Demystifying Responsible Investment Performance

Paris, November 15th, 2007

TBLI Europe

Xavier DESMADRYLHSBC InvestmentsGlobal Head of SRI ResearchUNEP FI Asset Management Working Group Co-Chair

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HSBC Investments

‘Sustainable Bank of the Year’ in the Financial Times Sustainable Banking Awards 2006

First major bank to go ‘Carbon Neutral’

The HSBC Climate Partnership: US$100 million investment – one of the largest ever corporate donations

Founding signatory of the United Nations Environment Programme’s Finance Initiative, Climate Group

Implementation of CR committees that function within the main structures of the HSBC Group

Development of sustainable business through: Equator Principles, sector guidelines and policies, microfinance, SRI…

Our quality is recognised by major rating agencies and indexes

HSBC: a leader of finance and sustainability

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HSBC Investments

HSBC Group Investment Businesses – A global SRI footprint

* Source: HSBC, figures as at 31/05/2007, relating to the assets of HSBC Investments, Halbis and SINOPIA

HSBC manages around $1.64bn of SRI assets globally*

Düsseldorf

Paris

London

Hong Kong

Vancouver

Singapore

Sao Paulo

Mandates

1 Global Equity fund2 UK Equity funds

+ Mandates

2 Pan-European Equity funds1 Euro Bonds fund

1 Pan-European Balanced fund+ Mandates

1 Brazilian Equity funds

1 Euro-Zone Balanced fund

Mandates

Mandates

AUM by investment vehicle

Funds of funds

Mandates

Mutual Funds

Balanced

Equities

Fixed Income

AUM by asset class

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Reflected into the structure of our product range

* Dedicated to UK charities** See prospectus for more information

The global SRI platform advises and supports the following funds…as well as a list of dedicated funds and mandates

Funds Domicile Available Investment universe SRI process SRI rating S&P rating

HSBC GIF Global Equity SRI Luxembourg Worldwide** Global equities Best in class - -

HSBC GIF Sustainability Leaders Luxembourg Worldwide** European equities Best in class - -

HSBC Mix Responsable France France Global balanced (50/50) Best in class - -

HSBC Valeurs Responsables France France European equities Best in class aa (Novethic) -

HSBC Euro Obligations Responsables France France Euro fixed income Best in class aa (Novethic) (31/08/2007)

HSBC Inik fonds LuxembourgGerman speaking countries

Euro fixed income Best in class - -

HSBC Common Fund for Growth* UK United Kingdom UK equities Ethical exclusion

HSBC Ethical Charity Unit Trust* UK United Kingdom UK equities Ethical exclusion - -

HSBC FI Acoes Sustentabilidade Empresarial - ISE

Brazil Brazil Brazilian equities Best in class - -

2 SRI projects are being discussed : a domestic Indian Equities SRI fund and a Global Emerging Markets fund.

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UNEP FI Asset Management Working Group in a nutshell :

A Strategic Alliance of leading asset managers :

ABN AMRO Banco Real Brasil Hermes Pensions ManagementAcuity Investment Management HSBC Investments (Co-Chair)BNP Paribas Asset Management Insight Investment ManagementCalvert Group (Co-Chair) Mitsubishi UFJ Trust & Banking Corp.ClearBridge Advisors, SAI Nikko Asset ManagementEurizon Capital Morley Fund ManagementGroupama Asset Management Pax World Management Corp.

Henderson Global Investors RCM (UK)

Mission :

Advance mainstream integration of environment, social and governance (ESG) issues into investment processes

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Sustainable Development and SRI: Definitions

People: consequences on employees, clients, suppliers, local communities

Planet: analysis of the impacts of companies and their products

Profit: financial performance, but also ability to contribute to economic development

* Source: From the Brundtland Report to the United Nations World Commission on Environment and Development, 1987

What is Sustainable Development?

What is CSR ?

Development that meets the needs of the present without compromising the ability of future generations to meet their own needs (Bruntland Commission, 1987)

CSR = Corporate Social Responsibility

The implementation, on a corporate level, of the three pillars of sustainable development

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What is SRI ?

SRI and its approaches

SRI = Sustainable & Responsible Investment

An investment strategy that takes into account a company's performance in the three pillars of sustainable development, in addition to its financial performance, when selecting and managing investment portfolios

SRI includes numerous, varied approaches:

– Ethical

– Negative screening

– Positive screening

– Best in class

– Engagement

– Shareholder activism

– ESG integration

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UN Principles for Responsible Investment :Institutional investors lead the way to mainstreaming

PRI launched in April 2006 by UN Secretary General

“The Principles provide a framework for achieving better long-term investment returns, and more sustainable markets. They offer a path for integrating environmental, social and governance criteria into investment analysis and ownership practices. If implemented, they have tremendous potential to more closely align investment practices with the goals of the United Nations, thereby contributing to a more stable and inclusive global economy”.

Significant and growing support : 245 signatories. Representing > US$10 trillion.September 2007

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According to Markowitz Theory SRI should structurally underperform …

1952 : Markowitz theory proposes

– How rational investors will use diversification to optimize their portfolios,

– How an asset should be priced given its risk relative to the market as a whole.

The basic concepts of the theory are the

– Efficient frontier

– Capital Asset Pricing Model

– Beta coefficient

– Capital Market Line and Securities Market Line.

According to this theory

If markets are efficient the CAPM model should demonstrate the underperformance of any restricted asset management style such as ethical or SRI investment approach. Indeed, a restricted investment universe should lead to a lower diversification potential, thus a higher risk exposure

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But Moskowitz says SRI could leadto a “virtuous circle”

According to this theory

High level of information quality can improve investors’ decision making process thanks to a better understanding of companies issues and opportunities.

• 1972 : Moskowitz states

“social performance of corporations can be influenced by capital markets responding to

pressures from investors and customers who perceive new goal for their money.”

“while corporations have long been under a variety of pressures to meet their social

responsibilities, they are now faced with the possibility that their publicly traded shares will be

bought or dumped on the basis of their actions or inactions on this front.”

“socially investments need not, of course, be unsound financially. To the contrary, the

argument has been made that the socially aware corporation possesses the special sensitivity that

will enable it to surpass peers.”

• From intuition to theory

The idea enhanced extra financial integration and stakeholders transparency provide

investors with higher level of valuable information not yet identified by the market.

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And traditional “market icons” have different points of view

1. CSR as a business opportunity driving a competitive advantage

ESG positively seen as a caution for reputation protection

« It takes 20 years to build a reputation and five minutes to ruin it. » Warren Buffet. 

2. CSR as an obstacle to capitalism, generating additional and useless costs

Milton Friedman. (The New York Times Magazine, 1970) shares these views, to say the least …

« The discussions of "social responsibilities of business" are notable of analytical looseness and lack of rigor. Businessmen who talk this way are unwitting puppets of the intellectual forces that have been undermining the basis of a free society… »

« There is one and only one social responsibility of business : to use it resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without fraud. »

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This controversy generated hugehuge academic research …

Around 150

research pieces published since the

early 70s

Nehrt (1996), « Timing and intensity effects of

environmental investments »

Dowell, Hart & Yeung (2005), « Do corporate global

environmental standards create or destroy value ? »

Wolf & Curcio (1996 ), « Corporate environmental

strategy : impact upon firm value »

Capon, Farley & Hoenig (1990), « Determinants of

financial performance : a meta-analysis »

DiBartolomeo & Kurtz (1999), « Managing risk

exposures of socially screened portfolios »

Blank, Herbert & Carty (2002), « The eco-efficiency

anomaly »

Abramson, Lorne & Dan Chung (2000), « Socially

responsible investing: viable for value investors ? »

Derwall & Koedijk (2005), « The performance of

socially responsible bond funds »

Angel & Rivoli (1997), « Does ethical investing impose a

cost upon the firm ? A theoritical examination »

King & Lenox (2000), « Does it really pay to be green ?

An empirical study of firm environmental and financial

performance »

Brown & Caylor (2004), « The correlation between

corporate governance and company performance »

Dimtcheva, Morrison & Marsland (2002), « Green with envy »

Dimtcheva, Morrison & Marsland (2002), « Boxing against green

shadows »

Goyen & Beal (1999), « To invest or to donate – an investigation of

the characteristics of some green investors »

Feldman, Soyka & Ameer (1996), « Does improving a firm’s

environmental management system and environmental performance

result in a higher stock price? »

Barth, McNichols & Wilson (1995), « Factors influencing firm’s

disclosures about environmental liabilities »

Fogler & Nutt (1975), « A note on social responsibility and stock

valuation »

Drobetz, Schillhofer & Zimmermann (2003), « Corporate governance

and expected stock returns, evidence from Germany »

Derwall, Guenster, Bauer & Koedijk (2005), « The eco-efficiency

premium puzzle »

Garz, Volk, Gilles (2002), « More gain than pain – SRI : sustainability

pays off »

Gond (2006), « Construire la relation (positive) entre performance

sociétale et financière sur le marché de l’ISR : de la performation à

l’autoréalisation ? »

And this is just a small sample …

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The Materiality of Environmental, Social and Governance issues to Equity Pricing, Launched in 2004 and Show Me The Money: Linking Environmental, Social and Governance Factors to Company Value, Second Materiality Report, July 2006

Objective: Identify and quantify the potential impact of Environmental, Social and Governance

(ESG) issues on stock pricing

Based upon research from major brokerage houses

Conclusion: Overwhelming evidence that ESG issues are material to portfolio investment value

Downloaded over 100,000 times

The broker community is publishing compelling ESG-related research

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… Producing interesting but diversified results

• This is why UNEP FI AMWG and Mercer Investment

Consulting have embarked into a meta analysis project.

• The idea is to link broker and academic research on

ESG factors in a report:

Demystifying the Responsible Investment Demystifying the Responsible Investment

PerformancePerformance.

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Demystifying Responsible Investment Performance :General outline of study

ForewordsUNEP FI Asset Management Working Group & Mercer Investment Consulting

Introduction

large matrix of studies and template aspects

Research20 academic and 10 broker studies

Conclusionacademic and broker/industry research connected

Future Research Opportunities

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Demystifying Responsible Investment Performance :A good start, the Mercer foreword

Foreword from Mercer’s Investment Consulting business

There has long been a debate between those who regard environmental, social and governance (ESG) factors as being risk factors which can have a material impact on investment performance and those who regard them as exclusive social issues. However, the evidence of materiality with regard to ESG factors is beginning to take shape as more academic and practitioner research in this field emerges.

Of the 20 academic studies reviewed in this report, it is interesting to see evidence of a positive relationship between ESG factors and portfolio performance in half of these, with 7 reporting a neutral effect and 3 a negative association. A combination of short data samples, variability in data sources and different geographical regions probably explains the divergence in results. Moreover, many of the academic studies are focused on examining the impact of screened versus traditional portfolio returns, which is not the approach that most mainstream investors now take in the integration of ESG factors into the investment process.

Over time, as more resources are allocated to research in this field and data comparability improves, we anticipate that the evidence supporting ESG integration will become more robust. Indeed, we are already seeing evidence of materiality in the returns that ESG integrated strategies are producing amongst practitioners (as evidenced by the broker studies also reviewed in this report). At Mercer we will continue to help asset owners in their quest to integrate ESG factors into fiduciary processes and to encourage investment managers to seek innovative solutions for integrating ESG into their investment decisions.

 

Tim Gardener Jane AmbachtsheerGlobal Head Global Head, Responsible InvestmentMercer’s Investment Consulting business Mercer’s Investment Consulting business

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Demystifying Responsible Investment Performance :Two representative samples

10 broker studies

Selected by the UNEP FI AMWG

Different research methods

Various sectors reviewed

Thematic bias reflecting brokerage industry’s current ESG research production …

… a smaller portion of quant ESG-integration research

20 academic studies

selected by Mercer Investment Consulting

approved by UNEP FI AMWG

representing almost all regions

applying diverse research methods

and the extent to which they measure the financial effect of E, S or G factors on portfolio performance.

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Framework of Study : A common matrix enabling comparison

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Academic studies : Detailed Results 1

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Academic studies : Detailed Results 2

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Academic studies : Key findings

The breadth and depth of academic research on measuring the relationship with portfolio performance has expanded.

Of the twenty studies reviewed :

- 10 showed evidence of a positive relationship between ESG factors and portfolio performance,

- 7 reported a neutral effect

- and 3 a negative association.

Results vary depending on the research methods used, and some of the studies still refer to a relatively short sample period that makes statistical analysis difficult to interpret

While the results vary, the evidence suggests that there does not appear to be a performance penalty from taking ESG factors into account in the portfolio management process.

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Brokers studies : Detailed results

*While the authors of these thematic studies were generally positive on ESG factors explored, specific tests for correlations between these considerations and investment performance were not conducted. For this reason, a neutral rating was assigned.

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Brokers studies: Key findings

True scarcity of brokers ESG quantitative research: Goldman Sachs and WestLB being exceptions with noteworthy findings highlighting that good ESG management demonstrates superior risk management and subsequently superior management overall

“ESG performance as a proxy for management quality, in so far as it reflects the company’s ability to respond to long term trends and maintain a competitive advantage” (2007). Goldman Sachs

Real hype about climate change, cleantechs, and Co2 related surveys seen as winning business case. But, there’s no free lunch. Some really original themes such as nanotechnology are also being reviewed (Oddo)

 

Still very difficult to find a clear link between mainstream financial criteria (e.g., share price volatility) and ESG factors: not yet been analysed long enough and in sufficient detail; and not yet been fully taken into account and priced in by many investors.

The studies suggest though there are important reasons to look at ESG factors more closely:

“ ESG issues, specifically climate change, can “gradually but powerfully change the economic landscape” and cause “periodic sharp movements in asset prices.” (2007:1) Lehman Brothers.

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Linking Academic and Brokers research :5 key messages

ESG integration is not synonymous to a few simple automatic exclusions.

SRI, as a financial discipline, which can be successfully implemented in virtually any investment style

The argument that integrating ESG factors into investment analysis and decision-making will only lead to underperformance simply cannot be made (manager skill, investment style, time period, etc. are integral)

More rigorous quantitative ESG research is vital to improve data comparability

Long-term horizon needed to integrate ESG factors more effectively and for investors to act more responsibly.

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Going forward:Lift off for a new research Odyssey New areas could be explored (e.g., ESG and emerging markets)

Systematically measuring ESG factors’ contribution on a sector by sector basis to:

- overall risk management policy: already embedded to some extent in large caps valuations

- opportunity generation: mainly considered for innovative small & midcaps

Next Step: UNEP FI AMWG initiating a second research project

The idea is obviously not to change the DCF model but to upgrade the discount rate valuation.

Our goal is to selectively mainstream ESG criteria but only if they deserve it.

“ Not everything that counts can be counted and not everything that can be counted counts “ (Albert Einstein) .

But we must try at least!