integration of esg into asset allocation

Integration of E S G into Asset AIntegration of E.S.G. into Asset A

TBLI CONFERENCE™ ASIA 2010

Tokyo, May 27th 2010

Dr. Steffen Hörter | risklab GmbH | Director

© Copyright of risklab GmbHDistribution or reproduction of this material only with prior written consent

AllocationAllocation

AgendaAgendaIntegration of E.S.G. Factors into Asset Allocatio

1. Putting E.S.G. Factors into the DNA of the Invest

2. Integrating E.S.G. in Top-Down Strategic Asset A

— Environmental Scenario Based SAA

— Integration of E.S.G. Risk Factors into SAA

3. Bottom up Modeling of Photovoltaic Investment a

4. Key Conclusions for Investor

on

tment Process

Allocation

and Asset Allocation

2

Putting E.S.G. Factors into the DNAA of the Investment Process

3

- Approach Towards ResponResponsible Investing

Positive Selection

Best in class E.S.G. scoring

1

E.S.G. themed funds

1. Asset Owner Engagement Activity2

Voting (shareholder rights)

Covenants (creditor)

Dialogue Dialogue

2. Exclusion (examples)

Cluster munitions provider3

Cluster munitions provider

E.S.G. rogue corporates(which violate environmentalstandards, labor rights, ...), g , )

3. Integration of E.S.G. factors4

nsible Investing

Explicit and systematic inclusion of E S G risk factors into traditional‘ investment process

- E.S.G. approach

E.S.G. risk factors into ‚traditional investment process and capital market research

Full spelling of E.S.G. alphabet – not only focus on environmental riskon environmental risk

Integrated E.S.G. client investment solutions

Formulation of Investment Policy & Strategy

Asset Allocation & Risk management

Asset Class Analysis incl. Alternative Real Assets

Timber

Renewable Energy/ Cleantech

Other

Bottom-up modelling

4

E.S.G. Based Portfolio Strategy Opt

C / E S G S t lit A hCore / E.S.G. Satelite Approach

C

Fixed Income (securitieexamples)

Worldbank Green Bond

Core: Traditional Finance Investments

Equity Strategies (examples)

Worldbank Green Bond

Social Impact Bond

Corporate Climate Bond (redemption value linachievement of envirThemed/ Green Equity Investing

Water

Low Carbon

achievement of envirtargets)

ABS Micro Finance Bond

Alternative (Real) AssetsTimber & Forestry ...

ESG Best in Class Emerging Market ...

Alternative (Real) Assets

Renewable energy(Photovoltaic, wind energy, ...)

Agricultural land ...

tions

E S G C / E S G S t lit A hE.S.G. Core / E.S.G. Satelite Approach

RI Equity Strategies (BM examples)RI Equity Strategies (BM examples)

Global Equity Sustainability Index

Asian / European Sustainability Index, …

Core: E.S.G. managedInvestments

s

RI Bond Strategies

…

nked to ronmental

E.S.G. Satellite Investments

…

ronmental

...

)

RI R ibl I i

5

RI =Responsible Investing

Integrating E.S.G. in Top Down Straategic Asset Allocation

6

E.S.G. Based Strategic Asset Alloca

SAA d t i t 90% f i t t i kSAA determines up to 90% of investment risks Considered more important than selection of sec

market timing etc. B ild l t i d ti Builds on long-term views and assumptions:

need to reflect major risk factors such as climchange

Financial direction and impact of E.S.G. factors toinvestigated Investors are uncertain about the risk/ return effe Investors are uncertain about the risk/ return effe

E.S.G. investing

Analysis of regional, sectoral and asset class imp New definition of asset risk profile based on E.S Changes of regional or sectoral attractiveness? Strategic flexibility in investments?Strategic flexibility in investments?

Please note: concerning the return and risk related information please refer to the disc

ation: Motivation

curities,

mate

o be

ects ofects of

pact.G.?

7

claimer at the end of the document.

Environmental Scenario Based SAAA

8

Example Scenario Based SAA Anal

Environmental Scenario I t AEnvironmental Scenario[2020 – 2100] Impact An

Scenario High Risk“ EconomyScenario „High Risk

High level/ increasing carbon

emission:

Economy

Energy price shock

Food / clean water

GDP shocks no global agreement on carbon

reduction objectives

extended use of fossile energies

GDP shocks

....

Capital Markets

Increasing (equity) comparatively small private

(sector) carbon offsetting

Measurable climate changes:

Increasing (equity)

Increasing credit sp

Higher liquidity prem

Inflation risk: + (foo

Desertification / Flooding

Extreme Heat/ Cold Days

Increasing frequency of severe

(industrial goods), .

Adjustment of real assumptions per as

For example equitieIncreasing frequency of severe

storms

Regional social unrest/ migration

p qdifferential vs. basemultiplier 1.4....


SIMPLIFIED: FORlysis

SIMPLIFIED: FOR ILLUSTRATION ONLY

l i C l i SAAalysis Conclusions on SAA

Difference of Assetks

price shocks

Difference of AssetAllocation vs. BenchmarkPortfolio

volatility

EM Equity

Developed Equity

volatility

preads

mia

d/ water) /

Real Rate (highly credit rated)

Bonds

Alternative Assets

..

return and risksset class

es: -2.0% return

Cash/ short term debt

e case; vola

9


Integration of E.S.G. Risk Factors in

1

nto SAA

0

Cornerstones of risklab E.S.G. StudObjectiveObjective

Integrated modeling of environmental, social and gove

Focus is the analysis of long-term risks on a 20 years h

E.S.G. Risk Factor Modeling Process

Key assumption: E.S.G. risks do not impact expected r

E.S.G. risk factor analysis and selection

E.S.G. risk factor modeling: definition + calibration of stochastic processes

EconomGeneraE.S.G. simulat

E.S.G. Risk Portfolio Analysis

Robustportfolio optimization(key criterion CVaR 95%)

Portfolio simulation (efficient frontiers: selection of 3 alternative portfolios)

ConclusioSAA w.r.t

1

dy

ernance risk factors in a portfolio context

horizon

I t f E S G E it

returns

InputPortfolioAnalysis

mic Scenario ation incl. risk factor

tion

Input of E.S.G. Equity risk sensitivities

Computation of prices for all assets [G i C hfor all assets [Govies, Cash, +E.S.G./Global/-E.S.G.Equity]

F t P j tiFuture Projections10,000 Paths

ons for Investors:t. E.S.G. risks

1

E.S.G. Risk Factor Screening and S

Environmental Risk S

Global Warming

Emission Waste+ Pollution

Hu

LaborRights

MultipleRisk

Factors

ResourceDepletion

Carbon Emission Sick Selection

RiskDriver

Rights Spot Price Change

Relative sector carbon RelatRelative sector carbon footprint costs

Short-listing E.S.G. risk factors: causalit

1

Short Listing

Social Risk Governance Risk

uman Rights

r s

Child Labor

Bribery + Corruption

Unequal share voting

Conflict ofInterest

Safety +Health

WrongIncentives

Rates Corporate Governance

tive sector staff

p

Relative sector s / sales governance ratings

ty, fit to modeling, data availability, SRI expert input

2

Risk / Return Characteristics of Equ

Return / Risk Metric Positive GlobalReturn / Risk Metric

(average values p.a. over 20 years)

Positive E.S.G.

Global

Equity Equity

Expected Return 7.6% 7.6%

CVaR 95% -26.7% -38.8%

Volatility 15.5% 19.3%

CVaR (95%):Conditional Value at Risk (CVaR) 95%: Average expected return incurred in the 5% worst case

* Global Equity represents an equity allocation with an average E.S.G. exposure

expected return incurred in the 5% worst case scenarios p.a.

1


uity Returns

Key findingsNegative Key findings

In comparison the CVaR risk of +E.S.G./Global/-E.S.G. Equity is very different

NegativeE.S.G.Equity

7.6% very different.

The CVaR risk of +E.S.G. Equity is approx. one-third less than Global Equity*

-52.3%

Global Equity .

The CVaR risk of –E.S.G. is approximately double that of +E S G Equity

23.7%

+E.S.G. Equity.

E.S.G. risk is assumed to have no impact on expected equity

t b t i i k d ireturns but is a risk driver.

3


Significant Optimization OpportunitieSignificant Optimization OpportunitieE.S.G. Equity Allocation

Portfolio “Balanced”Portfolio Balanced

Cash, 6%

Global Equity, 30%

B Equities +E40%

A

Government Bonds, 64%

Cash, 8%

Equities +E S G

Portfolio “Lower Risk”

Return / RisEquities +E.S.G.,

30%

Expected R


CVaR 95%

Volatility

1


es Through Positivees Through Positive

Portfolio “Higher Return”Portfolio Higher Return

Cash, 6%

Government

E.S.G.,


sk Metric Portfolio Portfolio Portfolio

Option BOption A

"Balanced" "Lower Risk" "Higher Return"

Return 5.5% 5.5% 5.8%

-7.4% -5.1% -7.4%

6.2% 5.2% 6.5%

4


Bottom up Modeling of Photovoltaic

1

c Investment and Asset Allocation

5

Real Alternative Assets

Alternative Re

IlliquidListed

Timbe

Agricultu

...

1

eal Assets

d

Renewable Energy

er Wind Energy

Photovoltaicure

...

6

Modeling of Alternative Real Assets

Bottom-up Modeling

+ RevenuesReturn

+ Revenues

- Investments / CapEx

- Operating Costs

- Interest

- Tax

Oth t- Other costs

1

s

Stochastic Drivers

For exampleGlobal Solar Radiation

InflationInflation

Interest rate

7

Photovoltaic: Modeling of Global So

Stochastic Model for Global RadiationStochastic Model for Global Radiation

tSIatSIatRad Rad0Rad1Rad0Rad ,,,, σ))((σ))(()(

Rad(t): Globalstrahlung, aRad,0, aRad,1: Lageparameter, I(S(t)): Indikatorfunktion, S(t): R

σRad,0, σRad,1 : Volatilitätsparameter, W Rad (t): Brownsche Bewegung

Probability DensityProbability DensityFunction

0 7 0 5 0 3 0 1 0 1 0 3 0 5-0.7 -0.5 -0.3 -0.1 0.1 0.3 0.5Global Solar

Radiation

Source: risklab. Vgl. auch Šúri M., Huld T., Dunlop E.D., Albuisson M., Lefèvre M., Wasolar radiation.

1

Please note: concerning the return and risk related information please refer to disclaim

olar Radiation FOR ILLUSTRATION

tWRad1

Paths of specific energy yield

Regime

450 p gy y(examples)

435

440

445

420

425

430

405

410

415

Time

ald L., 2007. Uncertainties in photovoltaic electricity yield prediction from fluctuation of

8

mer at the end of the document.

Efficient Portfolios and Share of Pho

Ausgangsportfolio

Effiziente Portfolios max. 25% Photovoltaik



ff f l h l k

Initial AllocationEfficient Portfolios with max. 25% PhotovoltaicEfficient Portfolios with max. 15% PhotovoltaicEfficient Portfolios with max. 5% PhotovoltaicEfficient Portfolios ith 0% Photo oltaicEffiziente Portfolios 0% PhotovoltaikEfficient Portfolios with 0% Photovoltaic

Ret

urn

Initial Allocation

Expe

cted

R

Expected Risk

Source: risklab; Mader, Treu, Willutzky (2010): „Alternative Real Assets in a Portfolio CPublisher: World Scientific.Expected return and expected volatility based on annualized IRR of portfolios.

1

p p y pPlease note: concerning the return and risk related information please refer to disclaim

otovoltaic FOR ILLUSTRATION

Context“, in: Kiesel, Scherer, Zagst „Alternative Investments and Strategies“,

9

mer at the end of the document.

Key Conclusions for Investors

20

Reasons for Investors to Integrate E

Fiduciary responsibility and opportbroader goals of society and other1

E.S.G. (risk-) factors considered imincorporation into asset allocation 2

More and more investment producfacilitate comprehensive responsib3

2


E.S.G. into Asset Allocation

tunities to better align investment objectives with r stakeholders (UN PRI).

mportant on a portfolio and asset class level: reveals optimization opportunities.

cts, service providers and data available which ble investing.

1


Appendix

22

Integration of E.S.G. Risk Factors in

For executive summaries of the risklab studyFor executive summaries of the risklab studyÈ.S.G. risks in a portfolio context´ please ref

Responsible Investor - Quant study shows signifterm ESG risk reduction and return boost

1term ESG risk reduction and return boost

http://www.responsible-investor.com/home/article

IPE - ESG risk in a portfolio context - 1 April 2012

http://www.ipe.com/magazine/esg-risk-in-a-portfocontext_34522.php)

PROJECT M Study: ESG delivers financial ben3 PROJECT M - Study: ESG delivers financial ben

http://www.projectm-online.com/en/globalopportunities/2009_3/Pagesnds aspx

3

nds.aspx

The study was also published as an article in GeŃachhaltige Investments im Portfoliokontext (Hö

4Nachhaltige Investments im Portfoliokontext (Hö

Menzinger)´ in Ábsolute Report 53/2010`

http://www.absolut-report.de/absolutreport/ausga

2

nto Strategic Asset Allocation

yyfer to

ficant, long-

e/risklab/)

0

olio-

nefitnefit

s/52StudyFi

erman örter Mader

The risklab study was performedby S. Hörter, W. Mader, B. Menzinger.

Expert responsible investing input was given by Mr D Diamond Head of SRIörter, Mader,

aben/)

given by Mr. D. Diamond, Head of SRI, AllianzGI France and other RI Experts. E.S.G. factor and data research was supported by Mr. S. Einsiedel, AllianzGI Europe .

3

Contact

Dr. Steffen HörterBusiness Director

Tel.: +49.89.1220 [email protected]

www risklab comwww.risklab.com

2244

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integration of esg into asset allocation

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