Advance Magazine June 2016

FROM SUGAR TO SOY – FOOD FOR THOUGHT P.6

SMART ENERGY INVESTMENTS FOR A LOW CARBON FUTURE: INTERVIEW WITH THIEMO LANG P.8 MORNINGSTAR’S GOLDEN GLOBES P.15

ADVANCE SUSTAINABILITY INVESTING IN FOCUS | JUNE 2016 For professional investors only S U STAI N AB I L I T Y I N VESTI N G I N FO C U S | J U N E 201 6 | 1

H IGH LIGHT

Cyber security boosts IT security market Companies from various sectors including financial services provider JP Morgan, health insurance company Anthem and retail giant Target have been hit by a cyber-attack over recent years. This involved the theft of millions of customers’ personal details, passwords and financial data.

According to IT research provider Gartner, global spending on information security was more than USD 100 billion in 2015. Over the next four years, the market is expected to grow by another 8.7%, reaching about USD 150 billion by 2019. IT security solutions providers are expected to benefit.

USD 575 billion

Costs of cybercrime for the global economy per year

Although the IT security segment is growing quickly, it only accounts for a fraction of total revenues for integrated solution providers such as Cisco or Juniper Networks. For pure-play companies such as Palo Alto Networks, FireEye or CheckPoint Software, growing IT security spending has a much stronger impact on corporate value.

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CO N T EN TS

COLUM N

In this edition of Advance: Peter van der Werf explains his attempts to clean up the soy supply chain; Portfolio Manager Thiemo Lang expects COP21 to transform the energy sector; and how the New Climate Economy initiative matches economic and environmental goals.

4 Highlights Climate change to be the central theme on the next RI conference, and how to measure your portfolio’s environmental footprint.

5 What’s behind the façade?

Willem Schramade give tips on how to get past asset managers’ marketing tricks.

6 Soy: a challenging supply chain to manage Soy is a controversial sector, but companies have been upping their game throughout the supply chain, says Engagement Specialist Peter van der Werf.

8 Smart energy investments for a low carbon future RobecoSAM Smart Energy Portfolio Manager Thiemo Lang on the future of the energy sector after COP21.

10 The intricacies of engaging in Asia Michiel van Esch on the do’s and don’ts of engaging companies in Asia.

11 External perspective Helen Mountford of the New Climate Economy initiative makes a business case for climate action.

14 Engagement case study Matthias Narr wrote the book on how utilities should deal with the low carbon economy.

15 Morningstar’s golden globes RobecoSAM’s Daniel Wild welcomes Morningstar’s initiative to rate funds on sustainability.

Sweetness and light Plans by the UK to follow other countries in imposing a sugar tax shows how that sweet powder so enjoyed by the world is following tobacco onto sustainability investors’ agendas. The British tax comes on the back of concerns about rising levels of obesity and diabetes which affect vastly more people than smoking. But what are the investment implications? It is not as clear cut as one might think.

The obvious effect is that sugar taxes will raise prices and therefore negatively impact food and drink producers’ volumes, particularly as consumers move to healthier products. The additional problem for manufacturers is that offering healthier, sugar-free versions is often more expensive, leading to pressure on margins and a potential double whammy. But there are also beneficiaries: the so called ‘Flavor & Fragrances’ or ‘Ingredient Companies’ who can help brand owners in reducing the bad stuff without affecting the taste profile of the product. For those companies, the move towards healthier eating implies better growth and margins, and we therefore see better investment opportunities with ingredient makers.

Such developments form part of our sustainability analysis at Robeco.

In the food and drinks industry, we assess material factors such as ‘innovation into healthier products’ at each affected company, and assess their impact on growth opportunities and margins. As a result, Robeco has no soft drinks companies in its Global Equity portfolios, but instead invests in the progressive health ingredients companies and those manufacturers that are at the forefront of reformulation, R&D and nutritional science.

And it doesn’t stop with sugar: as our cover story explains in this edition, the soy food chain is also problematic, requiring serious sustainability in action. Enjoy reading our latest Advance magazine … with, we hope, a sugar-free snack!

VERA KRÜCKEL, ANALYST, ROBECO GLOBAL EQUITY

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H IGH LIGHTS

Climate change theme runs through RI annual conference change; how do we make responsible investment mainstream?’ In a close look at data quality, a new Deep Data Initiative is set to be announced, with one plenary session dedicated to: ‘Proving the value of ESG data, investment activity and governance.’

The ninth annual Responsible Investor conference gets underway in London on 22-23 June, with a strong theme of climate change, decarbonization and the move away from fossil fuels running through the two-day event.

The keynote speaker on the first day is Helen Mountford, Director of Economics and the World Resources Initiative and Program Director of

the New Climate Economy initiative.

Ahead of the conference, Mountford outlines her thoughts in this issue’s External Perspective on page 11. On the second day, the keynote speaker is Jeroen Hooijer, Head of the European Commission’s Directorate for General Justice and Consumers.

A collection of no less than 26 breakout sessions will discuss a wide range of topics, from water shortage risk and making wealth management more responsible, to the perils of corporate lobbying and whether we have reached a tipping point for electric cars. Under the climate change theme, breakout panels will air their views on environmental reporting, engaging with fossil fuel companies and low carbon indices, among other topics.

Topics with other speakers from across the sustainability investing universe include: ‘The reality of the future energy mix, investing in green infrastructure and the climate change theme’; and ‘Leadership, culture and

“RI Europe addresses the most critical issues in sustainability,” says Michael Baldinger, CEO of RobecoSAM, which is once again lead sponsor for the event.

For more details, go to www.responsible-investor.com.

Identifying the impact of your portfolio Investors are increasingly interested in understanding the environmental and societal impacts of their portfolios – but how to measure it? RobecoSAM has been busy rolling out its Environmental Impact Monitoring tool that helps to quantify the impact of investments on four of the most significant environmental indicators.

The tool screens the environmental footprint of a client’s portfolio and its benchmark to determine the impact on greenhouse gas emissions, energy consumption, water use and

waste generation. We retrieve the environmental footprint of a company by dividing these impact indicators (i.e. tons of CO2) by the company’s total capital (enterprise value in millions of dollars). Aggregating these ratios to portfolio and benchmark level allows us to measure the impact of the investment, which is simply the deviation of the portfolio to the benchmark’s footprint.

“Based on this information, we work with our clients to jointly develop a customized impact investing strategy

with measurable targets, and help them determine how to adjust their portfolios accordingly,” says product manager Christoph Wolfensberger.

EUR

3 bln

The amount of assets managed by Robeco linked to environmental impact investing solutions

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COMM E NTARY

What’s behind the façade?

Many asset managers claim to do ESG integration.

But do they really? It can be a tough call, as the marketing is often stronger than the execution; scores and ratings tell only part of the story; and the confusion over concepts makes it even harder.

Willem Schramade, Sustainability and Valuation Specialist in Robeco’s Global Equity team, outlines four questions that can help you get behind the façade.

1. WHY DOES THE ASSET MANAGER INTEGRATE ESG? What’s the conviction behind a fund’s ESG integration? In the absence of a direct answer, try to get a sense of whether it is aimed at better decision making, better risk assessment, better insight into what they own, taking responsibility, or simply pleasing customers. Of course, a poor answer is telling, but also treat a strong answer with extreme caution: it’s easy to spin a good story about lofty ambitions.

It’s harder to put them into practice. So dive deeper. What do they really do? How do they do it?

2. WHAT’S THE APPROACH? Most asset managers will have a ready-made answer. But again, the key is to go deeper. At the fund level, typical follow-up questions are: – At what stages of the investment process do you find ESG integration most important?

– What role does materiality play in your assessment of ESG issues?

– Do you think ESG is about risk only, or upside too? If it is the latter, can you show examples of ESG affecting upside?

Taking it to the group level, you might ask: – How do your integration approaches differ across and within asset classes?

What’s the common thread? How is the approach adapted to investment needs?

– How do fundamental and quant-driven approaches to ESG integration complement each other?

3. HOW DOES IT AFFECT DECISION MAKING AND PORTFOLIOS? This question is typically answered by referring to the portfolio’s average sustainability scores and sector exposures. But that’s too easy. First of all, scores do not provide the complete picture. Second, it doesn’t mean that decision making is affected in all stages of the investment process. You should therefore ask questions like:

– Can they show their logbook?

– How does ESG analysis affect the analysts’ opinion on industry attractiveness, valuation assumptions and recommendations? What value drivers do they adjust, and how?

– Do they engage on their holdings?

If yes, how and on how many?

What are the criteria? Does engagement start before or after investing?

4. HOW HAVE THEY EXPERIENCED ESG INTEGRATION? In my experience, the killer questions in distinguishing the really advanced players from the mere marketing facades are the ones that dig into the asset manager’s experience, such as: – How long did it take to get seriously ESG integrated? What were the key incentives and impediments? What were the milestones and key events that boosted adoption? What swayed skeptics? What was the role of top management in driving ESG integration?

– What themes and material ESG issues show up most often in your investment cases? Do you have examples of ESG risks or opportunities materializing much faster than you anticipated?

– What do your analysts feel about the quality of ESG analysis and information delivered by brokers, ratings agencies, and corporates?

And no, don’t believe them if they say they did not have any problems.

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COVE R STORY

Soy: a challenging supply chain to manage Companies throughout the soy supply chain have made substantial improvements in managing risks, says Engagement Specialist Peter van der Werf.

The soy sector is known for poor labor conditions, forced labor, violation of land rights, harmful agricultural practices, deforestation, degradation of ecologically sensitive areas, soil erosion and nutrient depletion.

Soy is mostly used as animal feed for raising livestock and is traded as a bulk commodity. Top producers of soy in 2014 were the US, Brazil and Argentina. In the harvest season of 2013/2014, 284 million tons of soy were produced on more than 113 million hectares.

The sector is focused on the implementation of production standards, most notably through the Round Table on Responsible Soy. Despite these efforts, the total amount of soy certified to have been produced

responsibly and sustainably remains low, and deforestation continues on a large scale.

In 2012, Engagement Specialist Peter van der Werf started a project based on research conducted by risk analysis company Maplecroft. The group performed a deep-dive analysis of the regulatory environment in the main high-risk production country Brazil and of the sector’s initiatives on conservation and certification. “We selected eight companies reflecting the complete soy supply chain: commodity traders Noble Group and Bunge; ABF, whose division AB Agri is involved in soy trading; McDonald’s and Yum! Brands, who don’t have direct exposure but use large quantities of soy through the production of beef, pork and chicken meat in their supply chain,”

says Van der Werf. “We also talked to Monsanto and Syngenta, who only have a supplier role with the seeds they produce, but have a large footprint in the soy supply chain due to their joint market share of approximately 45%. The eighth company in our engagement was Carrefour: as a multiline retailer they have a small percentage of sales in products that have exposure to the soy supply chain.”

FOUR ENGAGEMENT OBJECTIVES Based on the initial scoping of the research, Van der Werf defined four engagement objectives which he extensively discussed with all the companies under engagement.

POLICY AND RISK ASSESSMENT “We expect companies to assess the environmental and social risks related

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COVE R STORY

made a public commitment to only using certified soy. For every company, depending on their place in the value chain, their risk management systems varied strongly. At the end of our engagement we concluded that three other companies now had sufficient risk management systems in place and another company had made substantial progress.”

TRANSPARENCY AND DISCLOSURE “We have encouraged companies to improve transparency and disclosure,” Van der Werf continues. “They can do this by committing to external reporting initiatives or through increased transparency and structured reporting on their corporate website.

Examples of external reporting are CDP Forest, or more general reporting initiatives such as the UN Global Compact and the Global Reporting Initiative. At the start of our program, there were only two companies that were sufficiently transparent. During our engagement we saw strong improvement, most notably on the corporate website of McDonald’s.

They launched a website on which consumers can ask questions about the origins of the raw material used for McDonald’s products. Monsanto and Bunge also made good progress.” to soy, and to communicate the results of these risk assessments,” Van der Werf explains. “In our initial research we found that companies generally provided limited evidence of assessing or monitoring such risks. During our engagement, all but one company developed a comprehensive policy in this area.”

RISK MANAGEMENT Third-party verification through, for example, certification or external supply chain audits can provide assurance that the relevant risks have been managed during the production of soy. “We want companies to implement environmental or social requirements for suppliers within the soy supply chain,” says Van der Werf.

“At the start of our engagement, only one company in our group had

PARTNERSHIPS AND COLLABORATION “We expect companies to collaborate and build partnerships with key players from across the soy sector, including peers, suppliers, business partners, customers, NGOs, government organizations and community groups, to work together to manage environmental and social risks,” Van der Werf continues. “Six of the eight companies already participated in the Round Table on Responsible Soy. During our engagement we had discussions with ABF’s division AB Agri on how they can take a leadership role in the European industry association to develop a new standard, which enables a larger group of companies to implement minimum sustainability requirements. AB Agri was active in this initiative as they consider it crucial to make a larger market for certified soy,

which can function more efficiently.”

IMPROVEMENT “After three years of engagement we have closed 87% of our dialogues successfully,” van der Werf concludes.

“The majority of the companies active in the soy supply chain now perform a risk assessment, make substantial improvements to their risk management approach, are more transparent and actively engage in partnerships and collaboration within the sector.”

Sourcing gets more investor attention Investors insist that companies raise their standards when it comes to the emotive subject of the food chain, says Vera Krückel, an analyst with the Robeco Global Equity team.

“Responsible sourcing – be it soy or any other commodity – is getting more and more investor attention, and rightly so, as we see multiple forces at work,” she says. “For one thing, today’s consumers care a lot more about the sustainability and general image of the products they consume. Sustainability is increasingly becoming a purchasing decision driver, and as such, a revenue growth driver for the producers. With sustainabilityconscious generations such as the millennials gaining in spending power, we expect that trend to further accelerate from here.”

“Also, sourcing with as little environmental risk and social harm as possible is an important downside protection mechanism, in that it helps to mitigate significant negative reputation or even legal risks. On top of that, it improves traceability and transparency of the supply chain, which can work positively on the margin structure of a company. Last but not least, for us it is also a sign of how the well the company has its internal control systems in place, and has mapped and is therefore able to manage its operational risks.”

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I NTE RVI E W

Smart energy investments for a low carbon future

THIEMO LANG, PHD RobecoSAM

Thiemo Lang, Portfolio Manager of the RobecoSAM Smart Energy strategy, discusses the future of the energy sector in

the wake of the COP21 agreement to limit global warming to well below 2°C.

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I NTE RVI E W

How do you see the energy sector developing in response to COP21?

“COP21 is the first global agreement to combat global warming that includes both developed and developing countries. It is truly transformative.

The investment implications for the energy sector will become clearer over the next few years as each country formulates its own action plan. The COP21 agreement’s goal of achieving zero net emissions in the second half of the century hangs like the Sword of Damocles over carbon investments.

Companies intending to invest in conventional energy sources such as oil exploration or coal power stations must think twice before doing so. Likewise, utilities using centralized conventional power generation and distributing it to millions of customers will have to adapt their business models to the trend of decentralized clean power generation and storage, or face their demise.”

“The COP21 agreement is an important tailwind for the clean energy industry, enabling it to reap the benefits of the improvements to its cost competitiveness over the last 10 years.”

A long list of investors including Norway’s Sovereign Wealth Fund, the Rockefeller Foundation and the Church of England have pledged to divest out of coal. Do you expect more investors to do follow suit?

“In the very long term, the entire traditional energy sector is at risk, not necessarily because of stricter regulations, but because of increasingly better economics for future clean energy solutions. As more investors recognize that it is becoming increasingly risky and detrimental to their performance to remain invested in hydrocarbon-heavy industries, we will see more moves to divest out of these sectors. Still, the impact of these structural headwinds will be felt from, say, 2020 onwards. Until then, we may still see some short-term cyclical improvements in the oil & gas sector.”

Will the current oil price slump deter the transition to less carbon-intensive alternatives?

“We have not seen any decrease in activity in renewable energies as a result of low oil prices. One of the main reasons for this is that renewable energies essentially compete with coal and natural gas for electricity generation and not oil: only around 3% of the world’s electricity is generated from oil.”

“Coal and natural gas prices have also been depressed in recent years, but we still haven’t seen any declines in retail electricity prices. In fact, quite the opposite has happened. For example, US residential electricity prices have increased by more than 3% per year over the last 10 years. This steady price increase is mainly driven by transmission & distribution costs, which account for an increasingly larger share of total electricity costs. They currently make up more than 40% of the total cost of electricity. As a result, the competitiveness of renewable power generation will only improve over time. For example, the cost of electricity generated from solar has declined by 5-10% per year over the last 10 years.”

‘COP21 hangs like the Sword of Damocles over carbon investments’

conventional energy sources such as oil and coal. A natural gas power plant emits roughly half of the CO2 compared with a coal power plant of the same size. We view natural gas as an important transitional energy source over the next few decades. However, from an investor’s perspective, we think that this is not necessarily an interesting sector, as companies have considerably increased their leverage over the last years, and are now suffering from deteriorating fundamentals. As a result, we recently removed the natural gas exploration & production sector from the eligible universe for our strategy. Meanwhile, we still invest in natural gas distribution and transport companies. These are mostly natural gas utilities, which show very high earnings predictability.”

What types of companies and sectors do you expect to benefit from COP21?

“In our strategy, we always try to find a good balance of sectors addressing different growth and value areas. In renewable energy, we currently focus on upstream solar companies and wind turbine manufacturers. As far as energy management is concerned, we have a decent exposure to the semiconductor power management sector, as companies in this sector enable the efficient conversion of power for consumer electronics, IT, storage and automotive applications.

Within energy distribution, not only do we own electrical and natural gas utilities, but also equipment companies for smart grid and smart city solutions.

And finally, in the area of energy efficiency, we like industrial automation and processes companies.”

Does natural gas still have an important role to play in the transition to a low carbon economy?

“Natural gas is by far the cleanest energy form compared with other

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COMM E NTARY

The intricacies of engaging in Asia

It was up close and personal for Engagement Specialist Michiel van Esch when he learnt the do’s and don’ts of engaging companies in Asia during a three-month spell in Robeco’s Hong Kong office. It requires a different approach to what is common practice elsewhere in the world.

next stage would we be confident in using other means of communication to express our expectations about the follow-up.”

“In Europe and the United States, starting an engagement dialogue can easily be done by just picking up the phone or sending an e-mail,” says Van Esch. “This route might not prove effective for many companies in Asia.

This is especially the case in Japan, where our experience showed that the first important step is to speak to the relevant people at the company and get to know them. Personal, face-toface contact is important. Only in a

“Of course, each country is different and has its own specific challenges for engagement. South Korea, for example, has relatively many crossholdings with its traditional chaebol structure, which implies a greater risk of insider trading. However, we are already seeing initiatives to disentangle these structures. China has a large amount of state-owned enterprises which are difficult to engage with.”

Another challenge is that research coverage in English is generally lower for Asian companies than for those in Europe or the US; this is definitely true for governance and sustainability research, he says. Public reporting requirements for listed companies are often very different than in, say, the US. “We get much more new information out of a conversation,” says Van Esch.

Corporate governance in Japan also is a story in itself. When in Japan, Van Esch took the opportunity to kick off an engagement with eight local companies. “The theme of our engagement is corporate governance in Japan,” Van Esch explains. ”With this engagement project we aim to fulfil our stewardship responsibilities, which are specified in the Japanese stewardship code. Our project focuses on shareholder value, board structure, the audit function, corporate culture, communication with investors, and shareholder rights and alignment.”

“Transparency varies very much from one company to the next,” he says.

“Mizuho Financial Group, for example, has been making impressive steps in corporate governance for years. Within their organization they had already thoroughly debated the topics of our questions on reducing crossholdings, establishing an independent Audit Committee and developing selfevaluation by the Board. On the other hand, there are many companies that appear to be very closed.”

“We also often have to overcome a language barrier by using interpreters,” Van Esch adds. “Still, we believe that constructive engagement is possible, if we make enough effort. Some companies, like automation specialist Fanuc, seemed hard to engage with at first, but have shown willingness to improve their governance over the last couple of years by hiring capable independent Board members, and implementing a more shareholderfriendly policy.”

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EX T ERNAL PE RSPECTIVE

Sustainable investment works best in combination with government policies How does your work at the New Climate Economy initiative work with investors in trying to prevent damaging climate change?

The New Climate Economy helps make the business and investment case for climate action. To meet development goals, we must approximately double the amount invested in global infrastructure by 2030. Our work shows it would not cost much more to make those investment choices low carbon, and we are helping to identify the financing opportunities for investors.

Do you think sustainability investing can make a real difference, or should the focus remain on tackling government policies at source?

Sustainable investment can make a real difference as a standalone effort, but it works best in combination with government policies. Targeted public financing interventions and key policy changes – like phasing out the USD 650 billion spent on fossil fuel subsidies globally each year – can make it more attractive for the private sector to invest sustainably. When the public sector shifts its infrastructure spending into the low carbon economy, it will encourage and leverage the private sector to move its trillions.

In which areas can we tackle climate change while promoting economic growth?

By improving efficiency, investing

in infrastructure and stimulating innovation across three key economic sectors – cities, land use, and energy – governments and businesses can deliver strong growth with lower emissions. Compact, connected, and coordinated cities are a USD 17 trillion economic opportunity by 2050, and can lower carbon emissions, air pollution and traffic congestion.

Reducing deforestation and restoring degraded land can raise agricultural output and rural incomes while reducing emissions and increasing resilience to climate change. Clean energy can create jobs and improve public health.

Are fossil fuels doomed, or do cheap coal and oil remain too irresistible for governments given the current higher cost of renewable alternatives?

Renewables are increasingly costcompetitive in many regions, and in future may be the clear choice on economic grounds alone. In Mexico, the first long-term energy auction yielded tariffs as low as 3.5 cents per kWh in March 2016.The effect of recent low oil prices on investments have also shown the economic risks of their price volatility. And a further USD 1.1 trillion of energy sector assets are at risk of stranding if financial markets fail to anticipate the transition to low carbon energy. The signals are clear, and the smart money is shifting.

HELEN MOUNTFORD

Helen Mountford is the Director of Economics at the World Resources Institute and the Program Director for its New Climate Economy initiative, which provides independent evidence on the relationship between actions which can strengthen economic performance and reduce the risk of dangerous climate change.

Would raising the price for carbon emissions (currently less than 6 euros) make a difference? If so, how could this be achieved on a global basis?

In fact, carbon prices are already spreading around the world – currently in 40 countries and over 23 subnational cities, provinces or states, and with internal carbon prices used by over 435 major companies for their investment decisions. The evidence shows that in many cases they have been effective in reducing emissions, while shifting economic activity to innovative and low carbon sectors to spur growth, and also raising fiscal revenues for governments to offset reductions in other taxes. Now is the time to introduce or strengthen carbon prices, as oil prices are still relatively low. International cooperation through groups like the G20 and the Carbon Pricing Leadership Coalition can help overcome competitiveness concerns.

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I N TH E PICTU RE

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Big in Japan Japan has now more than 40,000 places nationwide where electric car owners can recharge their vehicles, compared with fewer than 35,000 petrol stations. The US has only 9,000 public charging stations, but 114,500 filling stations.

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EN GAGE M E NT CASE STU DY

270

How do investors expect utilities to deal EUR with COP21?

Institutional investors backing the guide

20 trillion

Assets represented by the participants

A group of over 270 institutional investors representing more than EUR 20 trillion in assets recently published a guide for the electric utilities sector. In this guide, they explain how they expect utilities to align their strategies with the low carbon economy required to keep global warming below 2°C. Engagement Specialist Matthias Narr is the lead author.

The guide, titled ‘Investor Expectations of Electric Utilities Companies - Looking Down the Line at Carbon Asset risk’ , was published by the Institutional Investors Group on Climate Change (IIGCC). In this document, we as investors outline the threats and opportunities for utilities, and explain how we expect them to adapt their business strategies. With over 170 countries now clearly committed to the implementation of the Paris Agreement, institutional investors are concerned that some electric utility companies may not be adequately prepared for the transition to a lower-carbon economy.

The guide is a good example of how we leverage our engagement expertise and bring it onto a global collaboration platform to magnify our impact. With this document we want to shape a constructive dialogue between investors and electric utilities about the long-term risks and opportunities these companies face from climate change.

Investors need to know whether utility companies are prepared for the changing market dynamics that are likely to arise from the policies and actions put in place to limit global warming. Business strategy and capital allocation decisions made now and over the coming years will determine the sustainability and profitability of electric utilities for decades to come. Investors therefore have a clear need to establish that capital allocation decisions made by the boards of these utilities

2°C

Temperature rise base case scenario for the guide give due weight to the low carbon transition in order to protect the sector’s sustainability and profitability.

During the 2016 proxy season, investors clearly showed, for example in resolutions at the Annual General Meetings of shareholders of AES and Entergy, that they expect electric power companies to address carbon asset risk by assessing the impact of a 2°C scenario on their future resilience. Asset owners and fund managers need to know how power companies see the future impact of climate change on energy demand and pricing, and how they plan to align their business models with the required greenhouse gas reductions.

In addition to questions about policy, technology and demand changes, the guide encourages investors to ask electric utility companies about the management of legacy assets, such as power generation plants that are no longer economical to use, either due to a shift away from thermal coal, or as a consequence of increased water scarcity.

These risks are not theoretical: they are today’s reality for utility companies and their investors across all markets. Climate change is already driving structural transformation in the energy sector. It is essential for utility companies to undertake comprehensive 2°C stress testing of their business activities and to disclose to investors how their business model will fare in the face of climate change.

The guide can be downloaded from www.iigcc.org.

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COMM E NTARY

Morningstar’s golden globes A move by the investment research service Morningstar to give sustainability ratings to funds is a welcome step, though it remains work in progress, says Daniel Wild, Head of SI Research & Development at RobecoSAM.

Morningstar says it creates a Sustainability Rating for a fund in two steps. First, a score is calculated by taking an asset-weighted average of ESG scores assigned to the companies in the fund, with points deducted for any contentious issues at each company such as bribery or child labor. Then the funds are placed into peer groups by comparing their sustainability scores with those of rivals within the relevant Morningstar category. Scores above 50 indicate that, on average, a fund’s holdings sit in the top half of their industry peer groups.

The new Morningstar Sustainability Rating aims to judge funds in the same way that the group already rates them on performance and other financial metrics. It uses ESG data from the research provider Sustainalytics and then applies them to a fund’s holdings, awarding globes for sustainability rather than the stars that it uses for financial issues.

PROFILE OF HOLDINGS “In a nutshell, the rating evaluates funds based on the sustainability profile of their underlying holdings and is applied to all funds for which we have sufficient data, not just those that have an explicit mandate to focus on sustainability,” says Jon Hale, head of sustainability research for Morningstar.

“This means investors who care about sustainability can now can explore a much broader universe of funds (20,000 globally) when building and evaluating their portfolios.”

RobecoSAM has been aware of the development at Morningstar for quite some time, as the two companies share the same offices in Zurich and regularly exchange views on such topics, says Wild. The service was officially launched at a conference in Amsterdam earlier in 2016. “They started doing it because they realized that investors not only look at financial returns, but also the sustainability of a strategy, and we welcome that move,” says Wild.

“For the moment the ratings are based on a blunt screening of the holdings in the portfolio; what’s missing are aspects such as voting or engagement overlays, any analysis of the robustness of the fund’s ESG integration approach and the quality of its management team.”

PROBLEMS WITH BIASES Wild says Morningstar may run into problems with biases in the data set which can produce misleading results

if the wider context is not taken into account.

“For instance, European companies are typically better at sustainability than US or Asian companies. So if you look DANIEL WILD at the Morningstar rating for a global equity fund and the manager has higher exposure to Europe, then he automatically gets a higher sustainability rating from Morningstar, which is a bit misleading because the only thing you have actually measured is the European exposure against peers. This could lead to misunderstandings.”

THE VALUE OF VALUE STOCKS “Another bias that you find in the data is that some value stocks have a higher sustainability score, so you cannot take it as the pure truth of the overall sustainability of a portfolio. You simply cannot count the globes from one to five and say whether the fund is sustainable or not. It’s not that easy.”

That said, Wild believes Morningstar’s efforts are a positive development for the sustainability investing industry as a whole. “We welcome what they have done so far because it brings attention to the work we are doing and the issues that come with trying to rate companies on sustainability, but we hope there is also enough room for discussion, and that it’s not just a ‘take it or leave it approach,” he says. We see this as a starting point for Morningstar and a conversation starter for the broader industry. We all need to continue digging deeper, and that’s a good discussion to have.”

S U STAI N AB I L I T Y I N VESTI N G I N FO C U S | J U N E 201 6 | 1 5

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