balancing responsibility, risk and return...balancing responsibility, risk and return | 3...

Valerie S. Grant SVP—Senior Portfolio Manager, Responsible Investing

Harvard Business School Social Enterprise Initiative

Balancing Responsibility, Risk and Return

December 14, 2018

1|Balancing Responsibility, Risk and Return

Responsible investing is growing globally, across asset classes.

Growth is likely to continue, driven by demand from institutional asset owners and high net worth

individuals

Responsible investing can be implemented in a variety of ways, from screening to impact

investing, based on investor’s objectives and preferences for responsibility, risk and return.

Responsible investing is inherently more complex than traditional investing because it requires

attention to three dimensions rather than two.

A combination of strategies is often required to accomplish an investor’s goals within a particular

asset class or sub-asset class.

Summary and Conclusions


Balancing Responsibility, Risk and ReturnAgenda and Overview

Responsible Investing: Definition and Market Dynamics

Strategies for Implementing Responsible Investing

Role of Active Management in Balancing Responsibility, Risk and Return

Unintended Consequences of Restrictions and Exclusions

Relationship between ESG Ratings and Risk

Value of Fundamental Investment Research

Product Example

Q&A


Responsible Investing is Global and Encompasses All Asset Classes

Sustainable, responsible and impact investing (SRI) is an investment discipline that considers

environmental, social and corporate governance (ESG) criteria to generate long-term competitive

financial returns and positive societal/environmental impact.

Source: Forum for Sustainable and Responsible Investment (US SIF); Global Sustainable Investment Alliance 2016 Global Sustainable Investment Review

Europe, 53%

US, 38%

Canada, 5%

Australia / New

Zealand, 2%

Asia, 2%

100% = $23 trillion

~26% of Managed Assets

Bonds, 64%

Equities, 33%

PE / VC / Other Alts,

3%

100% = $23 trillion

~26% of Managed Assets

Note: Data on AUM by asset class is estimated based on data reported by Canada and Europe. The US and other markets have not reported data on asset

allocation for SRI investing.


Passively Managed Investments

Assets Under Management, $US trillions

Global Socially Responsible Investments

Assets Under Management, $US trillions

$10

$14

$17

2012 2014 2016

$13

$18

$23

2012 2014 2016

Responsible Investing is Growing Rapidly and is Larger than Passive

Investing

Source: Broadridge FundFile, McKinsey & Company, Inc., Global Sustainable Investment Alliance Global Sustainable Investment Review 2016 and 2014

15%

CAGR

14%

CAGR

Europe

and ROW

North

America

Europe

and ROW

North

America


Asset Owners are Committed to Responsible Investing

Strongly Agree, 44%

Agree, 33%

Neither Agree

Nor Disagree,

10%

Disagree

Somewhat, 7%

Disagree Strongly,

6%

To what extent do you agree or disagree with the following statement: “Asset owners have a

responsibility to address global sustainability issues through their investments”

Belief that Addressing Sustainability Issues is A Responsibility

100% = 116 Respondents

Source: Morgan Stanley, Sustainable Signals: Asset Owners Embrace Sustainability (2018). Based on a survey of 118 public and corporate pensions, endowments,

foundations, sovereign wealth entities, insurance companies and other large asset owners globally.


Future Growth Likely to be Driven by Private Equity and Hedge Funds

6

7%

36%

37%

50%

65%

24%

26%

37%

34%

20%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

Hedge Funds

Private Equity

Fixed Income

Real Assets

Public Equities

In your experience, in which sectors has your organization been able to find quality sustainable investing strategies / managers? (n=74)

Source: Morgan Stanley, Sustainable Signals: Asset Owners Embrace Sustainability (2018). Based on a survey of 118 public and corporate pensions, endowments, foundations,

sovereign wealth entities, insurance companies and other large asset owners globally.

Yes

Sometimes

Unmet Demand by Asset Owners for Quality SRI Strategies and Managers


Responsible Investing Requires an Active Approach

Responsibility Introduces

a Third Dimension

Corporate social responsibility

introduces investment

considerations beyond

investors’ goals for return and

risk.

Mechanical Approaches Have

Inherent Shortcomings

Conventional, rules-based

approaches fall short in

managing trade-offs, improving

corporate behavior, and

identifying investment

opportunities.

Investing Responsibly

Adds Complexity

Financially motivated decisions

by corporations can impact

society and the environment.

Similarly, decisions by

corporations to behave

responsibly can impact financial

performance and investment

outcomes.


RESPONSIBILITY

▪ Recognizes three dimensions instead of

two

▪ Helps uncover investment opportunities

and risks

▪ Offers tools to manage trade-offs and

engage constructively with management

on important ESG issues

▪ Exploits inefficiencies in ESG data and

reporting

▪ Enables shareholders to influence

companies to behave more responsibly

RISK

RETURN

Responsible Investing is Inherently More Complex than Traditional

InvestingActive Management Can Balance Objectives on All Three Dimensions


Responsible Investing Includes Diverse Strategies That Can be Used Alone

or In Combination

9

Corporate Engagement

and Shareholder Action$8T

Impact / Community

Investing$248B

Thematic Investing$331B

ESG Integration$10T

Negative

Screening$15T

Norms-based

Screening$6T

Positive

Screening$6T

“Table Stakes”

Expected even in

non-SRI portfolios

“High Growth”

Greatest opportunity

for differentiation

in public and

private markets

“Big but Mature”

Approaches to Responsible Investing

Global Assets Under Management, $US

Source: Global Sustainable Investment Alliance 2016 Global Sustainable Investment Review

Strategies are not mutually exclusive


Responsible Investing Strategies Address Different Objectives

Achieve

Positive

Outcomes

Align with

Mission

or Values

Influence

Corporate

Behavior

Avoid Bad

Actors

Manage Risk

or Volatility

Generate

Excess

Returns

Thematic Investing

Impact/Community

Investing

Negative Screening

Positive Screening

Norms Based

Screening

Corporate Engagement

and Shareholder Action

ESG Integration

Alignment with Investor’s Goals for Responsibility, Risk and Return is Critical

Objectives of Commonly Used Responsible Investing Strategies

Source: Global Sustainable Investment Alliance 2016 Global Sustainable Investment Review, AB Analysis


6.7% 7.2%

Screening Remains Popular, but Can Have Unintended Consequences

Source: Standard & Poor's, AB analysis

All data shown from January 2007 to January 2017. Screens exclude companies with any exposure to tobacco, alcohol, defense, gambling, guns, Sudan,

pornography, fossil fuels and nuclear power

Broad Screens Typically Add Risk While Detracting from Returns

Percent of Universe Excluded with Broad Screens

16.3%15.1%

Annualized Cap Weighted Returns Annualized Volatility

Restricted

Portfolio

S&P

500

Market

Capitalization

39%

Number

of Stocks

25%

Restricted

Portfolio

S&P

500


Dimension Metric Broad Screen*Targeted

Screen**S&P 500

% of Universe Excluded 39% 10% 0%

ReturnAnnualized return

(cap-weighted)6.7% 7.2% 7.2%

Risk Annualized volatility 16.3% 15.2% 15.1%

Risk Adjusted ReturnReturn/Risk Ratio

0.41 0.48 0.48

ResponsibilityESG Score

(equally-weighted)4.45 4.50 4.50

Tracking Error 2.5% 0.6% N/A

Targeted Screens Limit Negative Impact on Risk and ReturnsImpact of Broad vs. Narrow Screens on Return, Risk and Responsibility

Past performance does not guarantee future results. There can be no assurance that any investment objectives will be achieved.

January 2007 to January 2017

*Broad Screens include companies with any exposure to the 9 most common exclusions imposed on US responsible equity funds

**Narrow Screens excluded only those companies with material involvement in these business activities

Source: MSCI, AB Analysis


Research Can Be Used to Find Improvers, not Just Top Performers

Forward returns for the next 12 months following a change in rating

January 1, 2017 through December 31, 2016

Source: MSCI, S&P and AB analysis

Excess Forward Return vs. Equal-Weighted S&P 500

Basis Points

Excess Forward Returns for Stocks with Two-Notch ESG

Upgrade vs. Equal-Weighted S&P 500

Upgrades for Poorly Rated Firms Are Rewarded Most

93

-34-60

-40

-20

0

20

40

60

80

100

Upgrades No Change

+127

basis

points

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

CCC B BB BBB

“The Redemption

Effect”

ESG Rating at

Time of UpgradeWorst Best


ESG Ratings Are A Useful Indicator of Risk…

January 2007 to July 2017

Source: MSCI, S&P and AB analysis

Risk Premium for CCC vs. AAA Rated Stocks

= 2.83%

16%

17%

18%

19%

20%

21%

22%

CCC B BB BBB A AA AAA

Stock Specific Risk by ESG Rating CohortS&P 500


Thematic Investing Can Uncover Growth OpportunitiesUN Sustainable Development Goals + Deep Fundamental Research is a Powerful Combination

Investing in Clean Water Aligns with UN Sustainable

Development Goals

CLEAN WATER AND

SANITATION

ZERO

HUNGER

GOOD JOBS AND

ECONOMIC GROWTH

INDUSTRY, INNOVATION

AND INFRASTRUCTURE

Leading to Differentiated

Investment Insights


Portfolio Summary

Designed for clients seeking to invest responsibly

in their ‘core’ large cap equity allocation

Derived from the highest conviction holdings in

AB’s equity strategies and optimized for return, risk

and responsibility*

Balanced and persistent exposure to multiple

factors with long-term premia

Seeks to invest responsibly across multiple

environmental, social and governance parameters

Transparency in reporting performance on the

dimension of responsibility using key performance

indicators

Responsible US Equities (RE-USE)

Past performance does not guarantee future results. All portfolio statistics, characteristics and holdings are subject to change.

*Source portfolios include US Strategic Value, Relative Value, Large Cap Growth, Concentrated Growth, Strategic Core, Select Equities, Core Opportunities, Sustainable Thematic and US

Equity Income

**Based on 2008-2017 back test.

Portfolio Characteristics**

Holdings

Number of Holdings ~ 85

Annual turnover = 35-50%

Return and Risk Metrics

Target return premium: 1.0 – 1.5%

Tracking error: ~ 3.5%

Information Ratio: 0.4

Benchmark

S&P 500

Using Quantitative and Fundamental Approaches to Balance Return, Risk and Responsibility


Implementing Multiple Strategies to Incorporate Responsibility

For illustrative purposes only. There can be no assurance that any investment objectives will be achieved.

*Screening eliminates from the investment universe companies that generate >5% of total revenues from tobacco, defense, guns, pornography and nuclear power. For fossil fuels, the exclusion is

based on revenue-adjusted carbon emissions (T CO2 / $M in revenue) > median for all companies that have any exposure to fossil fuels.

Screening*

ThematicUses AB’s US Sustainable Thematic Research as

Source Portfolio

ESG Integration

Active Ownership

RE-USE team engages with portfolio companies on ESG

issues and collaborates with investment and governance

teams on proxy voting

+ Fundamental evaluation of ESG issues conducted

by portfolio teams

+ ESG Momentum added to traditional quantitative

factors like Value, Growth, Size, etc.

+ RE-USE team conducts additional due diligence

on controversial stocks

Targeted screens minimize exposure to Tobacco,

Guns, Pornography, Defense, Fossil Fuels, Nuclear




All metrics are reported

in absolute terms and

then measured vs. the

S&P 500

Qualitative measures,

including the efficacy of

our ESG engagements

with companies will be

monitored and reported.

As data on corporate

social responsibility

improves, we may add

new ESG metrics

ESG Momentum

For illustrative purposes only.

*CO2 emissions / $M Sales

**CO2 emissions / $M Invested

Climate Change

Diversity and Inclusion

Good Governance

% of Holdings with

ESG Ratings Upgrades

Average Board Tenure

% of Women on

Board of Directors

Carbon Emissions*

Carbon Intensity**

Transparency and Accountability on ESG Metrics


Responsible investing is growing globally, across asset classes.

Growth is likely to continue, driven by demand from institutional asset owners and high net worth

individuals

Responsible investing can be implemented in a variety of ways, from screening to impact

investing, based on investor’s objectives and preferences for responsibility, risk and return.

Responsible investing is inherently more complex than traditional investing because it requires

attention to three dimensions rather than two.

A combination of strategies is often required to accomplish an investor’s goals within a particular

asset class or sub-asset class.

Summary and Conclusions


Questions and Answers

balancing responsibility, risk and return...balancing responsibility, risk and return | 3...

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