CIO Insights Special Act today to ensure our future – Understanding ESG APAC Edition – November 2017 CIO Insights Special Act today to ensure our future Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined Uherenin.d Paest Presrfotramannced anidn fogrec aEstsS areG not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved. Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect. CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 1 CIO Insights Special Act today to ensure our future – Understanding ESG ESG Special Authors: 01 Sustainability – beyond 02 Defining sustainable Markus Müller philanthropy investment Global Head CIO Office – Environmental – Social Enrico Börger – (Corporate) Governance Financial Writer 03 The expectations of investors 04 The five levels of ESG approach and the main investment – Exclusions vehicles – Adherence to norms – Time to shake off the – Best in class approach perceptions of the past – Thematic investments – Historic milestones – Engagement & Impact investing – Demographic shifts among investors and their effects on investors’ expectations – The investment vehicles 05 Opportunities in Sustainable 06 The financial return of ESG Investment Vehicles strategies and the role of Guest comment by the German specialist research agencies Ministry of the Environment 07 The caveats and the “ashes to 08 Conclusion ashes” analysis Preface Investing on the basis of environmental, social and governance factors – or ESG for short – is not new. We have, for example, been able to invest in multiple socially- responsible stock indices for almost two decades. Concerns about individual firms’ impact on the environment and sustainability in general go back much further. ESG investing is now, however, increasingly centre-stage. In part this is because digital news flow has made investors more continuously aware of the underlying issues. The debate around climate change and the Paris Accord (and, most recently, the COP23 meeting held in Germany) has contributed to this. Christian Nolting Global CIO But I think that the rise of ESG investing also reflects two key changes in investor behaviour and aspirations. First, many private investors do not want a passive approach to investing: instead they want to use their investment knowledge to use their wealth in an active, objective-driven way. Second, there is a growing realisation that ESG is not just a step away from philanthropy. Private and institutional investors see that socially-responsible long term aims can be combined with attractive short and medium-term returns. This report, which includes a contribution from the German Environment Agency, aims to provide an overview of the various types of ESG investing, along with opportunities and risks. I believe that this subject can only grow in importance. Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined herein. Past Performance and forecasts are not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved. Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect. CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 2 CIO Insights Special Act today to ensure our future – Understanding ESG 01 Sustainability – beyond philanthropy “Don’t fell more trees than can grow as it was called, was the US Pioneer back“. Thus spoke nobleman and Fund, launched in 1928 with the aim ecologist Carl von Carlowitz in 1713 in of declining to invest in alcohol and his treaty on “Sylvicultura oeconomica”, tobacco industries on the grounds unwittingly laying the foundation for of their negative effect on human what was later going to be known as health. Nearly half a century later, two sustainable investing. Methodist ministers launched the Pax World Fund, an investment fund that At the time, the king‘s ore and silver excluded from its investment universe smelteries were burning through a shares deemed ethically unfit, focusing considerable amount of timber in order instead on securities of companies to produce armories and weapons for the that met certain criteria about the king‘s army, as well as producing building treatment of their employees and the material for infrastructure projects. The environment. In 1972 a United Nations ensuing deforestation caused an extreme conference in Stockholm on the human shortage of timber that prompted Carl environment first discussed the tradeoffs von Carlowitz to question the sense of and the challenges of sustainability, depleting natural resources for short- economic growth and development for term gain. In 1987, the Brundtland our planet. The same year, the Club of report on the subject reiterated this very Rome published the book “Limits to same point by defining that sustainable Growth”. In 1980, two UN agencies development “means that the present published a paper co-authored by the generation satisfies its needs, without World Wildlife Fund (WWF) titled “ Living endangering future generations Resource Conservation for Sustainable satisfying their needs.“ Development“. It was the first international document on living resource Similarly, in the early 19th century, conservation produced with inputs the German scientist Alexander von from governments, non-governmental Humboldt noticed during his journey organizations. through the South American rainforests that the Valencia lake in Venezuela In 1990 the Domini 400 Social Index had started drying up since nearby became the world‘s first “socially woodlands had been felled in order responsible“ stock index, aimed at to obtain arable land. Indeed, he first helping socially conscious investors established a link between deforestation weigh social and environmental factors and droughts, going as far as inventing in their investment choices by providing an energy-efficient fireplace to counter them with a benchmark. This index is the problem. today calculated by MSCI (MSCI KLD 400 Social Index) and is a leading index Even before Carl von Carlowitz‘s time, for socially responsible investments in however, we have evidence of what is the United States. known today as responsible and ethical investment practices. In the 17th century In general terms, however, the quest the Quakers in the newly established for sustainability is probably as old as territories of Northern America decided mankind itself. The ancient Romans to refuse making a profit from war were known to store wine and water and from the slave trade, which were in amphorae made of terracotta and incompatible with their ethical principles. ceramic. At the end of their useful lives, these amphorae were pounded into In modern times, the first recorded chips and and converted into “opus “responsible“ investment vehicle, signinum“, a type of concrete used as Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined herein. Past Performance and forecasts are not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved. Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect. CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 3 CIO Insights Special Act today to ensure our future – Understanding ESG building material. In AD 77 Pliny the agricultural communities throughout the environmental, social and governance Elder describes in his Natural History middle ages, and survives to this day. (“ESG“) considerations and questions how broken pottery “beaten to powder, how each economic activity contributes and tempered with lime, becomes more What is new about sustainability in our to human welfare for current and future solid and durable than other substances age is the consistent application of generations. Typical aspects taken into of a similar nature; forming the cement these concepts to investment strategies consideration are the protection of known as the “Signine“ composition, so and the elevation of sustainability to an human dignity, the observance of certain extensively employed for even making investment theme which, as we will see, labour and environmental standards as the pavements of houses“. Fragments is being articulated in many different well as the aforementioned cautious use of recycled amphorae have been found ways. The starting point is the realization of resources. in aqueducts and roads, revealing that a that any sort of investment can have considerable part of ancient Rome was unintended side effects, therefore It is important to differentiate between built on the basis of recycled materials, to investments are not ethically neutral. As sustainable investment strategies a degree far exceeding what is achieved an example, even if a certain investment and philanthropy. The latter consists in this regard in our times. However, pursues a worthy goal, it may use up of donating funds to a worthy cause the technique for reusing second-hand resources that need to be preserved without any expectation of financial amphorae predates even the ancient for future generations. Similarly, it is gain. Hence, philanthropy by definition Romans; it is known to have originated in important to take into account what is not an investment strategy, it is a North Africa some time before 256 BC. is known as the externalisation of form of charitable giving. The present costs, i.e. the effects of an economic report focuses exclusively on investment As the Brundtland report suggests, at activity on third parties, who may suffer strategies, defining sustainable its heart sustainability is the pursuit from its negative side effects without investments as a pursuit of one or more of a healthy balance between short- participating in the financial return of the following objectives: 1) achieve term profit and long-term preservation that is being generated. We therefore a positive environmental or social of resources. Intuitively, mankind has understand sustainability not just as the impact alongside financial returns; 2) known this and for a long time. Shared pursuit of noble goals but also as the align investments with personal values; ownership of grazing fields that are appreciation of the direct and indirect and 3) improve portfolio risk/return subject to strict guidelines to prevent effects of an investment on other people characteristics. In short, sustainability future depletion of the soil‘s nourishing and on the environment. To this end, can be defined as a fundamental step properties has been common in sustainable investing encompasses beyond philanthropy. 02 Defining sustainable investment Environmental, social, standards, such as the production governance aspects of chemical weapons, or business Roughly speaking, we differentiate practices such as child labor, to quote between environmental, social and two prominent examples. Of course, the governance goals when talking about definition of what is ethical is subjective sustainable or responsible investments, and can vary between countries, cultures hence the acronym “ESG“ which has and people. However, roughly speaking imposed itself as the most common “ethical“ investment is commonly term in this regard. At the most basic understood to involve the protection of level, social and ethical responsibility human dignity and the abstention from means an abstention from involvement practices that are detrimental to human in any industry or product line that is and societal welfare. The most common either harmful, i.e. polluting or unhealthy implementation of this approach is via in other ways, or not up to ethical an investment portfolio that filters out Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined herein. Past Performance and forecasts are not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved. Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect. CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 4 CIO Insights Special Act today to ensure our future – Understanding ESG securities linked to companies that don‘t fulfill these standards. Specialised Figure 1: analysts research the product mix ESG: An acronym with many meanings and the business practices of each A wide range of approaches and goals corporation in the investable universe Source: Schroders, Deutsche Bank Wealth Management. in order to rank them according to a set of criteria, with the aim of assessing Top down, issue driven their social, ethical and environmental impact on society and nature. Thus, an overlay can be created that filters out any security that doesn‘t fit in with Thematic these standards, obtaining an equity or investing bond portfolio that can be certified to be consistent with the desired conditions. Screened This approach represents the entry investments ESG level of responsible investing because Integration it merely excludes irresponsible or unethical practices, rather than being Governance an active quest for making a positive and active contribution to society. While it still is ownership Social benefits Performance benefits the most common approach to ESG (value) (value) investing, exclusion policies don‘t represent the main object of this paper, Best-in-class responsible as we are more interested in discussing investments investment strategies that aim to make a positive impact by pursuing Impact worthy causes rather than by excluding investing unworthy ones. One level up from exclusion policies there is the active approach: instead of thinking in terms of exclusions, it thinks in terms Bottom up, company driven of which investment opportunities can be found that make a positive contribution to society while at the same time ethical and socially responsible principles or the social context it operates in, and generating positive returns. The key can be applied, namely corporate the more it pursues long-term goals in to making a positive contribution is to governance. Even when a public harmony with its environment, the more identify promising but untapped areas listed company is not involved in any sustainable its revenues are likely to for sustainable development that are business or product line that may offer be in the long term. This is the concept currently overlooked, or whose potential potential for improvement in terms of the “going concern“, the long-term is not sufficiently appreciated by existing investment strategies. This implies a certain degree of risk that is inherent At heart, sustainability is the pursuit of a healthy in any innovative initiative, but at the same time offers the chance to develop balance between short-term profit and long-term revenue generating markets or business sectors that benefit all the stakeholders preservation of resources. along the value chain. A typical example is microfinance, which has exploited the innovative potential of applying a tried and tested business model (start-up financing) to a previously overlooked of ethical or social responsibility, the commitment to keep the company out of market, i.e. self-employed farmers and way in which the corporation itself is trouble by adopting a long-term vision artisans in developing countries with no governed matters a great deal, both in about its business practices, the sectors access to mainstream financial service terms of business ethics and in terms it operates in and its staff. Included is a providers. of the sustainability of its revenues. The commitment to acting in the best interest underlying assumption is that the more of all stakeholders of the company, Apart from these visible implementations an enterprise abstains from short-term shareholders, staff and customers, in there is another, subtler area where gains at the expense of the environment a way that assures meeting the long- Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined herein. Past Performance and forecasts are not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved. Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect. CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 5 CIO Insights Special Act today to ensure our future – Understanding ESG term requirements of each. Investment meaningful percentage of voting rights regardless of the industry or business managers who specialise in analysing in the shareholder assembly have the sector in which the company operates. the corporate governance of public clout to actively influence a company‘s An easily overlooked but important part listed companies can identify practices management board, thereby being of this is the avoidance of regulatory and principles that promise to ensure able to steer key corporate decisions in sanctions, reputational damage and long-term value creation independently line with certain principles of socially lawsuits that a socially responsible of which business a company is in, responsible corporate governance. and sustainable approach to corporate unlocking value for investors that is Again, this offers the opportunity to governance is meant to facilitate. not visible otherwise. Additionally, unlock shareholder value in line with large investment funds that control a a sustainable investment approach, Figure 2: ESG keywords categorized Source: MSCI ESG Research, Sustainalytics. Hazardous waste management Human capital management Anti-competitive practices Board structure/size Biodiversity/land use Fair trade products Employee relations Labour management Water management Anti-takeover measures Working conditions Ownership structure Business ethics Responsible marketing and R&D Shareholder rights Biodiversity programmes Advertising ethics Weather events Clean technology Corruption and instability Supply chain management Anti-money laundering policy Gender diversity of board Green buildings Community relations Union relationships Environmental Social Governance Corporate governance Customer relations/product Diversity and discrimination Employee safety Carbon emissions Accountability Energy efficiency Climate change risks Executive compensation schemes Recycled material use Controversial business Compensation disclosure Product safety Anti-bribery policy Bribery and corruption Waste and recycling Diversity issues Raw material sourcing Regulatory/legal risks CEO duality Energy usage Human rights policy Health and safety Natural resource use Transparency Voting procedures Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined herein. Past Performance and forecasts are not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved. Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect. CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 6 CIO Insights Special Act today to ensure our future – Understanding ESG 03 The expectations of investors and the main investment vehicles Time to shake off the nefarious effects on the environment that Figure 3: perceptions of the past persist to this day. Another prominent A willingness to invest for longer in ESG In the past, ESG approaches have all example was the oil spill of the tanker investments too often been seen as compromising Exxon Valdez in 1989 that lead to the Confirming our focus is right returns and standing in the way of spillage of over 40 million litres of crude Source: Schroders Global Investor Study, profit maximisation. In this view, ESG oil into the pristine waters of Alaska in conducted between 30 March and 25 April investments are considered to be one what represents the region‘s most tragic 2016. step away from charitable donations, a environmental disaster in history. More sort of hybrid between investment and recently, an altogether different scandal philanthropy. The fact that foundations has served to highlight that it is not just and churches have been early adpoters the environment and local populations of ESG-based investment strategies has that can suffer from a lack of proper only reinforced these views. However, corporate governance but also the these views no longer correspond to investors themselves, independently of reality, if they ever did. Far from being where they are based. The bankruptcy a contradiction to positive investment of Enron in 2001, a once highly regarded 3.2 years returns, as mentioned above, ESG American blue chip stock, wiped out the average period consumers usually strategies offer the potential for billions of equity and debt holdings leave money in an investment (excluding unlocking otherwise untapped value within a few days for reasons that can property and pensions) while at the same time helping to achieve be attributed directly to grave faults in more sustainable, long-term revenue corporate governance and oversight. flows. Additionally, these strategies This case has highlighted the benefit enable investors at the very least to of corporate governance in reducing avoid financing business practices they portfolio risk: well-governed companies don‘t agree with, and possibly to make a are less likely to cause bad surprises positive impact on society by achieving for investors because financial and particular ethical goals or improve human reputational problems are harder to hide welfare, all while generating positive if corporate oversight is strong. returns on their invested capital. The 2.1 years spectrum is very broad and deserves Changes in the attitudes and the average number of additional years more detailed analysis. the expectations of investors, that investors would hold ESG investments including demographic compared to standard investments Historic milestones changes. Before delving into the matter further, There are additional factors that have it is worth looking at investors‘ helped ESG considerations become expectations and opinions on the subject. more popular among investors. On the During the 1980s, a succession of high one hand, growing levels of investor profile corporate disasters made the education in financial matters have public aware of the risks associated increased the willingness to be actively with lack of discipline in environmental involved in financial decisions by people and governance standards. Some of who in the past may have been happy the most dramatic cases include the to delegate these entirely to their 82% disaster in the Indian town of Bhopal that advisers. Secondly, institutional investors of investors said they would hold an ESG happend in 1984, when 40 tons of highly have become more concerned about investment for longer than a standard toxic chemicals leaked out of a factory sustainability in a way that mirrors the investment owned by Union Carbide, with deadly general shift in attitude from the sole consequences for the population and quest for “quantity“ in the post-war Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined herein. Past Performance and forecasts are not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved. Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect. CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 7 CIO Insights Special Act today to ensure our future – Understanding ESG economic expansion to the aim for “quality“ in growth that can be observed Figure 4: in all aspects of society and that goes Motivation for social impact investing among respondents who own or are hand in hand with rising prosperity. interested in owning1 Additionally, public opinion surveys 1 2016 U.S. Trust Insights on Wealth and Worth – Annual survey of high-net-worth and keep showing a growing interest in ultra-high-net-worth Americans environmentally and socially responsible investments by younger generations, even though these surveys need to be 40% taken with a pinch of salt because an Believe companies that interest to invest ethically and actual are good corporate 53% investments into ethical vehicles are citizens are less susceptible two rather different things. Moreover, as to business risks Belief that corporate America 38% should be held accountable the “millennial“ generation is just about for its actions Believe companies entering adulthood, in aggregate it will that have a positive take decades to acquire the investible impact have better financial performance assets needed to have an impact on financial markets similar to the clout of 50% the current “baby boomer“ generation, except in those cases where the younger Strong feelings for certain social, environmental or generations are the recipients of governance issues inheritances in the shape of liquid assets, 49% 54% a trend that acccording to actuarial studies is set to increase. Want to make a positive It’s the right thing to do impact on the world Another reason that drives the search for sustainable investment products is the sheer growth of the world population that forces us to look for new ways to limit the population‘s impact on the planet. Feeding more people requires an increase in food production which, other things being equal, requires more agricultural land, more displacement of native plants and animal species and more pollution. Similarly, the rapid advancement in living standards causes more and more people Figure 5: to live in metropolitan areas, especially in How important are each of the following ESG issues to your choice of emerging Asia, which in turn confronts investments? (Scores out of 10) humanity with new environmental Source: Schroders Global Investor Survey (2016) - Global Consumers. challenges. 5 Concerns about global warming 4 6 represent yet another pillar of environmentally sustainable investment, especially in view of governmental 3 7 targets for limits to CO2 production and for a containment of raising temperatures. A final pillar in this 2 ctgcAatRfioooosvogi spnmevrtekhee etnr menecRricsxn eteWeykstmwn p s iiiosnta neoi rnb bn rtSlmthd lytt,eese e oiE tc n erahrstcme nrieh2ooe e sdi0nGnf r aet1oog e 5dtf7fmyrar v m dioitwmoilchem.ac h psrIFann eicfacot deorEichrni esbtuon gs meeamuvi.dlsn ita Tr‘, e dsoo nthanh nfyGtcee e wmtc lrhsgogooeeeubry n odeat tousli nptt g 1 ood corporate governaoond reccored of social rosietives imppoacnt soin btilhiositeitv e iyemnpavictr oonn lositiomve cieamlnp tascot coina l b1ro ou2tacdloym3-beass4ed s5ocia6l ou7tco8m9es 8 9 of the top five risks in terms of likelihood 0 G G P P P 0 10 10 Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined herein. Past Performance and forecasts are not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved. Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect. CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 8 CIO Insights Special Act today to ensure our future – Understanding ESG are considered to be environmental. For instance, one firm that invests in and still partly untapped. Moving away pollution-reducing technology may from stocks and bonds, the investment The investment vehicles at the same time own a division that vehicles become rather less liquid. Intituitively, most investors think itself constributes to pollution. Bonds, Private equity is a form of investment of equities when considering ESG on the other hand, can be issued in a that is extremely well suited to targeted investments. In the past, it was indeed much more targeted way, as they can be ESG aspects thanks to its flexibility. the case that the bulk of sustainable directed at financing specific projects or However, it is by definition illiquid and responsible investment strategies specific market niches without carrying and hence not suitable for all types of focused on equities, especially within the “baggage“ of a complex enterprise investor, at least as a direct investment. exclusion strategies. Even now, much with them. Additionally, the yield of a It becomes more accessible if it is of the attention of rating agencies bond can be linked to an infinite range offered as a fund on which a financial that focus on assessing companies‘ of criteria, indices and ventures so as to service provider guarantees a certain adherence to ESG standards and the allow targeting fixed income instruments level of liquidity. On the other side of sustainability of their business practices very specifically to certain endeavours the spectrum we are seeing growing think in terms of the equity market. in a way that is not possible to do with numbers of Exchange Traded Funds However, a listed company by definition equities. The use of ESG filters on bond (ETFs), which represent the most liquid tends to be a large entity, which is investments, possibly also mapping and most tradable type of mutual fund, inevitably involved in more than one sovereign issuers, completes the picture specializing in ESG investments. While single project and often in more than for ESG-conscious investors, giving for the most part these funds pursue a single line of business. Indeed, most them the possibility to choose integrated exclusion strategies, it is to be expected well-known stocks, especially those and balanced approaches according to that over time these retail investment included in the main market indices, their individual risk profiles. This step vehicles will be able to move into more are complex creatures whose impact represents the coming of age of ESG active and more targeted types of ESG on the environment and on society is investments. investment, making the sector more wide-ranging, making it difficult to pass easily accessible to private investors. a judgement on the contrasting positive The potential of fixed income instruments and negative types of impact they have. for ESG investments is therefore vast Figure 6: Top 5 Global Risks in Terms of Impact Source: World Economic Forum “The matrix of top 5 risks from 2007 to 2017”. 1st 2nd 3rd 4th 5th Failure of climate Weapons of mass Extreme weather Major natural Water crises change mitigation destruction events disasters and adaption 2017 Extreme energy Major systematic Chronic financial Water supply crises Food shortage crises and agriculture financial failure imbalance price volatility 2012 Retrenchment from Interstate and Asset price collapse Pandemics Oil price shock globalization civil wars 2007 Environmental Economic Geopolitical Societal Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined herein. Past Performance and forecasts are not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved. Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect. CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 9 CIO Insights Special Act today to ensure our future – Understanding ESG 04 The five levels of ESG approach Exclusions each other, rendering them mutually As mentioned before, exclusions exclusive: either one chooses the original represent the entry level of ESG investment strategy at the cost of owning investment, being the simplest way to a portoflio that rewards unsustainable implement ESG criteria in a portfolio. At practices, or one has a sustainable the most basic level, an exclusion policy portfolio at the cost of reducing the takes any existing portfolio and filters expected return. Investors who find out securities linked to companies that neither of these two options appealing don‘t conform to a certain set of criteria, are better served by one of the following be it ethical or environmental concerns approaches to sustainable investments. or issues linked to lack of sustainability or corporate governance. Firms involved Adherence to norms in the arms trade or judged to have This is a standardized way of unethical labour standards are typical constructing a portfolio based on targets for exclusion. However, this companies‘ adherence to a set of approach suffers from two flaws: one is industry standards and norms such financial, one is conceptual. The financial as international “SRI“ guidelines and flaw is that any existing investment the United Nations principles. It is a portfolio is inevitably going to be “positive“ approach to ESG investing because the portfolios are built according to ESG criteria from the start, rather than being an overlay to an existing The sheer growth of the world population forces strategy. On the plus side, taking well- known norms as criteria for the inclusion us to look for new ways to limit the population‘s into the investment portfolios allows for transparency and consistency. On impact on the planet. the other hand, restricting oneself to such norms as the only criteria for defining the investment universe limits the choice of investable securities to compromised by removing a certain part those of generally larger companies that of its investment universe, for certainly have taken the trouble to be certified by each security was included in the first official agencies and institutions. While place for some good reason. In the case this approach can lead to good results, of passive strategies that track a market its shortcoming is that smaller companies benchmark, taking out certain securities for whom a formal certification is too will increase the portfolio‘s tracking onerous or simply too laborious will error. Conceptually, the flaw is that it‘s be missed out. Given that small and a negative approach to ESG criteria: nimble companies are often the most one tries to do good not by adding to interesting players in terms of innovative the investment process but by taking approaches to sustainability, this matters. away from it. Merely eliminating certain Further, while official norms have a companies from the investment universe role to play in the standardization of does not represent an active approach minimum requirements and best practice to sustainability, nor is the underlying benchmarks, an approach that is tilted message a constructive one: there is no towards “box ticking“ will always be most reward for exemplary corporate behavior, useful in defining a basic level from which just the exclusion of the companies to start, rather than the goal to aspire deemed unethical, a much weaker to. Further, some market participants approach. Finally, the exclusion strategy fear that an eccessive reliance on formal pits ESG and return criteria against criteria may stifle the momentum of Note: All opinions and claims are based upon data on November 6, 2017 and may not come to pass. This information is subject to change at any time, based upon economic, market and other considerations and should not be construed as a recommendation. There can be no certainty that events will turn out as we have opined herein. Past Performance and forecasts are not reliable indicators of future performance. No assurance can be given that any forecast or target will be achieved. Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis which may prove to be incorrect. CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: [email protected] 10