heavy trucks moving in and out, the climate is almost brutal, and you get the feeling that people are here only because of the money. And money – lots of it – is pre-cisely what it is all about in these parts of the country. In an area the size of England many of the world’s lead-ing oil companies are investing in excess of USD 100bn to harvest oil from reserves that are considered to be among the most difficult to extract. And even though producing one barrel of oil here requires three times as much energy as producing one barrel of conventional crude for instance in the Middle East, the high level of oil prices has so far made it a profitable business. The rule of thumb for the multinational oil companies is that if oil prices exceed USD 65 a barrel, there are profits to be made in the area.

The fight seen from aboveTo be able to grasp what is at stake, you have to see it all from above. Because the area is so huge that it is impos-

sible to fully understand the scope of this industry and its environmental and social impact from ground level. Almost no matter in what direction you fly, it takes more than two hours by helicopter to get away. All over, we see Armageddon-like production sites. The oil resources in the tar sands (oil sands) are just beneath the surface and are extracted using vast amounts of energy and water.Actually, it was a local chemist who in the 1920s dis- covered how to wash oil out of the sand – using his wife’s washing machine! And although the helicopter flight reveals that much has happened since then, the method used to extract oil today is roughly the same. Either hot steam is injected through the sub-surface oil layers or oil sands are mined from unbelievably large open pits that leave the old Indian hunting grounds literally “scalped”. At an altitude of 300 metres above ground level you can see how massive the scenery is. The trucks used in the open mine pits operate 24/7 all year long and are the size of big houses. Also, out in the wilderness a number of landing strips have been constructed that the large oil companies use to fly in fresh supplies of multi-ethnic labour several times a day. With annual salaries in the USD 150,000-200,000 range the companies have no problem filling the seats of their jets.

Words, facts and feelingsBut this wilderness bonanza has come under attack from all sides, and in this fight between profits and environ-mental protection the ends justify the means. Greenpeace, the global environmental activist organi-sation and one of the more controversial players, has thrown the spotlight on the environmental hazards involved. And the hazards to highlight by the feared green activists are many. One ticking bomb is the huge artificial lakes, that is, the massive tailings ponds. The tailings ponds contain non-recycled water from the oil production and are thus large pools of toxic sludge from

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the extraction process. The companies use different methods to clean the water, but even after 40 years they still have not come up with an effective way to do so. In addition to the challenges associated with managing oil sands tailings, there are fears of leakage from some of the old ponds into the drinking water of the local population. Some of the indigenous Cree Indians, who have also themselves become part of the oil industry, are beginning to oppose the fast industrialisation of the area, among other reasons for fears of pollution of drinking water. Many have stopped using tap water following reports of people starting to suffer from eczema, amnesia and in some cases cancer. Instead, they have water containers brought in from elsewhere. However, with so much going on in the area it is dif-ficult to document and validate the many facts presented by the various parties involved: the powerful lobby of the oil industry, the different factions of the indigenous population, the environmental organisations, the human rights organisations, those who have become rich and those who have become ill. And the mere fact alone that the provincial government of Alberta does not appear to have a good grasp of what is going on is not a good sign. The contrasts between profits and environmental con-sequences are so manifold and diffuse that it will require thorough in-depth analyses to merely understand the basics of this real-life war game.

Big brother is covering the rear, for better or worseThe US is by far the biggest importer of Canadian oil. Canada overtook Saudi Arabia in 2004 as the number one supplier of oil to the US market. And in one way it is easy to understand why the Americans favour the expensive oil from Alberta. The massive oil spill in the Mexican Gulf, the worldwide debate on nuclear power and not least the many wars in the Middle East make oil deliveries from the neighbour to the North appear easy

and secure. However, several US states have started to apply the thumbscrews to fuel suppliers that leave a jet-black trail of CO2 emissions, and to meet their demands producers have to mix the oil with biofuels. Meanwhile, there are strong protests against the highly controver-sial Keystone XL oil pipeline that is planned to run from Alberta several thousand kilometres across the US to Texas. Recently, President Obama has postponed the decision until 2013 – after the US presidential elec-tion. Canada has responded by threatening to redirect the oil pipeline to the Pacific coast from where the oil can easily be transported to the Asian markets instead. But also here the industry faces almost insurmountable challenges as the indigenous peoples – First Nations, in Canadian terminology – in for instance the neighbour-ing province of British Colombia strenuously oppose the pipeline, and there are now indications that the parties have reached a deadlock.

Massive growth, CO2 war and a reindeerBack in the helicopter the global oil giants do not ap-pear particularly affected by the protests raised by their actions. After one hour’s flight we see yet another new investment. The big oil company ExxonMobil is in the process of constructing a huge plant at a cost of more than USD 20bn. Like many of its peers in the oil indus-try, the company is convinced that demand for energy will exceed supply by a wide margin in future. And many of the big oil companies, including Norwegian Statoil, have been granted a licence to take their share of the spoils. Local economists believe that 600,000 new jobs will have been created in the area before 2020 and that the oil bonanza will be a key growth driver for the Cana-dian economy going forward. But nobody denies that the commercial risk involved is huge. If oil prices plummet, as they did for instance in 2008, it could jeopardise the profitability of the pro-jects. Moreover, oil extraction presents other problems.

Focus Canada

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Canada is under massive pressure to meet international conventions and reduce its rising CO2 emissions. As the first country in the world Canada has responded by with-drawing from the Kyoto Protocol the objective of which is to reduce global CO2 emissions. Officially because the US and China have not signed the agreement. The biggest threats may be the challenges that are closer

to home, including the lawsuits instigated by groups of First Nation people against the Canadian federal government. The First Nations in Canada have a consti-tutional right of exclusive use and occupation of the land. If the indigenous people cannot fish in the big rivers or cannot hunt the caribou, the local reindeer, the oil com-panies’ licences could, in theory, be withdrawn.

Nordea’s analysis of the risks involved in oil sands extraction Nordea is in the process of analysing the environmental and human costs of oil sands extraction. In 2012 Nordea identified the oil companies involved in oil sands extraction and analyse how these companies manage the environmental and social risks.NordeaFundshasnotinvestedinthetwobiggestCanadianoilsandscompanies,SuncorandSyncrude,whosecorebusiness area is oil sands extraction.

Nordeaacknowledgesthesubstantialsocialandenvironmentalrisksinvolvedinoilsandsextraction,asreflectedintheongoing lawsuits raised to uphold the constitutional rights of Canada’s First Nations. Also, several environmental organisa-tions accuse the oil companies of damaging the environment, but no ruling against the companies has so far been handed down. And the provincial government’s management and supervision of the companies, their activities and the social and environmentalimpactfarfrommeetsinternationalstandardsincludingthoseoftheWorldBank.

Duringourvisitwetookwatersamplesofthepublicwatersupply.Thesesamples,whichweresenttoStockholm’sKarolinskaInstitutetfortesting,turnedouttobeofthesamequalityasdrinkingwaterinSweden.

Facts on the oil in AlbertaOil or tar sands consist of crude bitumen-saturated sandstone. Crude bitumen is a type of oil that is too heavy for extraction using conventional drilling techniques. Oil sands deposits are a very large proven energy resource. The biggest deposits are found in Venezuela, Canada and the Middle East.The Canadian oil sands deposits are estimated to hold about 175bn barrels of oil. By 2020 the production of synthetic oil is forecast to have risen to 4m barrels a day, which is twice as much as today. It requires huge amounts of energy to extract and wash the oil out of the oil sands. There are two main methods of extraction: surface mining (open mine pits) or in-situ mining where heated steam is delivered to the crude bitumen-bearing strata through injection wells. The processes require four times as much energy as conventional oil extraction methods and are three times as energy-intensive as for instance production of wind energy.

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Emerging Stars & Swedish Stars

The first investment products based on positive screening were introduced in the spring of 2011. Swedish Stars is a focused Swedish equity fund with 25-30 holdings. Emerging Stars invests solely in emerging markets countries such as Brazil, India and China. Its portfolio is considerably more concentrated compared to the majo-rity of other emerging markets funds. The portfolio of the Emerging Stars fund typically comprises 40-60 compa-nies. With the relatively low number of companies in the Star fund portfolios Nordea is able to constantly monitor and assess the performance of the individual companies. The portfolio managers pick the companies to invest in on the basis of Nordea’s own ESG analysis, which scores potential investment candidates based on an evaluation of how they handle ESG risks and opportunities. Only the companies that demonstrate an ability to handle both risks and opportunities and that have a positive approach to ESG issues will be selected.

Emerging Stars For the Emerging Stars fund we constantly look for the actual Emerging Stars, companies from the global emerging markets that have the star potential to be a global leader in their industry, both in traditional indu-stry and financial terms as well as from an ESG point of view.

Qihoo, ChinaQihoo 360 Technology Co. Ltd. (NYSE: QIHU) is a Chinese software company known for its antivirus soft-ware (360 Safeguard) and web browser (360 Browsers). It was founded by Hongyi Zhou and Xiangdong Qi in August 2006.As of March 2012, Qihoo’s monthly active users were 411 million for its security products and 273 million for the 360 Browsers at the end of the first quarter of 2012.The company is only active in China.Qihoo has a strong code of conduct that addresses the

company key risks adequately on acknowledgement and policy level. Qihoo was criticized in 2011 for its financial disclosure. The company responded by opening up its corporate governance structure and disclosure. The company does not provide any additional general corporate responsibility information, which is typical both in China and among internet companies. Privacy and freedom of association related risks are typical for Chinese internet companies that rely on social media. Qihoo does not have strong links to social media, therefore the risk is mitigated by low exposure. Urbi, MexicoDuring its 30 years of operations the company has built and sold more than 400,000 homes. It uses advanced business processes and has outstanding financial per-formance, which makes it the most profitable company in the sector. Urbi can serve all market segments, but focuses primarily on affordable entry-level and low middle-income housing.Urbi Desarrollos Urbanos SAB de CV is a Mexico-based company primarily engaged in the real estate sector. The company’s main activities include the acquisition of land, as well as the design, construction and deve-lopment of residential properties under the UrbiVilla, UrbiQuinta, UrbiHacienda and UrbiClub brand names. In addition, the company’s projects are supported by two information technology (IT) platforms that maintain the scalability of operations: UrbiNet and UrbiNova. The company shows a strong commitment to CSR. Urbi has a Sustainability Development Committee which from 2012 will be a part of the board of directors. The company has started a lot of initiatives but unfortunately lacks a bit in terms of a structured approach to CSR.

Anhanguera, Brazil Anhanguera is among the highest ranking Brazilian com-panies in the Emerging Stars fund. It is Brazil’s largest

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(second largest in the world) publicly held company in the education sector. Anhanguera focuses on post high school vocational education and has 400.000 students in 73 campuses and over 500 learning centres located across the 27 Brazilian states. Brazil’s growth rates, demographic changes and low unemployment rates have boosted demand for vocational training to a level that the government cannot fulfil on its own. Consequently, the government supports private involvement, enabling Anhanguera among other education companies to fulfil a social mission by providing vocational education for large parts of society that have not been able to benefit from the relatively high education standards of the few elite schools in Brazil. The social mission is also very visible locally. Graduation from private schools such as Anhanguera requires practical training, and Anhanguera often organises this training within its campuses, which would otherwise stay unused during daytime by the mostly working students. The practical training in for example nursing and healthcare enables these services to be available at zero or close to zero costs at Anhanguera campuses for people who otherwise might not be able to afford them. On top of their social mission, Anhanguera has thorough ESG management and reporting mecha-nisms in place addressing key stakeholder risks. The company has published GRI (Global Reporting Initia-tive) sustainability reports since 2009 and is included in the BOVESPA corporate sustainability index (ISE).

Swedish StarsSwedish companies are often described as mature companies well aware of any environmental and social risks and at the forefront of developing new sustainable technologies. Our analysis shows that this is true for some of them, but not for all. Through our ESG analysis both the leaders and the laggards have been identified. The leaders have a good structure in place to manage environmental and social risks, and are increasingly

integrating their commitment to sustainable business development, eg in group visions, mission statements and strategies. Our analysis has also identified compa-nies that are not top performers in this area today but demonstrate positive momentum and have a strategy for how to further improve, ie our future stars. SSAB and Tele2 are companies that show concrete improvements and also a willingness to go further.

SSAB & Tele2SSAB made progress addressing health and safety is-sues, supply chain management and business ethics in late 2011 and in the beginning of 2012. The company is now addressing all key issues at a strategic level in a structured way and with clearly defined responsibilities. To receive an even better rating the company now needs to show the results of its newly established strategies. Tele2 has been on a very positive journey over the past five years. Analysis conducted five years ago revealed the company’s limited interest in taking group-wide re-sponsibility for social and environmental issues. Today, key issues have been identified through stakeholder engagements, and the relevant policies are now in place. Disclosure has improved with the group publishing an annual corporate responsibility (CR) report (GRI), but detailed information, concrete actions and results are lacking. We have asked the company to further improve its communication regarding privacy protection and integrity and establish a stronger statement through a position paper that describes the situation and dis-close actions taken. Both of these companies have been subject to closer proactive engagement activities and it is good to see that recommendations from earlier analyses have been fulfilled.

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Feb-11 May-11 Aug-11 Nov-11 Feb-12 May-12 Aug-12 Nov-12

Nordea Swedish Stars 110228-121231 (after fees).

Nordea Emerging Stars 110415-121231 (after fees).

Performance chart: Swedish Stars

Performance chart: Emerging Stars

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Emerging Stars – product facts

PhilosophyThe Emerging Stars investment process includes an implicit environmental, social and governance (ESG) evaluation. The investment process is based on the belief that: • structuralchangesinthefieldsoftechnology,demographicsandglobalisationcombinedwithglobalchallenges such as climate change and resource scarcity are the main challenges and opportunities for companies. • companieswithacompetitiveedgeintermsofESGthatbenefitfromstructuralchangeswillachievesuperior cashflow growth over a prolonged period. • thematicresearchthatfocusesonstructuralchangesandidentifiescompaniesthatbenefitfromthemcan produce superior information, thus leading to excess returns.

Investment objectives • Excessreturntarget 4%perannum • Ex-antetrackingerror Minimum5%perannum • Benchmark MSCIEmergingMarketsasreferenceindex

Investment policy • Numberofholdings 40-60 • Activestockpositions Maximum5% • Cash/equivalents Maximum5%oftheportfolio’smarketvalue • Individualsecurities Maximum10%oftheportfolio’smarketvalue • Countrydeviations Norestrictions • Sectordeviations Norestrictions• Currency Nocurrencyhedging

The Emerging Stars Investment Process

Sustainable shareholder

valuegeneration

Valuation

Social responsibility

GovernanceEnvironment

Industry keysuccess factors

Theme & Strategy

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Published by: Nordea Investment FundsPhoto:HåkanFlank,iStockphoto,KlausFridorf

Graphic design: IMMERFRISCHSources:EthixSRIAdvisors,HermesEquityOwnershipServices,UNCTAD

March 2013

Responsible Investment & Governance Annual Report • 2012