Advance Magazine February 2016

INVESTORS NEED TO RETHINK DEMOGRAPHICS P.6

PUTTING THE PROMISES OF COP21 INTO PRACTICE: INTERVIEW WITH DIRK HOOZEMANS P.8 TRUST IS KEY IN IMPROVING GLOBAL ACCESS TO HEALTHCARE P.10

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HIGHLIGHT

Shining a light into Chinese power generation China is often considered to be a polluted country that is overreliant on coal. In fact the country is now the world’s largest installer of solar power plants, adding 10 gigaWatts of new capacity each year, according to International Energy Agency figures.

This has led it to become the second-largest solar power generator in the world, after Germany, with capacity that is almost twice the size of that installed in the US. As it moves away from reliance on coal and also seeks to lower its carbon footprint, China aims to have 150 GW of solar power generation capacity by 2020, equivalent to 50 average-sized power stations.

150 GW

China’s planned solar power capacity by 2020

More than 500 companies now make photovoltaic panels which turn the sun’s rays into electricity and are now a common sight on top of Chinese factories and homes.

It means China’s use of coal, which peaked in 2013, has been steadily declining, though the country still generates over 70% of its energy from fossil fuels and remains the largest producer and consumer of coal in the world.

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CO N T EN TS

COLUMN

In this edition of Advance: Amlan Roy explains why demographics is really about consumers and workers; energy expert Dirk Hoozemans thinks it’s quite feasible to meet COP21’s targets; and better cooperation between stakeholders in the healthcare sector would have major long-term benefits for global access to care.

4 Highlights The world’s most sustainable companies are from Europe and bad news for people over 53.

5 Sustainability leadership or déjà vu on CSR? Willem Schramade has flashbacks of Groundhog Day when talking to companies about sustainability.

6 Cover story: ‘Investors need to rethink demographics’ Demographics is not about counting people, and it’s not about age, says demographics expert Amlan Roy.

8 Interview: The promises of COP21 Robeco’s energy analyst Dirk Hoozemans is optimistic on the implementation of COP21’s climate change targets.

10 Trust is key in improving global access to healthcare Distrust among the major protagonists in the healthcare supply chain is leading to costly inefficiencies for society.

11 External perspective Onno de Lange, secretary to the Dutch Institute for Pension Education, teaches pension funds how to integrate sustainability.

14 Engagement case study Daniëlle Essink explains why data privacy issues also offer opportunities to ICT companies.

15 Strong momentum for corporate governance in Japan Abenomics has given corporate governance in Japan a huge boost.

Good stewardship: increasingly a condition for business A growing number of countries are introducing stewardship codes.

More and more asset owners require their asset managers to sign the codes as a prerequisite for doing business with them. Still, it is not always entirely clear to everyone what these codes entail.

Stewardship codes tend to be confused with corporate governance codes. The former target institutional investors, asking them to be a good steward. In practice this means investors should be transparent about their investment processes, engage with investee companies and vote at shareholders’ meetings. Corporate governance codes target companies, and promote good governance.

Stewardship codes are relatively new. The first one was introduced in the UK, in 2010. With the establishment of our UK office last year, Robeco became a signatory to the UK Stewardship Code. In early 2015, Japan was the first country in Asia to introduce a stewardship code, to which Robeco also is a signatory. The International Corporate Governance Network (ICGN) has recently taken the initiative to create a Global Stewardship Code.

Although stewardship codes are not compulsory, they are increasingly viewed as a condition to stay in business. Japan’s largest pension fund GPIF, for example, requires its asset managers to be a signatory to the Japanese Stewardship Code. At Robeco, we take our stewardship responsibility very seriously. We have a Stewardship Policy, which explains how we fulfil our duties as a good steward by engaging, voting and reporting about our SI strategy in a transparent way.

With this policy we comply with the codes that are out there.

CAROLA VAN LAMOEN, HEAD GOVERNANCE & ACTIVE OWNERSHIP

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HIGHLIGHTS

The world’s most sustainable companies are European Europe holds both the greatest number of companies included in the Yearbook as well as the most RobecoSAM Gold Class medal winners. The Electronic Equipment Instruments & Components (ITC) industry was found to be the sector which had made the most advances in adopting ESG, with a 6.2% relative improvement on 2015.

The world’s most sustainable companies are located in Europe, the latest Sustainability Yearbook from RobecoSAM reveals.

Of all the companies surveyed, 203 of the companies making it into the yearbook due to their exceptional sustainability credentials were based in Europe; 116 were from Asia Pacific; 87 are based in North America, and 58 in emerging markets.

RobecoSAM has been assessing the sustainability performance of the world’s largest listed companies on a yearly basis since 1999. This time, 2,126 companies from 42 different countries were assessed on their performance in financially material ESG criteria for The Sustainability Yearbook 2016.

Following this year’s research, RobecoSAM awarded 77 Gold Class medals, 74 silver and 97 bronze to the evaluated companies. Split by region,

Michael Baldinger, CEO of RobecoSAM, said: “We see competition for inclusion in the RobecoSAM Sustainability Yearbook steadily growing every year, so I congratulate all the companies that made it into the 2016 edition.

Sustainability has come a long way since the founding of RobecoSAM in 1995. What was once a very niche concept is now becoming more mainstream. For this reason, it is more important than ever that companies report on the positive financial impacts of their sustainability initiatives.”

The age at which your brainpower peaks…

People who plan carefully for their pensions should not rely on their ability to make sensible financial decisions once they are old enough to get them, says Tom Steenkamp, Head of Investment Research at Robeco Investment Solutions.

He told a recent Robeco Investments Day conference at which demographics expert Amlan Roy was the guest speaker (see pages 6-7) that your intellectual capacity peaks at the age of 53. This is because cognitive function comes in two key categories: crystallized and fluid

intelligence, according to The Age of Reason by economists Sumit Agarwal, John Driscoll, Xavier Gabaix and David Laibson. Crystallized intelligence encompasses your skills, knowledge and experience, and this rises until your 60s. However, fluid intelligence, or your ability to solve new problems, starts falling from the age of 20. Put together, your peak intellectual capacity occurs at 53, more than a decade before most people retire. And while most accept physical deterioration as an inevitable part of aging, lowered mental faculties can be harder to acknowledge.

“Many consumers make poor financial choices and older adults are particularly vulnerable to such errors,” the authors say in their book. From birth to death, “financial mistakes follow a U-shaped pattern, with the cost-minimizing performance occurring at around the age of 53.”

53

…and then it’s all downhill from there

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COMME NTARY

Sustainability leadership or déjà vu CSR? In the 1993 motion picture ‘Groundhog Day’, a weatherman finds himself in a time loop, repeating the same day again and again. At some point he’s in a restaurant and asks the waitress: “Do you ever have déjà vu?” She clearly doesn’t understand the question: “I don’t think so, but I could check with the kitchen.” I often have a similar experience when asking corporate representatives about the integration of sustainability into their strategy and investment decisions.

After a moment of confusion, they usually refer to their sustainability reporting typically an underwhelming document that amounts to telling the world what kind of nice things the company does. This is old school Corporate Social Responsibility (CSR): too easy, no targets, and limited accountability.

THE UNDERLYING PROBLEM: CORPORATE SILOS Many corporations have a highly motivated sustainability team in place that works hard to improve and communicate their firm’s sustainability profile. But sustainability isn’t an extra something that you can delegate to a separate team.

For sure, such a team can be very useful and effective, but only if it manages to mobilize the rest of the corporation. That means having top management commitment, but also reaching key functions like operations, finance, IT and human resources. And this is where it typically fails, even at the most advanced sustainability players.

SUSTAINABILITY LEADERSHIP: STRATEGY, OPERATIONALIZATION AND INTERNALIZATION That change process should eventually result in the internalization of sustainability issues across corporate functions, i.e. people in finance, HR, IT, etc. taking sustainability issues into account in their day-to-day decision making. To get there, top management needs to incorporate sustainability issues into strategy and operationalize it. This goes well beyond being vocal about how important sustainability is. It means that management understands very well how sustainability issues affect the corporation’s competitive position and the ability to achieve its strategic objectives. Moreover, it makes sure that the strategic implications are operationalized into targets, resources and methods that middle management can use across all functions or silos. If management does this, it can achieve sustainability leadership and might even reinvent its business model. If not, you have déjà vu all over again.

NO INTEGRATION INTO INVESTMENT DECISIONS & CORPORATE FUNCTIONS When I met a board member of such an advanced corporation, I asked him how they integrate sustainability into their investment decisions. His answer was sobering: they simply split the list of proposals into sustainability projects and all other projects. And for the former group, they even take projects with negative Net Present Values, since not doing them is not an option. What I like about that approach is that sustainability is at least prioritized. But this isn’t integration, as you still don’t know how valuable these sustainability efforts are, and whether they really should happen. It also means that top management fails in really making middle management change their approach. And that’s what sustainability leadership is about: a multi-year change process.

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COVE R STORY

‘INVESTORS NEED TO RETHINK DEMOGRAPHICS’ Investors need to rethink their entire views about demographics because the current pensions system is unsustainable, says population expert Amlan Roy.

“It is not about counting people, and it is not about age,” says Roy, Head of Global Demographics and Pensions Research at Credit Suisse. “Even if we are all the same age, we are all different. Women are different from men. People spend money differently.

Age is not the most important component of demographics because other things are important too.”

“Just counting people also does not give you a demographic solution, as in my native India, more than 400 million people are uneducated, in ill health, unskilled or poor. That’s not a demographic promise, that’s a demographic burden, or curse,” Roy told a recent Robeco conference on the subject.

Roy says he is fond of a quote by the

American human behavioral expert Peter Drucker, hailed as the founder of modern management, who said in 1999: “Demographics is the single most important factor that nobody pays attention to, and when they do pay attention, they miss the point.”

So what is it about? “Demographics is about consumers and workers,” says Roy. “The most important characteristic of everyone in the world is from the time you are born until the time you die, you are a consumer. As workers we make the GDP and as consumers we consume the GDP. Consumers are revenues and workers are costs on each side of a balance sheet in every household, company and country… and that’s why it affects growth in asset prices.”

“But it’s not predictable, because you cannot predict where you will work, or what you will consume, in five years’ time. We all have the same information, but we don’t consume the same goods. We are very heterogeneous and no-one can predict how we will change as consumers and workers.”

THROWING DARTS AT LONGEVITY Roy warns that retirement planning should be related to life expectancy, not by moving the goalposts on the retirement age. “Using age doesn’t work, as an 80-year old can cost double in healthcare what a newly retired 65-year old costs, and the number of octogenarians has risen by 400% in the world since 1970 while the global population has only doubled during that time. This means that the

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COVE R STORY

been throwing darts when dealing with longevity, and getting it badly wrong.”

The high number of octogenarians in Japan led to the country’s credit rating being downgraded due to the high cost of looking after them.

CORPORATE GOVERNANCE MISTAKES Roy says the biggest mistake of corporate governance is to give workers a pay raise without thinking through the long-term consequences of what it will mean for pension or healthcare commitments, particularly in societies which still pay defined benefit (final salary) schemes. “A USD 1,000 pay rise given to US auto workers in 1985 translates today into USD 17,937 in post-retirement health obligations,” he says. “Long-term promises which were made by GM, Chrysler and Ford for defined benefit pension plans are the biggest travesty and the biggest mistake of corporate governance. That’s what has driven down DB pension plans.”

oldest and most expensive part of the population is growing at four times the rate of the rest of the population.”

“That’s why every country has made the mistake of viewing retirees above 65 as one homogenous group; it’s a big blunder made by pension funds, insurance companies, asset managers, academics and quant people. A 65-year-old is very different to an 85 or 90-year-old.”

“On a national level, the five countries with the oldest populations in 2010 were Japan, Italy, Greece, Germany and Sweden, yet all are dramatically different, with different public finances.

We used to have mortality models that predicted someone would retire at 65 and die at 72. In Japan, 8% of the population is now over 80. We have

A better use of corporate governance would be for companies to be more flexible about how they view, and use, older workers, says Roy. He says people will probably have to work part-time after official retirement ages because they cannot predict how much money they will need. And it would be in companies’ own interests to retain these older but experienced workers as numbers of young people entering the workforce drop due to declining birth rates. Remote working is also likely to increase, particularly for women in an attempt to improve female participation rates, he believes.

And the answer does not lie in blindly raising the retirement age, currently 67 for state pensions in most European countries, he says. “Flexibly enabled retirement means the retirement age should be a function of life expectancy at birth, at 60, at 80,” says Roy. “If we increase the retirement age to 68, what percentage of people could actually work? Less than 10% could do the exact job that they did. Nurses cannot lift patients out of bed like they used to when they were younger, so just mechanically changing the retirement

age does not solve the problem anywhere in the world.” Proposed changes to UK laws requiring firemen to work after 55 when they may not have the physical ability to run up ladders or rescue people from burning buildings have already led to strike action.

Roy says that due to longevity, the parents of someone retiring at 65 may still be alive. “Now we have two generations of retirees, and we have not even started thinking about this.

We are putting an inordinate burden on the young people who are being asked to fund it.”

Longevity to profit age-related sectors The aging population may become a problem for governments, but it also provides interesting opportunities for investors, says Chris Greenwald, head of sustainability research at RobecoSAM. The sectors most likely to benefit are led by pharmaceuticals, financial services, leisure goods (including travel) and consumer products companies, he says.

“The healthcare sector will most clearly experience the greatest increase in demand from the growth in an aging population, ranging from pharmaceutical companies that provide treatments for chronic diseases and cancer, to medical technology companies which will see an increase in demand for orthopedic and cardiovascular implants. Companies providing services such as elderly care will also experience growth,” Greenwald believes.

“The growth in elderly will also lead to increasing demand for financial services, as elderly people have greater wealth, requiring an increase in demand for pension solutions and asset management services. In addition to serving increased demand, companies in a variety of sectors will also have unique opportunities to differentiate their products and services to meet the needs of this growing segment.”

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INTE RVIE W

Putting the promises of COP21 into practice

DIRK HOOZEMANS Robeco

Dirk Hoozemans, energy and utilities analyst within the Robeco Global Equities team, outlines why he is optimistic that the

targets set at December’s climate change summit can be implemented.

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INTE RVIE W

Do you think the core goal of COP21 to limit global warming to 2 degrees will actually be enforced? Or do governments still have their heads in the sands on climate change?

“Governments pretty much have their heads out of the sand now and are very well aware of the need to address climate change. There were 196 countries attending COP21 and 187 signatories. The good thing about what’s different from the previous way of dealing with this is that now it’s a bottom-up approach, with every country submitting its own NDC (Nationally Defined Contribution) on emissions, so it looks like we’re more committed than before to get there in the goal of limiting warming to two degrees Celsius while striving for 1.5 degrees.”

“What also came out of the conference is that current NDCs won’t support a two degree scenario, and that’s why countries have put in place a review mechanism to check the progress of every country on how it is delivering every five years, and also very likely continuously tightening the targets.

So in that sense it’s a true milestone, and countries look quite committed to doing this. The bottom-up targets and ambitions in my view work better than a top-down approach in reducing emissions, where enforcement is tougher.”

What will happen to the energy industry amid these efforts to combat climate change?

“We will see much more tightening of climate policies, aimed at cutting carbon emissions by tackling the most carbon-intensive burners of fossil fuels first. I think the pecking order of what will be targeted is coal first – it accounts for roughly 45% of all CO2 emissions in energy – and then oil next and gas last, as they are less carbonintensive. At the same time, countries will need to invest more in renewable energy sources such as wind and solar

power. The problem we face now though is that about a year ago, the oil price was very high and the costs of wind and solar were falling. That made renewables more competitive.

But right now, hydrocarbons are very competitive with renewables again.

So the big question mark is: how are the individual countries going to treat this? Do they focus on the long run and make big investments in renewables, or do they want short-term economic competitiveness and so plan to postpone investments as oil prices are so low?”

‘It’s not always possible to put a monetary figure on carbon risk’ “The other thing that will change is the G20’s Financial Stability Board becoming more forceful in putting pressure on how companies disclose their exposure to climate change.

But it’s not always possible to put a monetary figure on carbon risk. It’s more straightforward if you are a hydrocarbon producer or an airline, but it’s less straightforward if you are a bank or a retailer for instance.

And then there are de-carbonization trends within the investment industry to contend with. The Portfolio Decarbonization Coalition (PDC) was formed to look at how investors are measuring carbon risks to portfolios, and how investors are tackling them with either exclusion or some sort of risk adjustment. So it’s a multi-faceted approach.”

Will energy companies realistically change their business models to move away from fossil fuels and into renewables?

“It’s evolution, not revolution. Energy companies have a large vested interest in the hydrocarbon economy of course, but they are also very aware of what’s going on. Big oil companies are transitioning their portfolios from oil to gas, which is a cleaner fuel. But you can’t rule out traditional fossil fuels overnight. Under the scenario that would seriously limit global warming, electric vehicles would have to make up a quarter of the global car fleet by 2030 or so, and it’s now less than 1%. It would require massive growth, backed by massive infrastructure investment in this field. With high oil prices you are easily incentivized to switch car type, but much less so if gasoline at the pump is cheap again.

Furthermore, emerging economies are still heavily reliant on coal for their power generation needs. So I think moving away from fossil fuels will be a gradual process.“ How can investors adjust to the move to combat climate change using alternative forms of energy?

“Divestment out of polluters like coal is a case of voting with your feet, but engagement is another way of making a difference. Robeco for one has been sitting around the table with energy companies, talking to managements about their strategies for the future with renewables, making them understand that they need to prepare for a shift. You can’t ignore what’s going on outside your window. But the investment that is needed to get renewables rolling is massive of course.

So the other thing that COP21 did was to identify the role of funding emerging markets by over USD 100 billion per annum by 2020 in developing renewable energy infrastructure.”

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COMME NTARY

Trust is key in improving global access to healthcare Distrust among the major protagonists in the healthcare supply chain is leading to costly inefficiencies for society.

Better cooperation would have major long-term benefits for global access to care and innovation, says Stijn Vanacker, Healthcare Analyst in Robeco’s Global Equity team.

Drug pricing and access to medicine are hot topics in the healthcare sector.

If we want to make any progress, all stakeholders, such as pharma companies, regulators, payers and patients, need to be better aligned.

There are initiatives aimed at overcoming the lack of trust between stakeholders in the healthcare system and the pharmaceutical industry in order to ensure that

effective, affordable and innovative medicines get to patients who need them. PharmaDiplomacy is such an initiative, bringing together senior executives from both the industry and health systems in Europe and the US. Examples of participants are GlaxoSmithKline, the International Diabetes Federation, Novo Nordisk, the UK’s National Institute for Health and Care Excellence (NICE), and Yale University.

NOT ALL DRUGS ARE EQUAL In the issue of drug pricing, there is an important distinction between two types of drugs: innovative drugs that are effective and drugs that don’t have any added benefits over existing ones.

The latter are mostly produced by companies that often don’t do research and price irrelevant drugs high, simply because they can.

On the other hand, there are companies that do perform research and focus on one particular area which they make their core expertise. It is

these companies that substantially outperform their peers in terms of both drug innovation and stock performance. This is illustrated by the case of Gilead, which spent USD 10 billion on Pharmasset to acquire hepatitis C medicine Sovaldi. Gilead has been focusing diligently on liver disease since 1996 and that pays off very well over the long haul.

Throughout history, every time a new drug is launched, it is invariably considered ridiculously expensive.

However, paying USD 1000 a day for Sovaldi is justified, as it is a cure that eliminates a lot of future healthcare costs. Efforts like Gilead’s should be applauded rather than criticized.

The industry has to communicate better to overcome a number of misunderstandings. Currently there is a lot of political rhetoric about drug pricing. This can have long-term negative effects. Drug price controls by governments, for example, will hamper innovation, as they take away the incentive for drug companies.

In contrast, if the rest of the chain is willing to cooperate for change, drug companies will also be willing to take action. We see this, for example, with Roche’s indication-based pricing in oncology. This means that the price of a drug is no longer based on the research and other costs that went into it, but rather on the benefit or efficacy for the patient.

REASON FOR OPTIMISM Efforts like PharmaDiplomacy make a small contribution to the rebuilding of trust between stakeholders. This takes time. However, this dialogue has fostered a more open stance among industry stakeholders. Concretely, it has come up with a checklist of practical suggestions for drug pricing that are acceptable for both companies and payers. When drug companies and patients can benefit from this, investors in this sector will also be rewarded.

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EX T ERNAL PE RSPECTIVE

We want to inspire pension funds to make their strategies sustainable ONNO DE LANGE

What is sustainability to you and why is it important?

Sustainability to me means that we may use the Earth’s resources for what we need in a way that will leave (more than) enough resources for others, producing minimal waste in the process. Organizations with socially and environmentally responsible business practices reduce operational costs, improve stakeholder relations, and increase their profitability and competitive advantage.

Why should a pension fund integrate sustainability into its investment policy?

In ‘The Profit of Sustainability’ it is argued that the science of economics contains a moral code, with the Golden Rule: Do unto others as you would have them do unto you. Application of the Golden Rule leads to the optimal solution under the given circumstances. In other words, there is no possible situation that is superior to it. Economics forms the foundation of investment policies. Including sustainability factors (environmental, social and governance aspects) in investment policies as an application of the Golden Rule creates economically efficient situations.

How advanced are Dutch pension funds in making their investment policies sustainable?

While there is great interest from Dutch pension funds in sustainability, their strategic and tactical asset allocation is hardly adapted to include it. Boards are rethinking their investment beliefs, but there is not much thought of including sustainability as a business strategy that makes a pension fund as an organization sustainable for the future. In ‘The Profit of Sustainability’, market leaders such as Novozymes and Dow Chemical show how they implement sustainability in their business strategies, cutting costs and creating value for their stakeholders.

Pension funds may be inspired by these examples to include sustainability in their business strategies.

What is the role of the Dutch Institute for Pension Education in promoting sustainability?

The Institute for Pension Education is a not-for-profit foundation set up to bring a quality impulse to the Dutch pensions industry. With the publication of ‘The Profit of Sustainability’ the Institute aims to show that applying sustainability to investment policies

Onno de Lange is trustee and secretary to the Dutch Institute for Pension Education. He compiled a book on sustainability for companies and institutional investors, published by Wolters Kluwer and titled ‘Het profijt van duurzaamheid’ (The Profit of Sustainability. A Business Approach).

and business strategies helps pension funds to get an optimal risk/return ratio and have a business case to still exist as an organization in the long run.

In addition, the Institute has developed an executive course, ‘Sustainability for Institutional Investors’, teaching sustainable business strategy and investment policy - including the economic and geopolitical aspects of global energy - and reporting about sustainability.

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IN THE PIC TURE

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COP21 2 °C ­the number of degrees global temperatures may rise by to provide a chance of avoiding catastrophic climate change, as agreed at prior negotiations.

4-6 °C ­the number of degrees global temperatures are predicted to rise by in the absence of action.

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EN GAGE ME NT CASE STUDY

Data privacy: a tricky issue that also offers opportunities In an increasingly digitized world, telecommunication and IT companies are ever more associated with the collection of customer data and subsequent data privacy breaches. As a result, ICT companies are exposed to reputational, legal, and operational risks. At the same time, a proactive approach, for example by raising awareness or implementing different levels of privacy in products, can also result in opportunities, says Engagement Specialist Daniëlle Essink.

The ICT sector is particularly exposed to risks associated with privacy breaches as the business models of these companies are fully built around electronic data. The financial impact is manifold and is felt in both costs - through fines - and revenues due to reputational damage, boycotts of products or loss of contracts due to mistrust. Discredit by financial markets can also prompt investors to sell, thus sending down share prices. Privacy issues are clearly material to ICT companies.

ROUNDTABLE: FREE EXCHANGE OF IDEAS In early 2015 we started a three-year engagement program with selected companies, focusing on improving their policy, risk management, transparency and collaboration in the field of data privacy. As part of this program and with the aim of further building our expertise on the topic, we invited companies for a roundtable discussion in Horgen, Switzerland, to exchange ideas and share experiences on the topic of data privacy. Seven ICT companies from Europe, the US and Asia met with Robeco and RobecoSAM analysts and engagement specialists.

3.2 billion Internet users

4.2 million Facebook posts liked per minute

30 New victims of identity theft per internet minute

The roundtable provided unique insights to us as investors into how companies understand privacy risks and opportunities. We were pleased to see how advanced the participating companies are in managing this complex issue. Since privacy needs and expectations are different among people and organizations, a company has to understand those needs and expectations. At the same time it has to ensure that all stakeholders are aware of what a company does and, equally important, what it doesn’t do with their data. Raising awareness, therefore, is seen as critical in managing privacy. If there is a clear understanding of how data is handled, products with different privacy levels can be designed and offered. And by doing so, companies can differentiate their products from competitors.

COMPETITIVE EDGE The companies perceived the roundtable as a great success because they were able to speak freely with their peers, share experiences and hear the investor’s viewpoint. Our dialogue with companies creates value for them as we clarify shareholders’ expectations and helps to strengthen the links between sustainability initiatives and financial performance. In this way, companies can increase their competitiveness and attract investors with longer-term investment horizons.

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COMME NTARY

Strong momentum for corporate governance in Japan Recent changes, such as amendments to the Japanese corporate law, the introduction of a Japanese Stewardship Code and the Japanese Corporate Governance Code, are driving the improvement of corporate governance in Japan.

These developments can unlock more investment potential in Japanese equities and enhance communication between shareholder and company, says Michiel van Esch, engagement specialist at RobecoSAM. Historically, corporate governance mechanisms in Japan have been very different from those in other developed countries such as the United Kingdom and the United States. In Japan, it’s often the larger shareholders or companies with intra-group crossholdings (‘keiretsus’) that have had an important role in monitoring investee companies. In contrast, countries such as the UK and the US are marked by a high degree of transparency to minority investors, independent boards, and structures that align the interests of management with those of minority shareholders.

ABENOMICS Over the past years, there have been substantial changes to Japan’s

corporate governance regulations.

These changes are part of Prime Minister Abe’s economic policies. One of the three pillars of these ‘Abenomics’ consists of structural reforms, which aim to end two decades of sluggish economic growth by increasing companies’ competitiveness. Japanese companies have generated remarkably low returns on equity, making them unattractive for foreign investors. In 2012, firms in the TOPIX 500 index had an average return on equity of 7%, against over 15% for American and European companies. Enhancements of a company’s corporate governance may improve performance and longterm shareholder returns.

shareholder confidence, board independence is only one aspect of corporate governance.

Other areas also deserve attention.

Looking more closely MICHIEL VAN ESCH at audit committees, for example, we often see that the members are classified as independent, but do not always have a strong background in audit and accounting. Transparency also varies from one company to the next. While some of the selected investments have detailed sustainability reports, others disclose insufficient information on basic targets.

Robeco has conducted extensive research on developments in Japan’s corporate governance. This research will be used as a starting point for a new engagement project on corporate governance in Japan. With this engagement project we aim to improve the corporate governance systems of Japanese companies within the Japanese context. We will explore the opportunities for value-enhancing change in a small selection of portfolio companies. Our project focuses on several interrelated topics, namely shareholder value, board structure, audit function, corporate culture, communication with investors and shareholder rights and alignment.

To achieve comprehensive corporate governance improvement, shareholders should not content themselves with ticking boxes, but rather have a thorough understanding of the business. This is why our engagement approach starts with an analysis of a company’s value creation process. We examine our investment case and identify how corporate governance changes can boost value creation. All companies in our selection have their own strengths and weaknesses, both in their business proposition and in their corporate governance structure. We will use our research to identify which parts of corporate governance have the most potential to enhance value creation for all shareholders.

BEYOND INDEPENDENT BOARDS The current debate on corporate governance in Japan mainly focuses on increasing the number of independent board members. Although such an approach can certainly enhance

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Important Information This document has been issued by Robeco Institutional Asset Management B.V. (trade register number: 24123167), which has a license of the Netherlands Authority of the Financial Markets in Amsterdam, and RobecoSAM AG (trade register number: CH-020.3.025.346-2), which has a license of the Swiss Financial Market Supervisory Authority FINMA in Berne.

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