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CERES BLUEPRINT FOR SUSTAINABLE INVESTING June 2013 Updated June 2016 Authored by Peter Ellsworth, Ceres Kirsten Snow Spalding, Ceres THE 21 ST CENTURY INVESTOR:

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  • CERES BLUEPRINT FOR SUSTAINABLE INVESTINGJune 2013Updated June 2016

    Authored by

    Peter Ellsworth, CeresKirsten Snow Spalding, Ceres

    THE 21ST CENTURYINVESTOR:

  • THE 21ST CENTURY INVESTOR:CERES BLUEPRINT FOR SUSTAINABLE INVESTINGJune 2013, first printingJune 2014, second printingJune 2016, third printing (with selective updates, including fund performance on page 41)

    Authored by

    Peter Ellsworth, CeresKirsten Snow Spalding, Ceres

    ACKNOWLEDGEMENTSWe would like to thank the members of the INCR 21stCentury Investor Working Group who provided invaluableguidance and feedback as we developed this InvestorBlueprint: Bob Arnold (New York State Common RetirementFund); Bruno Bertocci (UBS Global Asset Management);Matt Filosa (MFS Investment Management); Julie Gorte(Pax World Management); Dan Hanson (Jarislowsky Fraser);Paul Hilton (Trillium Asset Management); Donald Kirshbaum(Consultant); Nancy Kopp (Treasurer, State of Maryland);Mike McCauley (Florida State Board of Administration);Chris McKnett (State Street Global Advisors); Craig Metrick(formerly Mercer Consulting, currently Cornerstone Capital);Meredith Miller (UAW Retiree Medical Benefits Trust); BrianRice, (CalSTRS); Christopher Rowe (Prudential InvestmentManagement); and Jimmy Yan (NYC Comptroller’s Office).

    We also want to recognize the expert advice and commentsprovided by Klaus Chavanne (MEAG); Kelly Christodoulou(AustralianSuper); Sarah Cleveland (Consultant); Tim Coffinand Robert Fernandez (Breckinridge Capital Advisors);Mike Garland (New York City Comptroller’s Office); KeithJohnson (Reinhart Boerner Van Deuren); Adam Kanzer(Domini Social Investments); Tom Kuh (MSCI); Ian Lanoff(Groom Law Group); Ken Locklin, (Impax Asset Management);Tim MacDonald (StoneBridge Partnerships); Jameela Pedicini(formerly CalPERS); Elizabeth Seeger (KKR); Tim Smith(Walden Asset Management); Nick Stolatis and PandaHershey (TIAA Global Asset Management); John Wilson(formerly TIAA, currently Cornerstone Capital); John Stouffer(New York State Comptroller’s Office); and David Wood(Harvard Initiative for Responsible Investment).

    This report was made possible, in part, by support from theKresge Foundation.

    Report design by Patricia Robinson Design.

    DISCLAIMERThis publication has been prepared for general guidanceand does not constitute legal, accounting or investmentadvice. Investors should not act upon the informationcontained in this publication without obtaining professionaladvice. No representation or warranty (express or implied)is given as to the accuracy or completeness of the informationcontained in this publication.

    © 2016 Ceres

    The opinions expressed in this publication are those ofCeres and do not necessarily reflect the views of any of ourdonors, member organizations or advisors. Ceres does notendorse any of the organizations used as examples orreferenced in the publication, or their products or services.

  • FOREWORD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

    LETTER FROM THE PRESIDENT. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

    INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

    THE BUSINESS & INVESTMENT CASE FOR SUSTAINABLE INVESTING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

    FIDUCIARY DUTY & ESG FACTORS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

    21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTING. . . . . . . . . . . . . . . . . . . . . . . . . . . 12

    THE CERES INVESTOR BLUEPRINT: 10 STEPS TOWARD SUSTAINABLE INVESTMENT PRACTICES . . . . . . . . . . . . . 13

    STEP 1: Establish a Commitment to Sustainable Investment Through a Statement of Investment Beliefs . . . 14

    STEP 2: Establish Board Level Oversight of Sustainability Policies & Practices . . . . . . . . . . . . . . . . . . . . . . . 16

    STEP 3: Identify Sustainability Issues Material to the Fund . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

    STEP 4: Evaluate Material Sustainability Risks to the Portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

    STEP 5: Integrate Sustainability Criteria into Investment Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

    STEP 6: Require Sustainable Investment Expertise in Manager & Consultant Procurement . . . . . . . . . . . . . . 23

    STEP 7: Evaluate Manager Performance Against Sustainable Investment Expectations . . . . . . . . . . . . . . . . . 25

    STEP 8: Establish Engagement Strategies & Proxy Voting Guidelines. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

    STEP 9: Support Policies & Market Initiatives that Promote a Sustainable Global Economy . . . . . . . . . . . . . 30

    STEP 10: Integrate Sustainable Investment Approaches Into All Asset Classes & All Strategies . . . . . . . . . . 33

    CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

    APPENDIX A: THE BUSINESS CASE FOR INTEGRATING ESG ANALYSIS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39

    APPENDIX B: EXAMPLES OF INVESTMENT BELIEFS THAT INCORPORATE ESG . . . . . . . . . . . . . . . . . . . . . . . . . . . 42

    APPENDIX C: EXAMPLES OF ESG QUESTIONS IN RFPS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46

    APPENDIX D: FLORIDA SBA INVESTMENT PROTECTION PRINCIPLES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48

    REFERENCES & NOTES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

    THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGTable of Contents 1

    TABLE OF CONTENTS

    Three years after this Blueprint was released in 2013, investors are routinely considering howenvironmental, social and governance (ESG) factors contribute to investment risk and opportunityand engaging companies on these issues where material. During that same period considerablemomentum developed concerning recognition of the material risks associated with climate change andthe investment opportunities arising from climate adaptation and mitigation. Among major globalinvestors the climate debate is now largely over, and holdout deniers might as well argue that theworld is flat. This is a remarkable change in a short time.

    This Blueprint, which provides guidance on integrating material ESG issues into ten core activitiescommon to most investors, continues to offer a pragmatic approach for integrating sustainabilityfactors into investment practice. We have selectively updated the content where necessary to keepit current and relevant to investors (e.g., on investment beliefs, investing in climate solutions, andthe outperformance of certain ESG products and indexes). We hope you will find it useful inaddressing the rapidly evolving investment risks and opportunities that inform sustainable investing.

  • FOREWORD

    THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGForeword 2

    I am pleased to introduce the 2016 edition ofThe 21st Century Investor: Ceres Blueprint forSustainable Investing. This report outlines 10steps that will help institutional asset owners andmanagers steer a sustainable investment course—one that satisfies fiduciary responsibilities to acton behalf of our beneficiaries in an ever-changing,increasingly interdependent global economy.

    I serve as Trustee of the New York StateCommon Retirement Fund, a highly diversified,global portfolio invested across multiple assetclasses. Ultimately, we seek long-termsustainable economic growth to meet pensionfund obligations to our current and futuremembers, retirees and beneficiaries, and tominimize attendant costs to taxpayers.

    In my introduction to the 2013 edition of thisreport I stated: “It has been our experiencethat integrating relevant environmental, socialand governance (ESG) considerations into theinvestment decision-making process enhancesour ability to achieve our objectives.” Thisremains true today. Indeed, since 2013, manyleading investors in both the private and publicsectors have embedded ESG criteria into theirinvestment practice. In 2015, the U.S.Department of Labor issued an interpretivebulletin clarifying that environmental, social,and governance issues may have a directrelationship to the economic value of investmentsand that, in those instances, such considerationsare proper components of a fiduciary’s primaryanalysis of competing investment opportunities.

    Investors face circumstances in the 21st centurythat challenge our traditional understanding ofeconomic and investment risk. On a global scale,climate change represents a crucial example of these new challenges. Respected economists,scientists, political and religious leaders warnthat without significant worldwide reductions in greenhouse gas emissions, climate changewill produce severe economic disruption.Already, a series of destructive climate-relatedevents have produced unexpected devastationand recovery challenges around the world.

    The Blueprint’s 10 steps provide asset ownersand investment managers with a framework forreviewing their investment policies and practicesto better manage risk, protect principal andenhance investment return. Since the Blueprint’srelease in 2013, the Common Retirement Fundhas actively pursued the recommendationsembodied in these 10 steps. We adopted anESG investment belief, created a SustainableInvestment Subcommittee of our InvestmentCommittee, and developed criteria and processesto ensure the integration of ESG considerationsinto our investment decisions and to guide ourinvestment managers. At the United NationsParis Climate Conference in December 2015, I announced our scalable $2 billion commitmentto a low emission index and also committed anadditional $1.5 billion to the Fund’s SustainableInvestment Program, bringing our totalcommitment to sustainable investments to morethan $5 billion. I believe that all investmentorganizations will find similar opportunitieswhen applying the Blueprint’s guidance totheir own unique needs and policies.

    Because ESG factors can have financialrepercussions that can make them primaryeconomic factors in decision making, they are being integrated into our analyses and can no longer be viewed as “nonfinancial”considerations. This means accounting for a range of risks, some unprecedented, manynot identified in financial statements, and allof which are here for the foreseeable future.This also means identifying opportunities forinvestment in climate solutions. The 10 stepsin this report can help us fulfill our roles asresponsible stewards of the assets we managefor the benefit of our retirees, members andbeneficiaries. I urge you to read this valuablereport and add your voice to the criticallyimportant discussions within the investmentcommunity about how we can achieve long-term sustainable growth.

    Thomas P. DiNapoliNew York State Comptroller

    INVESTORS FACE NEW RISKS IN THE 21ST CENTURY

    Thomas P. DiNapoliNew York StateComptroller, Sole Trustee, New York State CommonRetirement Fund

    “Our goal is simple: we want long-termsustainable economicgrowth. And we havefound from experience that comprehensivelyintegrating environmental,social and governanceconsiderations into theinvestment process isessential to achievingthat goal.”

  • THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGLetter from the President 3

    LETTER FROM THE PRESIDENT

    The task of building a sustainable economy—one that meets the needs of people todaywithout compromising future generations—is an essential and increasingly urgent challengefor institutional investors, their clients andbeneficiaries. Rapidly accelerating climatechange, dwindling water supplies, supplychain breakdowns, population growth andother sustainability issues pose enormous,unprecedented risks to companies, investors andthe overall global economy. These mega trendsalso create enormous financial opportunities in renewable energy, efficient technologies,resilient infrastructure and other solutions.

    For more than a decade, through our $14 trillionInvestor Network on Climate Risk (INCR),Ceres has been leading a growing movementof institutional investors who recognize thatsustainability challenges are fundamentallyeconomic and financial challenges. Successfulinvesting in the 21st century will requireinvestors to fully account for sustainabilityrisks in their portfolios and in the economy in general, and to integrate sustainability acrosstheir investment policies and practices.

    “Sustainable investing” requires investorsto think more broadly about material risks

    and opportunities across all asset classes, and as such is integral to fiduciary duty. Itrequires attention to climate risks and growinginvestment opportunities that mitigation andadaptation will create. In 2014 Ceres coinedthe term “Clean Trillion” to quantify the annualaverage additional clean energy investment weneed over the next three decades to limit globalwarming to two degrees Celsius. And in 2014and 2016 more than 500 global investorsgathered at our Investor Summit on ClimateRisk at the United Nations to strategize aboutinvesting in a low carbon economy consistentwith long-term value creation and investmentreturn needs.

    Climate has local, regional, global and systemicconsequences for investors. This reality wasrecognized by the more than 500 investors

    managing nearly $25 trillion in assets whosigned the 2015 Global Investor Statement on Climate Change in support of a strong globalclimate agreement. The landmark Paris accordsent a clear signal to the capital markets thatwill accelerate the transition to a low carbon,clean energy economy.

    Prudent investors know they cannot afford toignore the impacts of climate change on thefood and agricultural sectors, or the economiccosts of increasingly common severe weatherevents. Nor can they ignore the estimated $5 trillion market for additional global cleanenergy investment. Simply stated, sustainableinvesting is about the integration of a new set of risks and opportunities into investmentdecision-making, and a shift from short-termthinking about earnings and profits to long-termreturns and value creation. It means goingbeyond traditional financial analysis that fails toaccount for sustainability risks and opportunities.

    In 2010, Ceres created The 21st CenturyCorporation: The Ceres Roadmap forSustainability, a recently updated tool kit nowbeing used by hundreds of major corporationsworldwide to help them become moresustainable. This updated guide, The 21stCentury Investor: Ceres Blueprint for SustainableInvesting, makes the business case forsustainable investing and examines how 10 keyinvestment activities can be modified to achievea sustainable investment strategy. It providestools to help investors be successful long-termenterprises that protect their current and futurebeneficiaries in a world facing unprecedentedenvironmental and social challenges. In so doing,investors will be doing their essential financiallysmart part in building a sustainable 21stcentury economy.

    Mindy S. Lubber

    President, Ceres

    SUSTAINABLE INVESTING

    Mindy S. Lubber President, CeresDirector, Investor Network on Climate Risk

    “Sustainable investing…means going beyondtraditional financialanalysis that fails toaccount for sustainabilityrisks and opportunitiesand developing newanalytic tools that will.”

  • INTRODUCTION: SUSTAINABILITY RISKS &

    THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGIntroduction 4

    This Blueprint is written for the 21st Century investor—institutional asset owners and their investment managers—whoneed to understand and manage the growing risks posed byclimate change, resource scarcity, population growth, humanand labor rights, energy demand and access to water—risksthat will challenge businesses and affect investment returns inthe years and decades to come.

    These risks can and do influence financial performance andinvestment returns, yet they are often not considered wheninvestment decisions are based primarily on traditionalfinancial analysis.

    This Blueprint is designed to help concerned trustees or boardmembers advance a process for better oversight and decision-making that enhances sustainable risk-adjusted returns. Itoutlines the critical decisions that trustees must make regardingboard policies and implementation, and specific steps in theinvestment process that will benefit from trustee involvement.

    It is intended to prompt asset owners and asset managers toconsider their investment strategies in light of new systemic risksand to think more comprehensively about risk management andnew investment opportunities. The audience for The 21stCentury Investor: Ceres Blueprint for Sustainable Investing (“theCeres Investor Blueprint”) is any trustee, board member, CEO,CIO, portfolio manager, governance staff, analyst or consultantcommitted to evaluating material risks, maximizing risk-adjustedreturns and promoting sustainable long-term value creation.

    Even though asset owners and asset managers bear fiduciaryresponsibility, “the buck stops” at the highest level of fiduciaryauthority for the asset owner. That may be a board of trusteesof a pension fund or the board or investment committee of afoundation, endowment or Taft-Hartley fund. For convenience,we will use the term “trustee” throughout this Blueprint withthe understanding that we’re also referring to any person in a role with primary fiduciary responsibility.

    Trustees are empowered and obligated to serve the bestinterests of the fund, its members and its beneficiaries. That

    empowerment can take many forms, but if there is no clearcommunication from the trustees concerning investmentobjectives and beliefs that should guide investment decisions,the trustees cede important decision-making for the fund to theconsultants, managers and staff, who will manage the fund’sinvestments based on their own predispositions and judgments.

    Even though much of this document is directed toward thetrustees of institutional investors and the staffs they direct,many of the key action steps that support sustainableinvesting require continual interaction between asset ownersand their managers and consultants, and consequently applyto all three.

    This Blueprint has been developed based on a decade ofworking with institutional investors and after extensiveconsultation with a broad cross-section of asset owners andasset managers. It includes 10 key action steps that mostinvestors are familiar with or already doing—and reframeseach in the context of a sustainable investment strategy:

    1. Establish a commitment to sustainable investment thougha Statement of Investment Beliefs

    2. Establish board level oversight of sustainability policiesand practices

    3. Identify sustainability issues material to the fund

    4. Evaluate material sustainability risks to the portfolio

    5. Integrate sustainability criteria into investment strategies

    6. Require sustainable investment expertise in manager andconsultant procurement

    7. Evaluate manager performance against sustainableinvestment expectations

    8. Establish engagement strategies and proxy votingguidelines consistent with sustainable investment goals

    9. Support policies and market initiatives that promote a sustainable global economy

    10. Integrate sustainable investment approaches across allasset classes and strategies.

    Ceres defines “sustainable investing” as investing to meet the needs of current beneficiaries without compromising theability to meet the needs of future beneficiaries. It is about sustaining the fund’s ability to meet its multi-generationalobligations by taking a broader perspective on relevant risks and opportunities. It is not a new method of investing, but a more comprehensive approach to investment analysis, decision-making and engagement that includes fullconsideration of environmental, social and governance (ESG) risks and opportunities that can impact investment returns.

    OPPORTUNITIES WILL SHAPE THE 21ST CENTURY ECONOMY“Environmental and other sustainability issues are core to business performance in the 21st century.”

    Anne Stausboll, CEO of the California Public Employees’ Retirement System (CalPERS)

  • THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGThe Business & Investment Case for Sustainable Investing 5

    THE BUSINESS & INVESTMENT CASEFOR SUSTAINABLE INVESTING

    RETHINKING RISK-ADJUSTED RETURNS The Ceres Investor Blueprint is designed to help institutionalinvestors and their investment managers and advisors bettermanage the emerging risks and opportunities of investing inthe 21st century.

    Risk is hardly new, but the nature of risk facing investors,communities and businesses in the 21st century is different—even unprecedented. Even now, as economies and financialmarkets rebound from the 2008 meltdown that took manyfinancial institutions to the brink of insolvency and reducedthe value of investments in all asset classes, another suite ofrisks remains embedded in almost every investment portfolio.These risks are the result of a rapidly growing global populationthat is stressing water availability, demanding more energy andresources, pressuring supply chains and accelerating climatechange, which has already triggered widespread physicaldisruptions and caused hundreds of billions in economic losses.These emerging risks—which we refer to as “sustainability”risks—will almost certainly have more severe and longer lastingeconomic consequences than the recent financial crisis.

    In the run-up to the 2008 financial crisis, too many investorsfailed to adequately account for, or even understand, therisks of subprime mortgages, credit default swaps and otherderivatives. The pressures to achieve strong short-termreturns and invest in instruments the market had judgedcredible deflected attention from material and longer-termrisks. Today, investors face new risks, some not readilyapparent, that could have equally disruptive consequences.

    When evaluating their portfolios, asset owners and managersshould be asking: what environmental and social risks am Itaking—or ignoring? What risks do my portfolio companiesand investment structures have that I should be aware of? Inlight of these risks, what is the appropriate investment timehorizon for measuring and rewarding investment performance?What analytic tools exist that can add another dimension toour understanding of company, industry, asset, portfolio andfund risk? Does the integration of such additional analysisoffer a richer and more comprehensive understanding of risk-adjusted returns? Is our approach to investing contributing toa sustainable economy, which underpins our ability toachieve sustainable long-term investment returns?

    Sustainable investing is about making sure thatinvestment decisions are made with a fullunderstanding of risks and opportunities, over theshort-term and the long-term. Awareness of materialenvironmental, social and governance (ESG) issuesenhances that understanding.

    Financial Analysis + Sustainability (ESG) Analysis =Comprehensive Investment Analysis

    A common misconception is that ESG analysis, a keytool for sustainable investing, is not compatible withoptimizing investment returns. To the contrary, whenESG analysis and conventional financial analysis areintegrated, the prospects for maximizing sustainablerisk-adjusted returns are improved because morematerial information is examined as part ofinvestment analysis.

    SRI, or sustainable and responsible investing, isanother conceptual framework for sustainable investing.Many mainstream investors think of SRI as a stand-alone strategy that subordinates investment returns to considerations such as alcohol, tobacco, gambling,weapons, pornography and genocide. The connectionto financial performance has not always been clearand the use of exclusionary screens, which caneliminate large segments of the investment universe,has encountered resistance.

    While such strategies remain important to manyinvestors, the mainstream investment community hasgravitated toward an approach to sustainable investingbased on positive attributes (i.e., “best-in-class”assets with positive traits), shareholder advocacy, andgeneral integration of ESG risks and opportunities intobroad investment analysis and portfolio construction.

    Sustainable Investing

    “Environmental, social and governance factors can affect the risk and return performance of investment portfolios

    to varying degrees across companies, sectors, regions and asset classes.”

    Anne Simpson, Senior Portfolio Manager and Director of Global Governance of the California Public Employees’ Retirement System

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    THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGThe Business & Investment Case for Sustainable Investing 6

    “E” – Environmental analysis reveals strategies for energyefficiency, better water and waste management, reductionof greenhouse gases and other pollutants, and deploymentof renewable energy alternatives. It also reveals businessimpacts on the local, regional and global environmentthroughout the product and business life cycle, fromsourcing to disposal. A full environmental analysis canalso reveal company and portfolio vulnerability toregulatory changes and preparedness for extremeweather trends. In the process of revealing risk, it canalso highlight new investment opportunities based onadaptation strategies and innovative solutions to energy,water and pollution control demands.

    “S” – Social analysis reveals a company’s commitment tohuman rights and well being that extends across globalsupply chains, from worker health/safety and labor rights,to stakeholder engagement and preparedness for reducingcritical operational risks that can adversely impactworkers, the company and the community. As competitivepressures increase in a resource constrained globaleconomy, ongoing attention to labor and societal demands

    will elevate company, consumer, community and investorawareness to sub-standard labor practices, productintegrity and disregard for community values. Socialcriteria, which often elude traditional investmentanalysis focused on financial metrics only, can havesignificant consequences for a company’s reputationalrisk and license to operate.

    “G” – Governance analysis reveals the strength of a company’s management systems and its standardsand practices for holding itself accountable. This includesboard and management commitment to social andenvironmental performance expectations that reduce risk and reinforce brand integrity from the board room tooperations to supply chains; accountability at the boardand C-Suite levels for anticipating and managing risksand opportunities, including social and environmentalones, that can affect sustainable business growth andprofitability; executive compensation linked toachievement of sustainability goals; and board diversity;gender equality; and transparency and alignmentconcerning policy positions and political contributions.

    E, S & G: Essential Elements of Sustainable Investing

    © 2016 Münchener Rückversicherungs-Gesellschaft, Geo Risks Research, NatCatSERVICE – As at January 2016

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    1,060Loss events

    Source: Munich Re, NatCatSERVICE, 2016

    DroughtUSA, Jan–Oct

    EarthquakeNepal, 25 Apr

    Winter Storm NiklasEurope, 30 Mar–1 Apr

    Severe stormsUSA, 7–10 Apr

    Typhoon MujigaeChina,1–5 Oct

    Severe stormsUSA, 23–28 May

    EarthquakePakistan, Afghanistan, 26 Oct

    Heat waveIndia, PakistanMay–Jun

    TornadoChina, 1 Jun

    Winter stormAustralia, 19–24 Apr

    Flash floodsChile, 23–26 Mar

    Flash floodsGhana,2–5 Jun

    FloodsMalawi, MozambiqueJan–Mar

    LandslideGuatemala, 1 Oct

    Flash floodsUSA, 2–6 Oct

    Winter stormUSA, Canada, 16–25 Feb

    Severe stormsUSA, 18–21 Apr

    WildfiresUSA, 12 Sep–8 Oct

    Heat waveEurope,Jun–Aug

    Typhoon SoudelorChina, Taiwan, 2–13 Aug

    M

  • THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGThe Business & Investment Case for Sustainable Investing 7

    Some investors are beginning to grapple with these risks andincorporate them into the investment process, but manyinvestors are either ignoring them altogether, in part becausethey’re hard to quantify, or acknowledging them only as extra-financial factors that don’t yet warrant serious analysis. Theseinvestors will discover at their peril that traditional financialanalysis, by itself, no longer provides an adequate assessmentof these portfolio risks—nor does it shine sufficient light onthe substantial investment opportunities in solutions to theseglobal challenges.

    Financial analysis is being supplement by analytic tools thatbetter identify sustainability risks, including those associatedwith greenhouse gas emissions, energy, water, supply chains,human rights and natural resource scarcity. Data concerningenvironmental, labor and operational practices are widelyavailable, as are comparative rankings of companies basedon performance in key environmental, social and governance(ESG) areas that tend to elude mainstream financial analysis.The participation of investors with more than $40 trillion inassets in investor groups focused on sustainable investment—such as Ceres’ Investor Network on Climate Risk (INCR), theUN supported Principles for Responsible Investment (PRI),the Forum for Sustainable and Responsible Investment (USSIF), and European, Australian and Asian investor groups onclimate change—is testament to the importance of these newtools for managing emerging ESG risks.

    NEW ECONOMIC & INVESTMENT REALITIESThe complex, interrelated challenges of meeting energydemand, mitigating the worst impacts of climate change andensuring that future generations have water and other naturalresources to sustain their own economies pose enormousshort and long term risks for investors.

    Climate change in particular—15 of the warmest years onrecord have occurred since 2000—is already having profoundeconomic consequences around the world. Extreme weather,which is the predictable consequence of climate change,accounted for more than 90 percent of the natural catastrophesworldwide in 2015 (see Figure 1, p. 6).

    In 2011, the United States experienced 14 extreme weatherdisasters causing more than $50 billion in total damages. In 2012, insured losses from Hurricane Sandy, a historicdrought and other climate-influenced extreme weather topped$58 billion.1 In 2014 and 2015 total losses were a combined$200 billion and insured losses almost $60 billion. The broadereconomic ripples were even higher, for example food priceinflation and shipping disruptions resulting from the ravagingdrought in the U.S. Midwest.

    Hurricane Sandy alone caused more than $70 billion ineconomic losses2—the second largest catastrophic event on

    BILLION CUBICMETERS OFWATER— 154 BASINS /REGIONS

    Figure 2: Global Fresh Water Demand Gap Projected By 2030

    4,500

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    Surface Water

    Ground Water

    2005Demand1

    2030Demand2

    2030PlannedSupply3

    Domestic

    Industry

    Agriculture

    -40%

    1. Demand in 2005 based on inputs from IFPRI2. Demand in 2030 based on frozen technology and no increase in water efficiency after 20103. Supply at 90% reliability and including infrastructure investments scheduled and funded

    through 2010; supply in 2005 is 4,081 BCM per year; supply in 2030 under projectedtechnological and infrastructural improvements equals 4,866 BCM per year; net ofenvironmental requirements

    Source: Water 2030 Global Water Supply and Demand model; agricultural production based onIFPRI IMPACT-WATER base case. [extracted from Charting Our Water Future; Executive Summary;McKinsey and Company; 2009; p 12]

    that scale, after Hurricane Katrina in 2005. Sandy’s impactswere exacerbated by a record-breaking storm surge abettedby rising sea levels caused by warming global temperatures.

    These trends have profound implications for low-lying citiessuch as New York, Boston, New Orleans, Miami and manyothers. In the United States alone, nearly five million peoplelive less than four feet above mean high tide. In just threesouth Florida counties, excluding the most populated, Miami-Dade, $30 billion in taxable property lies less than three feetabove mean high tide.

    Globally, the economic and investment risks from climatechange and other sustainability challenges are increasing as well. Even with accelerated investment in water efficiencyand resource management, many countries and continentsare on course to suffer major freshwater deficits in the nexttwo decades. (See Figure 2.) A McKinsey study estimatesthat by 2030 global water demand will outpace supply by 40 percent. This shortfall will hit all corners of the world,including the southwest United States, Australia, Africa andEast and Southeast Asia.

  • Uncertain water supplies—whether a lack of water, or toomuch at once—has obvious reverberations across supplychains and can cause severe business interruptions that poseinvestment risk. More than 160 companies in the global textileindustry were affected by Thailand’s 2011 floods, stoppingabout a quarter of the country’s garment production and alsodisrupting auto parts and computer hardware supply chains.Insurance company Munich Re received claims worth morethan $350 million from the 2010-2011 Australian floods,contributing to a 38 percent quarterly profit decline.

    Government responses to these challenges create additionalrisks and opportunities for investors. While U.S. lawmakers

    have failed to enact carbon regulations, much of the world—including California, the world’s ninth largest economy—has moved forward on this front. Carbon regulations to reducethe emissions that cause climate change affect one-third ofthe world’s population today, with economic implications forbusinesses operating in those jurisdictions. Sector-specificcarbon regulations are also gaining traction, including morestringent fuel-economy standards for US-made vehicles andwidely anticipated greenhouse gas regulations for powergeneration facilities. As domestic and global pressures buildto ward off worst-case climate warming scenarios, all companiesand investors should expect to be operating in a carbon-constrained global economy before long.

    THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGThe Business & Investment Case for Sustainable Investing 8

    The value of incorporating sustainability into businessstrategies and investment decisions is not hearsay or anecdotal, but strongly supported by an increasingbody of academic research and industry evidence.Examples include:

    Ñ A meta-analysis by Deutsche Bank Climate Advisorsin 2012 found that 89% of the more than 160academic studies, research papers and meta-studiesshowed that companies with high ESG performanceratings exhibit market-based outperformance comparedto industry peers, and 100% of the academic studiesagree that companies with high ratings for CorporateSocial Responsibility (CSR) and ESG factors have alower cost of capital in terms of both debt (loans andbonds) and equity.4

    Ñ In 2016 Deutsche Asset Management and theUniversity of Hamburg collaborated on a study thattracked the positive effect of integrating ESG into the investment process has on corporate financialperformance across markets and asset classes.

    Ñ In an 18-year study (1993-2011) conducted byRobert Eccles and George Serafeim of HarvardBusiness School, 90 companies with strongsustainability policies and practices outperformed a similar sampling of 90 companies having lowsustainability standards. “The annual above-marketaverage return for the high-sustainability sample was4.8% higher than for their counterparts and with lowervolatility. The high-sustainability companies alsoperformed much better as measured by return onequity and return on assets5,” the report concluded.

    Ñ In 2015 George Serafeim, Mozaffar Khan, and AaronYoon of Harvard Business School published “CorporateSustainability: First Evidence on Materiality,” that

    found that companies rated highly on addressingmaterial sustainability issues significantly outperformcompanies rated poorly on these issues.

    Ñ Companies on the California Public Employees’Retirement System’s Governance Focus List, selectedfor in-depth engagement because of CalPERS’concerns about weak sustainability performance,produced cumulative returns averaging 39% belowtheir benchmarks in the three years prior to CalPERSengaging with the companies and 17% above theirbenchmark returns for the five years after theengagement was undertaken.6

    Ñ A portfolio of 151 SRI funds between 2002 and 2009,a period of high market volatility, outperformed theMSCI World Index.7

    Ñ In a study of more than 450 companies between 2001and 2010, Sustainable Asset Management found thata portfolio of sustainability leaders outperformed anoverall sample by 1.74% annually, while a portfolio of weak sustainability performers underperformed theoverall sample by 1.87% annually.8

    Ñ In a 2011 white paper, Allianz Global Investorsfound that over a five-year period (2006-2010) aportfolio comprising the top quintile of global best-in-class ESG companies outperformed the benchmarkMSCI World Equal Weighted Index by 1.7%, whilethe bottom worst-in-class portfolio underperformedthe benchmark by 1.0%.9

    See Appendix A for more in-depth discussion ofsupporting evidence that ESG focused strategies canproduce superior results.

    Additional studies by UBS, MSCI, Morgan Stanley, TIAAand others, along with summary descriptions, can befound at http://paxworld.com/about/sustainable-investing.

    The Business & Investment Case for Sustainable Investment

    http://paxworld.com/about/sustainable-investing

  • STRATEGIC RESPONSES BY FORWARD-LOOKING PORTFOLIO COMPANIESMany of the world’s leading corporations are already integratingsustainability considerations into their business models. Ratherthan be at the mercy of sustainability pressures that will continueto reshape the global economy, companies are mitigatingsocial and environmental risks and seizing opportunities toinvest in solutions, enhance their brands and help assuresustainable earnings.

    Building on these trends, Ceres in 2010 created The 21stCentury Corporation: The Ceres Roadmap for Sustainability(“the Ceres Corporate Roadmap”), a virtual owner’s manual for the sustainable corporation. Now being used by hundreds of major companies and by investors in corporate engagements,The Ceres Corporate Roadmap contains 20 specific expectationsin key areas of governance, disclosure and engagement, as wellas performance indicators such as reduced greenhouse gasemissions, improved water efficiency, and improvements inhuman and worker rights in supply chains. Companies that meetthese expectations will be best prepared to compete in the 21stcentury global economy—an economy rapidly being shapedby climate change, resource scarcity, population pressures andrelated challenges. The Ceres Investor Blueprint providesguidance to help investors address these same challenges.

    INVESTOR RESPONSES TO THECHALLENGES OF SUSTAINABILITYInvestors are increasingly aware that sustainability challenges arealso investment challenges. Ahead of the 2015 COP21 climatenegotiations in Paris, a coalition of more than 400 global investorsmanaging $24 trillion in assets called on governments to adoptcarbon-reducing policies that will accelerate the investmentin clean energy required to slow climate change.

    In recent years there has been rapid growth in the number of financial indices that address sustainability, including the S&P/IFCI Carbon Efficient Index, HSBC Climate Index,Prudential Green Commodities Index, the NASDAQ GlobalSustainability 50 Index, and full suites of sustainable andenvironmental indexes by FTSE and MSCI. Some major stockexchanges, including those in London, Rio de Janeiro andJohannesburg are requiring public disclosure of sustainability-related information (such as greenhouse gas emissions) byall listed companies. In response to a petition from Ceres andleading investors, the U.S. Securities and Exchange Commissionin 2010 issued climate change disclosure guidance thatrequires disclosure of material climate-related risks bypublicly-held companies.

    Despite these encouraging steps, most institutional investors donot yet fully understand how environmental and social forcesshaping the 21st century economy will impact their portfolios.And even those investors with an awareness of these trends

    may not be familiar with available analytic tools or even havemade the commitment to become “sustainable investors.”

    This Blueprint is intended to guide asset owners, assetmanagers and consultants through a step-by-step processthat will lead to a more comprehensive understanding ofmaterial risks and opportunities that will help maximizesustainable risk-adjusted investment returns.

    INTEGRATING SUSTAINABILITY ANALYSISINTO INVESTMENT DECISIONSThere is a strong and growing body of objective evidence thatcompanies that integrate sustainability principles into theiroperations and strategies perform better and, over time,produce superior returns with decreased volatility and risk to shareholders, than companies that do not.3

    But sustainable investing isn’t simply about identifying andinvesting in companies with proven sustainabilityperformance; it is also about:

    analyzing ESG risks in every asset class and mitigatingthese risks across the entire portfolio;

    understanding the economic impact of increasinglycommon severe weather events that are causing hundredsof billions in economic losses and tens of billions ininsured losses every year;

    knowing the practices that safeguard worker health andsafety, protect human rights and support local communitiesacross the supply chain

    financing the clean energy technologies of the future and understanding the risks in water infrastructure bondsin a world that can no longer take ample supplies of freshwater for granted;

    preparing for the impact of new regulatory frameworksthat will inevitably catalyze a shift away from fossil fuels torenewable energy sources;

    understanding the risk to infrastructure, real estate10 andsupply chains that sit on land just a few feet above sealevel and are vulnerable to stronger storm surges fromrising seas and more powerful storms.

    These are just some of the “sustainability” risks andopportunities that often elude traditional financial analysisand overall investor interest.

    Sustainability challenges are also opening up large newopportunities for investors. The International Energy Agencyhas estimated the global clean energy investment opportunitiesin renewable power, energy efficiency and cleaner transportationat $5 trillion within the next decade.11 Climate changeadaptation will require enormous infrastructure investmentsrelated to power generation and distribution, transportation,agriculture and water efficiency. Mercer Consulting estimatesthe investment opportunities to be as high as $5 trillion overthe next 15 to 20 years.12

    THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGThe Business & Investment Case for Sustainable Investing 9

  • THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGFiduciary Duty & ESG Factors 10

    FIDUCIARY DUTY & ESG FACTORS

    Fiduciaries who manage institutional assets owe a duty ofutmost good faith, loyalty and prudence to the beneficiarieswhose money they are managing. Integrating material ESGfactors into their investment decision-making is fullyconsistent with the fiduciary duty of institutional investors.

    The overriding objective of institutional trustees and managersis to generate sufficient, consistent risk-adjusted returns thatenable the fund to pay benefits and meet its liabilities overmultiple generations. This goal is embedded in fiduciary dutyand is often cited as an obstacle to incorporating ESG factorsinto the investment process. The argument that ESG-inclusiveinvesting is inconsistent with fiduciary duty is based on thepremise that including ESG factors in investment decision-making would compromise returns to achieve extraneoussocial or environmental objectives. This perspective misses themark on both the nature and goals of “sustainable investing.”

    Institutional investors are bound to meet their obligations totheir fund’s or client’s beneficiaries over the life of the fund.Fund trustees and managers must therefore manage theirinvestments to satisfy both long and short-term liabilities,using strategies designed to meet target return rates thatprovide sustainable benefits over multiple generations.

    In the United States, the fiduciary duties of institutional assetowners and asset managers are generally defined by statecommon law and statutes for public, religious, endowmentand foundation funds; and by federal statute (ERISA) andregulations for labor (Taft-Hartley) and corporate plans.Although there are some differences, the essential elementsof fiduciary duty are generally quite similar.

    While the exact formulation varies among jurisdictions and bytype of investor, the two basic elements of fiduciary duty areduty of care (or prudence) and the duty of loyalty (includingimpartiality among participants and beneficiaries).13 Generallyspeaking, fiduciaries must act:

    Solely in the interest of participants and beneficiaries

    For the exclusive purpose of providing benefits

    Impartially, taking into consideration the differing interestsof various classes of participants and beneficiaries

    With the care, skill and prudence exercised by similarfiduciaries, including with respect to diversification ofinvestments and monitoring of performance

    Incurring only reasonable and appropriate costs

    In accordance with the governing law, documents andpurpose of the trust fund14

    Under the Employee Retirement Income Security Act (ERISA),the key duties of a fiduciary administering a coveredretirement plan, as outlined by the U.S. Department of Labor,similarly include:

    Acting solely in the interest of plan participants and theirbeneficiaries, with the exclusive purpose of providingbenefits to them

    Carrying out their duties prudently

    Following the plan documents (unless inconsistent with ERISA)

    Diversifying investments

    Paying only reasonable expenses15

    So how is sustainable investing relevant to the discharge of fiduciary duty?

    Modern Portfolio Theory (MPT), an approach to portfolioconstruction first developed in the 1950s, has played a dominantrole in prevailing concepts of fiduciary duty—in particular theduty of care and its principles of prudence and diversification—over the past several decades. Briefly, MPT is a mathematicalformulation of the concept of diversification of assets in a portfolio,in which higher risk demands higher returns. According to MPT,portfolio risk is reduced by investing in multiple non-correlatedasset classes, thereby maximizing risk-adjusted returns.16

    MPT is based on a number of economic assumptions,including that markets are fully efficient and investors areentirely rational—i.e., that all market players have access toall relevant information and act in their economic self-interestbased on that information.

    Some commentators have criticized MPT as having variousshortcomings and counterproductive effects as applied.17

    However, MPT is not inconsistent with sustainable investingstrategies and the incorporation of ESG factors into investmentdecision-making.

    The interpretation of fiduciary duty has evolved significantlyover time and must continue to evolve to adjust to changingsocial and economic realities. For example, rigid rulesspecifying prohibited and permitted investments gave way to MPT and diversification across multiple asset classes.18

    It is again time to re-examine current concepts of “prudent”

    “To ignore the risks around climate and sustainability in your portfolio could be and will be characterized as a dereliction of your fiduciary duties.”

    Kevin Parker, Chief Executive Officer, Sustainable Insight Capital Management

  • institutional investing in light of basic fiduciary duty principlesand new factors affecting investment risk and opportunity.19

    Today, new investment risks and opportunities based onemerging trends like climate change and resource scarcityrequire consideration by prudent fiduciaries. This approach,which we have termed sustainable investing, adopts a longer-term focus, is less tied to short-term benchmarks as the sole measure of success, and incorporates ESG factors intoinvestment analysis and strategy. This is fully compatible with MPT and provides a clear path for today’s fiduciaries to comply with their duties of loyalty and prudence.

    The courts and the Department of Labor have permittedconsideration of social and environmental issues in investmentdecisions, provided that the trustees reasonably believed theywere acting in the interests of beneficiaries and would notcompromise the fund’s risk-adjusted returns.20 A thorough 2005legal analysis by the international law firm Freshfields surveyedthe law of fiduciary duty in a number of leading jurisdictionsincluding the U.S., and concluded, “ESG considerations maybe taken into account as long as they are motivated by properpurposes and do not adversely affect the financial performanceof the entire portfolio.” The Freshfields report noted that the duty of prudence may even require investors to considerrelevant ESG factors in making investment decisions, andconcluded that consideration of climate change in investmentanalysis is “clearly permissible and is arguably required in

    all jurisdictions.”21 A 2015 report, Fiduciary Duty in the 21stCentury, published by the PRI (with UNEP FI, UNEP Inquiryand the U.N. Global Compact) further addresses the impactmaterial ESG factors can have on long term investmentperformance and that failure to consider such factors is afailure of fiduciary duty. In 2015 the Department of Labor furtherclarified that when ESG issues directly affect the economic andfinancial value of an investment they are a proper component of investment analysis and fiduciary obligation.

    The 2015 Department of Labor interpretive bulletin wasreinforced in a 2016 PRI report, Addressing ESG FactorsUnder ERISA, that provides two legal perspectives on theU.S. funds market and the consideration of ESG factors by fiduciaries. The legal perspectives by Morgan Lewis andthe Groom Law Group find that ESG factors are appropriateconsiderations when evaluating investment risk and return.

    Environmental and social variables can no longer be treatedas extraneous “non-financial” matters. These drivers ofinvestment risk and opportunity are becoming increasinglyimportant in developing strategies to manage risk and seekadequate risk-adjusted returns. Given the increased availabilityof ESG data and evidence of its materiality to company andinvestment performance, we believe that disregarding suchinformation would be inconsistent with the responsibilities of 21st Century fiduciaries.

    THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGFiduciary Duty & ESG Factors 11

    Environmental and social variables can no longer be treated as extraneous “non-financial” matters.

  • THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGCeres Blueprint for Sustainable Investing 12

    21ST CENTURY INVESTOR: CERES BLUEPRINTFOR SUSTAINABLE INVESTING

    INVESTMENT GOVERNANCE�

    Step 1: Develop Investment BeliefsThe Board of Trustees, or highest levelof fiduciary authority, will establishcore investment principles that includea commitment to sustainableinvestment.

    Step 2: Implement Trustee OversightThe Board of Trustees, or highest levelof fiduciary authority, will establishoversight of sustainable investmentinitiatives and accountability forimplementation.

    INVESTMENT PRACTICES�

    Step 3: Assess MaterialityThe trustees, in collaboration withinvestment and governance staff,consultants, managers, and sector & issue experts will identify thesustainability issues and risk factorsthat are material to the fund.

    Step 4: Evaluate MaterialSustainability Risks to the PortfolioThe trustees, in collaboration with theCIO, investment staff, consultants,managers and sector & issue expertswill evaluate asset allocation modelsfor material sustainability risks.

    Step 5: Integrate SustainabilityCriteria into Investment StrategiesTrustees, investment staff, consultantsand managers will select sustainabilitystrategies best suited to the fund’s risk-adjusted return objectives.

    Step 6: Incorporate ESG intoManager SelectionTrustees, investment and governancestaff and consultants will requiresustainable investment and engagementexpertise in manager and consultantprocurement.

    Step 7: Evaluate ManagerPerformanceTrustees, investment and governancestaff and consultants will monitormanager performance againstsustainable investment expectations.

    Step 10: Integrate SustainabilityApproaches Into All Assets Classesand StrategiesTrustees, investment and governancestaff and consultants will assess ESGrisks and opportunities in every assetclass and incorporate sustainabilitycriteria into all investment strategies.

    ASSET STEWARDSHIP �

    Step 8: Align Active Ownershipand Proxy Voting WithSustainable Investment GoalsTrustees, investment and governancestaff, and investment managers willestablish engagement strategies andproxy voting guidelines consistent withsustainable investment goals.

    Step 9: Support Policies andMarket Initiatives that Promote a Sustainable Global EconomyAsset owners & investment managerswill support market & policy initiativesthat advance sustainable investmentinitiatives and promote a sustainableglobal economy.

  • THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGTen Action Steps Toward Sustainable Investment Practices 13

    CERES INVESTOR BLUEPRINT: 10 ACTION STEPS TOWARD

    SUSTAINABLE INVESTMENT PRACTICES

    These 10 action steps are aimed at institutional investor governing boards, investment consultants, internal investment and governance staff, and external asset managers. The dots show who is primarily responsible

    for each step, and most involve collaboration among these groups.

    10

    9

    8

    7

    6 5

    4

    3

    2

    1

    Trustees

    Consultants

    Investment &Governance Staff

    Investment Managers

    ManagerSelection

    Monitoring

    Active

    Ownership

    Solut

    ions

    Invest

    in

    Investment

    Strategy

    Risk

    Alloca

    tion

    Materiality

    Oversight

    Beliefs

    Initiatives

    Market

    Based on more than a decade of experience working with institutional investors, and extensiveconsultation with a broad cross-section of asset owners and managers, this Blueprint recommends10 action steps for institutional investors seeking to become sustainable investors. While thesesteps are presented in what we believe is a logical sequence, they can be undertaken in any order.

    “Every investor needs to work through these 10 steps. By asking these questions, each investor will figure out what issues are material to their particular investment objectives and

    how to ensure that they are mitigating investment risks and seizing opportunities that might otherwise go unnoticed.”

    Nancy Kopp, Treasurer, State of Maryland

  • THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGTen Action Steps Toward Sustainable Investment Practices 14

    � ESTABLISH CORE FUND VALUES

    Beliefs have consequences for investment decisions madeby consultants, staff and asset managers. When trusteesarticulate the belief that sustainable investing leads to betterfinancial outcomes because all risks and opportunities areconsidered, “then arguably the role of the fiduciary is clearer.Assessment of beliefs helps to identify distinct views onsustainable investing issues such as climate change andresource scarcity. The strength of the beliefs held willdetermine how the investment strategy can be adapted totake account of long-term factors.”22

    If trustees do not articulate principles to guide their approachto investing and risk management—and why those principlesmatter—they effectively defer key decisions to others(investment managers, consultants and staff) who willmanage according to their own policies, practices andprejudgments.23 When trustees clearly communicate a set of investment beliefs, every person and entity associated with the fund has a framework for understanding what thetrustees expect.24

    Investment Beliefs Require Self-Examination Establishing investment beliefs encourages trustees to askimportant questions, debate priorities and seek advice fromindustry experts and peers in similar organizations. Theprocess gives trustees a better understanding of the fund, its beneficiaries, its goals, key challenges for meeting short,medium and long-term obligations, relevant time horizons forinvestments, and the risk factors that could impact returnsover the fund’s life. Consequently, the process of reviewing orformulating investment beliefs is a good moment to evaluatethe role of ESG analysis in identifying material investmentrisks and to commit to integrating ESG considerations intoevery aspect of the investment process.

    A survey of 685 asset owners, asset managers and consultantsby Pensions & Investments found that 57% have formalizedInvestment Beliefs that provide guidance on such issues asreturn objectives, risk management, diversification, marketefficiency, costs, governance, the goals of longer terminvestment, reforms that support the integrity of economiesand markets, engagement with portfolio companies and thecontribution of environmental, social and governance factorsto sustainable investment performance.25

    � COMMITMENT TO UNDERSTANDING ESG ISSUES AS THEY AFFECT THE FUND IS A CRITICAL INVESTMENT BELIEF

    Towers Watson, in their 2012 report on sustainableinvestment, We Need a Bigger Boat, advises trustees toconsider sustainability beliefs in the context of risk,opportunity and “the longer-term risks and costs associatedwith sustainability issues such as resource scarcity andclimate change.”26

    There is no template for investment beliefs; they are uniqueto every fund and will differ depending on such factors asinvestment objectives and liabilities. Trustees can obtainuseful input and guidance from their investment consultants,peers and outside experts but must make and “own” the keyjudgments on what to include concerning the contribution ofESG factors to the fund’s expectations for sustainable risk-adjusted returns.

    Because many trustees do not have an investmentbackground, and those that do are not necessarily familiarwith ESG risks, trustee education on these issues is crucial.Such training can be done in-house, preferably in collaborationwith experts in relevant aspects of sustainability risks or in off-site sessions conducted by established programs for trusteetraining, such as those affiliated with Harvard and StanfordUniversities. Ceres, the Initiative for Responsible Investing at Harvard, ICGN or PRI are useful resources for identifyingor developing trustee training programs.

    Step 1: Establish a Commitment to Sustainable Investment Through a Statement of Investment Beliefs or Investment Policies1

    Trustees assure consistent decision-making by investment staff, consultants and managers byestablishing clear core values—values that should include full consideration of material issues thatmay affect sustainable investment return, including environmental, social and governance factors.

  • THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGTen Action Steps Toward Sustainable Investment Practices 15

    Ñ the california State teachers’ retirement System (calStrS)Board of trustees links fiduciary duty to critical factors thataffect global economic growth and the long term sustainablereturns CalSTRS requires. The trustees also support specificpolicies the staff has developed to support sustainableinvestment returns:

    As a significant investor with a very long-term investmenthorizon and expected life, the success of CalSTRS is linked toglobal economic growth and prosperity. Actions and activitiesthat detract from the likelihood and potential of global growthare not in the long-term interests of the Fund. Therefore,considerations of environmental, social, and governanceissues (ESG), as outlined by the CalSTRS 21 Risk Factors, are consistent with the Board fiduciary duties.27

    Ñ ontario municipal Employees’ retirement System (omErS)explicitly incorporates ESG factors into its investment analysisfor reasons of long-term financial performance:

    2.1 Socially Responsible InvestingOAC [OMERS Administration Corporation] believes that well-managed companies are those that demonstrate high ethical andenvironmental standards and respect for their employees, humanrights, and the communities in which they do business, and that these actions contribute to long-term financial performance.As part of its due diligence in researching investments andmonitoring performance, OAC incorporates environmental, socialand governance factors into its decision-making processes.28

    Ñ the Washington State Investment Board (WSIB) includesamong its Investment Beliefs the recognition that climatechange is a risk factor to long-term investment return thatcompanies and external managers need to consider,disclose and manage:

    The WSIB has a long investment horizon and therefore issubject to complex and systemic global risks that unfold overtime, including financial risks resulting from global climatechange. Many of these risks are difficult to quantify, butnevertheless, we consider all identifiable risks in our investmentprocess and believe thoughtful consideration of these evolvingglobal challenges is inseparable from long-term investmentstrategy and performance. We believe that a full disclosure ofthese risks anticipated by the companies in which we investand the investment managers with whom we partner, alongwith full disclosure of what they are doing to manage theserisks, is necessary for us to invest responsibly by includinglong horizon risk assessment in our investment process.

    Ñ mainepErS adopted in 2015 a set of six principles aroundESG factors that are consistent with fiduciary responsibilityand sustainable investment return. They include:

    Principle #4: ESG Characteristics

    ESG factors will be updated based on continuous monitoringof the investment environment and incorporated into theinvestment process.

    Principle #5: MainePERS Investment Decision-Making Process

    The MainePERS investment team will incorporate analysis of all relevant factors into its strategic asset allocation andinvestment decision-making process, including ESG factors.

    Principle #6: ESG and Investment Managers

    MainePERS prefers to invest with managers that value andincorporate ESG factors into their investment decision-makingprocess. MainePERS encourages all managers with whom itworks to adopt ESG policies for themselves.

    Asset managers should also develop investment beliefs,including attitudes toward ESG factors.

    Ñ Wespath Investment management, the investmentmanagement division of the General Board of Pension andHealth Benefits of The United Methodist Church, incorporatesinto its investment philosophy the integration of ESG factorsas essential to its fiduciary responsibility to deliver long terminvestment return:

    Wespath sees the growing importance of ESG as affirmation ofour belief that corporate responsibility and long-term performanceare not mutually exclusive but are complementary. We embraceESG in our investment strategy not just because it is right or good,but because it is an integral element of sustainable businesspractices and ultimately, profitability.

    We believe that:

    • Sustainable investing should be a proactive, positive force,rather than the widely-held view that it relies solely on thenegative, exclusionary screening of so-called “sin stocks.”

    • We can influence corporate behavior through theencouragement of responsible actions, because a steadfastfocus on ESG can help make a company’s stock moredesirable and profitable.

    Ñ Bmo Asset management incorporates material ESGconsiderations into their investment decision-making process forall but non-discretionary accounts where clients make their owninvestment choices or investments where they replicate an index.

    At BMO Global Asset Management, portfolio investment decisionsare always made in the best interests of our clients. Supportingthese investment decisions is the belief that prudent managementof environmental, social and governance (ESG) issues canhave an important impact on the creation of long-term investorvalue. Companies that successfully manage their ESG risks,and proactively follow ESG best practices, may experience risk-adjusted outperformance over the longer-term. This beliefunderpins our commitment to being a responsible investor.

    Material ESG considerations are integrated into our overallinvestment process. Our research analysts and portfoliomanagers follow a process that considers the potential impactof ESG issues related to investments in our internallymanaged portfolios, and we seek partners that do the same.This analysis informs our asset allocation, stock selection,portfolio construction, shareholder engagement and voting.29

    ExAmplES of InvEStmEnt BElIEfS thAt IncorporAtE ESG

  • THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGTen Action Steps Toward Sustainable Investment Practices 16

    � OWN THE INVESTMENT PROCESS

    Decisions affecting the fund are continually being made atmany different levels of the organization. Chief investmentofficers, investment committees and portfolio managersroutinely make decisions that affect asset allocation, portfoliocomposition and, in many cases, the selection of consultantsand external managers.

    The active involvement of trustees in ESG integration sends a strong message to investment and governance staff—andto their asset managers and consultants—that investmentrisks and opportunities are being comprehensively examinedin ways that “investing as usual” may not account for. It alsoalerts investment consultants and managers that the fund willhold its providers accountable for integrating ESG factors intotheir investment processes, practices and advice.

    � ASSIGN OVERSIGHT

    The responsibility for overseeing an investment process thatincorporates ESG analysis needs to be formalized by appointinga point person (or committee) who is already a member of theboard or reports directly to the board. Ideally such individualshave an interest or expertise in sustainable investment andshould seek appropriate training about key sustainability risks,especially if someone with limited knowledge of these issueswill conduct oversight. Where a fund has a sole trustee (suchas the Treasurer of North Carolina or the Comptroller of NewYork State) with other competing responsibilities, a practicalsolution to ongoing oversight of sustainable investmentpractices is to delegate a senior staff member whounderstands the mandate and has relevant expertise.

    � UNDERSTAND RISK

    Trustees need sufficient involvement in the fund so theyunderstand where the fund may be vulnerable to strategies,companies, sectors, and industries poorly prepared for futurecompetitive pressures and trends. They should understandESG factors that impact all asset classes and investmentstructures. Among the factors that all investors should belooking at: the physical and regulatory impacts of climatechange that will affect investment strategies for energy, water,real estate, utilities, agriculture, tourism, forest products andother industries; depletion of water resources that areessential to agriculture, power generation, most industrialprocesses and human survival; and human rights violationsand unsafe or exploitive labor practices that can affect brandvalue and the legal and ethical license to operate.

    � MONITOR IMPLEMENTATION OF SUSTAINABLE INVESTMENT INITIATIVES

    Trustees should require investment managers to submitwritten reports on the implementation and results ofsustainable investment initiatives on a regular schedule. The trustees should also require similar formal reporting from investment consultants and internal staff concernedwith investment, manager selection and governance. Thetrustees should review and discuss these reports, askquestions of their service providers and staff, evaluate theprogress and success of these initiatives, and periodicallyconsider whether adjustments in strategy and tactics (andpotentially service providers) are needed.

    Step 2: Establish Board Level Oversight of Sustainability Policies and Practices2

    Trustees need to actively support and oversee key aspects of the investment process to assure that sustainable investment practices are being implemented.

  • THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGTen Action Steps Toward Sustainable Investment Practices 17

    Investors need to identify issues and risk factors that, for them, are significant enough to influence investmentdecisions. This process of identifying material risk factorsmust be undertaken in dialogue among asset owner Boardsof Trustees, investment consultants, investment staff and theasset managers who will implement investment strategies.

    The U.S. Supreme Court has ruled that a material fact is onewhose existence, were it known, “would have been viewed by the reasonable investor as having significantly altered the‘total mix’ of information made available.”30 As interpreted bythe U.S. Securities and Exchange Commission, “a matter is‘material’ if there is a substantial likelihood that a reasonableperson would consider it important.”31 ESG analysis can oftenreveal such material facts that would have gone unnoticedusing traditional financial analysis.

    The Supreme Court has also established principles thatacknowledge the place of uncertainty and contingencies, whichskeptics often cite in challenging the materiality of ESG risks:

    1. Contingent or speculative events are not immaterialsimply because they are contingent or speculative;

    2. The materiality of contingent or speculative eventsdepends on the significance the reasonable investorwould place on the information;

    3. The significance of contingent or speculative events toinvestors depends on both the likelihood of occurrenceand the magnitude of potential impact.32

    Like other investment risks, those associated with ESG factorscan be unpredictable concerning timing and magnitude. Thatdoes not make them any less material. Some investment risksand opportunities may be more significant to particularinvestors and should be carefully analyzed by the investmentstaff, consultants and managers. For example, while energyconsumption of a real estate portfolio would be a materialconcern for all investors (because it will impact the operatingcosts and long term value of the real property), it could be ofparticular concern to a construction industry pension fundbecause of the impact of this issue on members’ jobs andpension contributions as well as investment performance.

    � WHAT GUIDELINES HAS THE INVESTMENTCOMMUNITY ESTABLISHED FOR MATERIALITY?

    Whether it relates to conventional financial performancemeasures or ESG factors, “materiality” is a subjective standard.The first effort to codify sustainability indicators, commonly calledkey performance indicators (KPIs) was undertaken in 1997 by the Global Reporting Initiative (GRI). GRI guidelines placethe responsibility on companies to identify their own material issues and recommends that companies use multi-stakeholderengagement, including investors, to determine key issues. While GRI has identified hundreds of KPIs that help companiesdisclose their sustainability performance, most companies do not consistently follow the GRI guidelines, including disclosureon how companies identify material ESG factors that affect theirbusiness. Consequently, many sustainability reports do notprovide investors with reliable, actionable information aboutmaterial ESG risks. The fourth generation of GRI Guidelines (G4)continues to place a strong emphasis on corporate reporting of material ESG issues and performance.

    In response to the lack of objective standards for determiningmateriality, and because company reporting and conventionalfinancial analysis often does not include material ESG risk factors,a group of investment industry experts knowledgeable aboutsustainability issues convened in 2011 to form the SustainabilityAccounting Standards Board (SASB). SASB’s objective is toestablish “industry-specific accounting standards for materialsustainability issues for use by U.S. publicly listed corporationsand their investors”33 and to have its standards become asauthoritative as the financial accounting and reporting standardsof FASB. SASB has issued provisional sustainability accountingstandards for 79 industries in 11 sectors (see www.sasb.org).

    Another Initiative, Project Delphi, a collaboration by morethan three-dozen asset managers, asset owners, consultantsand ESG service and data providers spearheaded by StateStreet Global Advisors, identifies the material ESG factorsmost likely to influence corporate financial performance,affect decisions and impact long-term value. This initialphase has been completed in preparation for transitioningProject Delphi to a public platform and advancing theframework through feedback and further research.

    Step 3: Identify Sustainability Issues Material to the Fund3

    Understanding and addressing material sustainability risks is integral to fiduciary duty.

    http://www.sasb.org

  • THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGTen Action Steps Toward Sustainable Investment Practices 18

    Universe of PotentialSustainability

    Issues

    Sustainability Issues

    Most Relevant to the Sector

    Financial Impacts / RiskIssues that may have a financial impact or may pose a risk to the sector in the short-, medium-, or long-term (e.g., product safety).

    Legal / Regulatory / Policy DriversSectoral issues that are being shaped by emerging or evolving governmentpolicy and regulation (e.g., carbon emissions regulation).

    Industry Norm / Competitive IssueSustainability issues that companies in the sector tend to report on and recognizeas important drivers in their line of business (e.g., safety in the airline industry).

    Stakeholder Concerns / Social TrendsIssues that are of high importance to stakeholders, including communities, non-governmental organizations and the general public, and/or reflect social andconsumer trends (e.g., consumer push against genetically modified ingredients).

    Opportunity for InnovationAreas where the potential exists to explore innovative solutions that benefit the environment, customers and other stakeholders, demonstrate sector leadership and create competitive advantage.

    MATERIALITY TEST

    ExAmplES of mAtErIAl SUStAInABIlIty ISSUES for InvEStmEnt & lonG tErm vAlUE crEAtIon

    A 2010 report by Harvard’s Initiative for ResponsibleInvestment provided an intellectual foundation for SASBthrough guidance on and tests for materiality.34 The authorsidentified a set of representative sustainability issues thatinvestors may find material, including:

    Ñ Climate change and the efficient use of energyÑ Releases of toxic chemicals into the environmentÑ Sustainable management of forests, fisheries, and other

    natural resourcesÑ Safety and decent working conditionsÑ Equal access to technologies and financial services for

    all members of societyÑ Availability of waterÑ Equal employment opportunitiesÑ The need for sustainable products and services

    The authors also recognized that the materiality of ESGissues varies by sector and industry. Instead of settling on asingle definition of materiality, they developed a frameworkfor assessing materiality that can be used at the sector,industry or company level, including issues such asregulation of carbon emissions that will affect some sectors

    more adversely than others and innovative responses to riskand problem solving “that demonstrate sector leadershipand create competitive advantage.”35

    Investors can also learn from stakeholder groups that routinelymonitor company policies and practices, and from thecompanies themselves, especially those that are thinkingstrategically, taking action and communicating about nearterm and longer term critical success factors for value creation.Companies should be encouraged to report to investors onhow their sustainability initiatives affect their financialperformance, and investors should consider how a company’sdisregard for social and environmental risks reflects flawedgovernance or shortsighted management that couldundermine long-term competitiveness and value creation.

    The more investors discuss and debate the issues and riskfactors they believe may be material to their portfolio or fund,the more probing questions they ask of their consultants,managers and portfolio companies—and the more theirgovernance staff may become aware of a need for shareholderengagement around ESG issues (see Step 8).

  • THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGTen Action Steps Toward Sustainable Investment Practices 19

    Trustees should review current asset allocation strategies todetermine whether they are prepared for risks arising fromclimate change, supply chain interruption or increased costsfrom human rights issues, increased demand for energy,political risks, affordable access to water and other resources,foreseeable limits on greenhouse gas emissions and othermaterial sustainability risks. These new risks are typically notan explicit part of fund analysis and asset allocation strategiesand are not systematically managed. At best, many of theserisks tend to be discussed anecdotally or understood as partof inflation or GDP projections.

    � CLIMATE RISK POSES UNIQUE & UNPRECEDENTED CHALLENGES TO ASSET ALLOCATION

    Because climate change risk is ubiquitous, commonly usedstrategies for diversifying risk, such as Strategic Asset Allocation(SAA), may leave entire funds still exposed under certainscenarios. While these asset allocation strategies are generallyeffective in mitigating risks across traditional and alternativeassets, including risks associated with many ESG factors, theywill provide limited diversification to carbon risk. For example,when carbon emissions become taxed or regulated, all assetclasses that have investment exposure to carbon producers(oil/gas/coal producers) will be affected. That risk extends toinvestments in heavy users of fossil fuels (utilities, transportation),which, as costs increase, may experience reduced profitmargins that will impact investment returns. These risks lackprecedent, and asset allocation models that rely on historicquantitative analysis do not adequately account for them.

    � UNDERSTAND THE RISKS ASSOCIATED WITH A DIFFERENT REGULATORY ENVIRONMENT

    The prevailing investment model that has led most investorsto diversify across asset classes did not work particularly wellduring the financial market breakdown of 2008, and it willnot work well when widespread regulatory controls that tax or put limits on carbon emissions (or physical risks) adverselyimpact investments across many of those same asset classes.

    An alternative approach is to diversify across sources of risk.Climate Change Scenarios—Implications for Strategic AssetAllocation, a 2011 report by the consulting firm Mercer,estimates that institutional portfolios could be exposed tosystemic risks from climate related policies that could affectinvestment returns by as much as 10% over the next 20years. Mercer suggests that to “manage climate change risks, institutional investors need to think about diversificationacross sources of risk rather than across traditional assetclasses.”36 According to one of Mercer’s scenarios, a typicalportfolio seeking a 7% return could manage climate changerisk by shifting about 40% of their portfolio into climate-sensitive assets such as infrastructure, real estate, privateequity, and timberland.

    While there is no single solution for mitigating portfolio riskfrom regulatory, legislative and other responses to climatechange, investors should begin examining climate risks by:

    including climate risk assessments in routine reviews ofportfolio and fund strategies;

    increasing allocations to assets that will benefit fromgrowing demand for low carbon, efficient, clean energysolutions, effectively creating a climate hedge;

    boosting engagement with portfolio companies to improvetheir policies and practices on climate risks.

    This Mercer report and its 2015 successor “Investing in aTime of Climate Change” includes in-depth analysis of existingclimate-related risks by asset class and a menu of suggestionsfor new allocation strategies to help mitigate those risks.

    Climate-related risks, both carbon-reducing regulations and physical impacts, were not part of investment dialogueswhen many institutional investment policies and assetallocations were being formulated. Can investors with multi-decade liabilities afford to ignore them now? Assessment ofcarbon risk exposure across portfolios is a prudent initial stepin understanding and considering appropriate responses,including investments in both climate mitigation (e.g., lowcarbon energy sources, energy efficiency) and climateadaptation (i.e., resilient infrastructure projects).

    Step 4: Evaluate Material Sustainability Risks to the Portfolio4

    Decisions about asset allocation directly affect the incurrence and management of material sustainability risks.

  • � UNDERSTAND HOW ASSETS ARE EXPOSEDUNDER A RANGE OF ENVIRONMENTAL & SOCIAL SCENARIOS

    Entirely different climate-related investment risks are thoseassociated with physical impacts such as stronger storms,rising sea levels, wildfires, and droughts that can affect broadgeographic areas, regional economies and specific sectors.37

    Likewise political instability, national or international workerprotections (or lack thereof) can affect a range of industriesin geographic regions. There are cross sector risks frominternational and regional regulatory changes. For example, if policy makers act to limit global warming to 2 degreesCelsius, or if demand decreases due to other environmentaland market factors, a substantial percentage of oil, coal andnatural gas reserves—now considered valuable assets—may become “stranded” and unusable.38

    Trustees and CIOs should ask their consultants to “stresstest” traditional allocation models by running sustainabilityscenarios on these issues. A consultant can model factorssuch as a drought, a particular sea level rise prediction, theimpact of civil unrest in a region, resource scarcity, energyefficiency improvements, or a new regulatory framework forclimate change and assess the impact on the portfolio. Thesescenario overlays may reveal previously unrecognized, materialrisks that can then be mitigated.

    THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGTen Action Steps Toward Sustainable Investment Practices 20

    If policy makers act to limit global warming to 2 degrees Celsius, or if demand decreases due to other environmental and market factors, a substantial percentage of oil, coal and natural gas reserves—now considered valuable assets—

    may become “stranded” and unusable.

  • THE 21ST CENTURY INVESTOR: CERES BLUEPRINT FOR SUSTAINABLE INVESTINGTen Action Steps Toward Sustainable Investment Practices 21

    Implementing a sustainable strategy can be a one- or two-step process that follows the larger asset allocation decision.

    Trustees and investment staff make choices about investmentstrategies in public equities—the largest allocation in mostfunds—that are as basic as active versus passive and asspecific as index weighting or investment theme.

    In the two-step process, the specific investment strategy will be determined first and the integration of ESG second.Investors new to ESG integration may find this approachcloser to their comfort zone, because of familiarity withcertain investment strategies not necessarily associated withincorporating ESG factors. Ideally these are done together in one unified process, but either approach is workable. Any chosen strategy can be configured for ESG integration.

    Among equity strategies there are two primary approaches—investors with active strategies can use ESG analysis in the stockselection process. Passive investors can license an ESG index orcan modify an existing index to incorporate ESG components.

    � ESG INTEGRATION FOR ACTIVELY MANAGEDEQUITIES STRATEGIES

    Many active managers, such as Boston Common AssetManagement, Calvert Investments, ClearBridge Investments,Generation Investment Management, Impax Asset Management,Parnassus Investments, Pax World Investments, BrownAdvisory, RobecoSAM and Trillium Asset Management,among many others, offer dedicated investment productsthat incorporate ESG analysis with the goal of generatingsuperior investment returns. In many cases client requestsfor further customization of ESG criteria are possible, butthe core investment process is informed by a proprietaryapproach to analyzing ESG risks and opportunities. Otheractive managers who do not yet routinely examine ESGfactors could be engaged to develop client specific investmentstrategies that target sustainable holdings or strategies that build ESG analysis into the fundamentals of portfolioconstruction.

    � ESG INTEGRATION FOR PASSIVELY MANAGEDEQUITIES STRATEGIES

    For those investors who choose a passive strategy, virtuallyevery major index provider has an ESG or sustainabilitythemed offering that is already licensed by an investmentmanager—or is available for licensing. Many of the passivestrategies that integrate ESG are benchmarked against abroad-based investment universe. One example is a best-in-class approach that focuses investment exposure withinindustries (or regions) to companies demonstrating strongersustainability practices. This approach is commonly used to