Sustainable Investing

1. Finance and Sustainability The Financial Case Empirical Studies Live & Model Investment Portfolios Financial Analysis Incorporating Sustainability Case Studies Logical Connection to Known Value Drivers Socially Responsible vs. Sustainability Investing Sustainable Investing November 28, 2001

2. What’s here & what’s not Here • How do you think about the financial case for corporate sustainability? • What are Wall Street investors are up to in this area? Not here • Other sections deal with how to work with internal financial people and investors • Red hot investment advice

3. Finance & Sustainability • Systems perspective • Capital & related financial services play crucial roles: • Investment: capital formation for growth, compensation • Insurance: risk underwriting let’s firms reduce the risk they face directly • Lending: capital formation

4. Forces for Change • Physical Forces • population • climate • H20 • soils • megacities • etc. • Magnifiers • connectivity • transparency • social action • CNN World • victory of markets • etc. • Operating Environment for Companies • > expectations • accountability • disclosure • target for action • Analysis by Investors • new risks • unfamiliar actors • connection to society is key • odd partners & opportunities.

5. Forces for Change and Finance • For financial service companies: • Lenders & Insurers: no upside, so risk management at operating company is crucial. Understanding changes affects pricing (interest rates & premiums) • Investors: face upside and downside for companies’ performance as well as how they behave when combined in a portfolio • Intermediaries: face upside and downside for companies’ performance during transactions

6. Overview • Sustainability and Finance • The cases for connection & how they “fit” • Socially Responsible Investing (SRI) • Mainstream financial institutions • System change • Getting CFOs to “Get It” • Making the business case • Creating value and communicating • Targeting the right investors

7. Sustainability – Finance Connection The Case comes from: • Empirical Studies • Live & Model Investment Portfolios • Financial Analysis Incorporating Sustainability • Case Studies • Logical Connection to Known Value Drivers

8. Empirical Studies • Most studies conclude there is a positive relationship between financial and sustainability performance • Problems with statistical approaches: • Lack of data (i.e., What to really measure?) • Causation vs. correlation • Coincidence • Even if it were true, so what? • “It doesn’t say anything about my company.”

9. Investment Portfolios • Asset managers using “best-in-class” on environmental and/or sustainability criteria overall have outperformed their benchmarks regardless of: • Active versus passive (index) • Large or small companies • US or global focus

10. Passively Managed Gobal Large Cap Dow Jones Sustainability Index (DJSI) Performance 1994 - 12/31/00 Total Return

11. Passively Managed Global Large Cap DJSI Performance 1994 - 12/31/00 by Region Total Return

12. Actively Managed Global All Cap: Sustainable Performance Group • Market capitalization CHF 400 mio. • Performance 1999: 36% • Performance 2000: 17% 62.5% 32.2%

13. Actively Managed Global Small Cap SAM Sustainability Pioneer FundPerformance: November, 10 1999 – January 31, 2000 46.2% 16.6%

14. Passively Managed US Large Cap: Weighted to Environmental Leaders

15. 12/27 1/10 1/24 2/7 2/21 3/7 3/21 4/4 4/18 5/2 5/16 5/30 6/13 6/27 7/11 7/25 8/8 8/22 9/5 9/19 10/3 10/17 10/31 11/14 11/28 12/12 12/26 Model Portfolios • Innovest eco-efficiency premium • Top and bottom rated companies -- 1998 return

16. Detailed Financial Analysis The next big horizon • Best way to demonstrate that environmental and social issues can be “material” in specific industries and at specific companies • Can integrate analysis of sustainability issues with analysis of other financial issues • Few examples beyond WRI’s Pure Profit • “Proves” business case only in specific instances, but shows the way for main-stream analysts • Is based on understanding causal relationships, not correlation

17. Financial Analysis: WRI Methodology • It is forward-lookingand uses scenarios to envisage different futures • It can readily be integrated into conventional valuation techniques

18. Financial Analysis: The Four Steps PHASE 1 Identify salient impending environmental issues PHASE 2 Develop scenarios around each PHASE 3 Assess individual company exposures PHASE 4 Analyze financial implications of each scenario

19. Financial exposure of major pulp and paper companies to pending environmental issues Expected Financial Impact (as %age of market value)

20. Case Studies • Anecdotes of financial experience of companies • Same old [tired] examples: • 3M • Interface • Electrolux • Often not rigorous, but do bring some of the potential to light • It is not clear how much anecdotes matter; they don’t appear to move other people or organizations

21. Connection to Known Drivers • Standardized shareholder value • Ecos Corporation screens for strategies that: • Improve margins • Reduce risks • Increase revenues • Increase capital efficiency • Doesn’t “prove” business case; “proves” that the right sustainability strategies can produce value

22. The Overall Business Case Empirical Evidence • Preponderance of evidence • Different methods • Different data, time periods, analytical techniques • Doesn’t mean “be sustainable and financial success will follow” • A measure of good management • Does mean that value is at stake: companies create or destroy value on sustainability issues

23. So Who Understands the Value of Sustainability? • Lenders understand environmental liability associated with properties & big issues, but most US lenders don’t see additional risks to their repayment based on sustainability performance • Insurers understand the connection to liabilities, but are insulated from many ongoing risks by contractual provisions • Reinsurance industry is beginning to understand climate change • Investors • Socially responsible investors get it • Mainstream showing hopeful signs but no more • The CFOs of leading companies get the operating issues, but have yet to apply the same to their role as investor in other companies both directly and through their pension funds

24. Investors on Sustainability Moving toward “best-in-class” and understanding the business case • Socially Responsible Investing (SRI) • Most still just screen out undesirable industries & companies • Some apply positive screens for good performers • Sustainable Investors • Use “best-in-class” rather than negative screens • Short track records, but interesting results • Sustainability as investment insight • Mainstream • Long-term value investors are place to start

25. SRI Avoid companies whose industry or practices offend Impact: raise cost of capital shareholder action Sustainable Investing Select “best-in-class” Not “good & bad”, but best prepared for Forces of Change Impact: Create competition on sustainability performance Socially Responsble vs. Sustainable Investors

26. Socially Responsible/Sustainable Investors • Significant and growing part of capital markets in US, Europe, Japan & Australia • Reliable US estimate is $100B in US SRI mutual funds plus perhaps a slightly larger amount in private accounts

27. The Record of Socially Responsible Investment Morningstar: • 21% of SRI funds in Morningstar database have 5-star ratings—twice the rate of the overall fund universe. • SRI funds look even better when compared to their specific Morningstar categories. ¼ have 5 stars; half have ratings of 4 or 5 stars. • SRI funds have top category ratings in seven different categories. • “That doesn’t mean social screens add value, but it’s hard to make the case that they subtract it.” (source: Calvert Funds Presentation)

28. Mainstream Investors • Main game in town • Some using “best-in-class” approach • CitiAsset Mgmt • UBS • Credit Suisse • Storebrand • Friends, Ivory applies sustainability engagement across whole portfolio • Hermes Investment Management: portfolio companies should report on “social, environmental & ethical matters”

29. The Value–Sustainability Connection The System Conditions to Drive Change • Rules of the game consistently make doing the right thing economical • Companies articulate how they are creating value through sustainability • Investors have suitable means to incorporate sustainability into existing analysis • Sustainability contributes to investment outperformance Becomes part of investors’ fiduciary duty

30. Pathways World Resources Institutewww.wri.org/sep We gratefully acknowledge the financial support of: The Surdna, Joyce and Olin Foundations & WRI’s Corporate Council and Partners And the support and contributions of the talented staff of WRI’s Sustainable Enterprise Program

31. Terms of Use Pathways is provided to help foster environmentally sound and socially equitable economic development. We request your compliance with the following terms of use: • All materials contained in Pathways modules are believed to be property of World Resources Institute or to be in the public domain. • The opinions and analysis contained herein is that of the authors and editors. • Original sources are credited on the slides or in the notes to the best of our knowledge; please bring errors or omission of citation to our immediate attention. • Please credit original materials to World Resources Institute. • Materials may be copied and edited and revised for internal company use and for non-commercial, educational purposes. • For commercial or other use of materials, please contact Don S. Doering at dsd@wri.org or (202) 729-7655.