sustainalytics: 10 for 2015 executive summary

8/9/2019 Sustainalytics: 10 for 2015 Executive Summary

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10 for 2015:

Generatingvalue

in a fragile market Executive Summary

January 2015

Thematc Research


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About SustainalyticsSustainalycs supports investors around the world with the development and

implementaon of responsible investment strategies. The rm partners with

instuonal investors, pension plans, and asset managers that integrate environmental

social and governance informaon and assessments into their investment decisions.

Headquartered in Amsterdam, Sustainalycs has oces in Boston, Bucharest,

Frankfurt, London, New York City, Paris, Singapore, Timisoara and Toronto, and

representaves in Bogotá, Brussels, Copenhagen and Washington, D.C. The rm has

200 sta members, including more than 120 analysts with varied muldisciplinary

experse and a thorough understanding of more than 40 industries. In 2012, 2013

and 2014, Sustainalytics was voted best independent responsible investment

research firm in the Extel’s IRRI survey.

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January 2015 10 for 2015

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Executive SummaryGenerating value in a fragile market

Analysts

Dr. Hendrik Garz

Managing Director, Thematic Research

[email protected]

Doug Morrow

Associate Director, Thematic Research

[email protected]

Thomas Hassl

Analyst, Thematic Research

[email protected]

Key TakeawaysMacro picture – short-term stability, but at what cost?

With the ECB’s EUR 1.1trn quantitative easing programme, financial and economic

imbalances are aggravated, and the risk of a new financial crisis has increased.

The economic and social costs of a new financial crisis could outstrip those of the

last one and may trigger fundamental systemic discussions.

Investors do not have many options to hedge themselves, due to already existing

or newly emerging bubble situations in many asset classes.

The “good news” is that investors can expect that the situation, which is

unsustainable over the mid- to long term, will probably be sustained over the

short term. The slump in oil prices might lead to a positive growth surprise, which, ironically,

may exacerbate systemic risk when put into the above context.

The oil price drop has further lowered the probability for achieving a multilateral

climate agreement at the COP21 conference in Paris in December.

Generating value at the asset selection level in a fundamentally unsustainable

market environment is more than challenging, but analysis through an ESG lens

may assist in this process.

Micro picture – finding value through ESG?

We present 10 forward-looking company stories where ESG factors may have

material impacts over both the short and long run. Our analysis supports a positive view of Intel, GlaxoSmithKline, Lafarge and

Holcim, Telenor and Pemex, with value drivers ranging from innovative

remuneration models and energy efficiency programmes, to human rights policies

and health and safety improvements.

We take a generally negative stance on DuPont, Lonmin, National Commercial

Bank, Coca-Cola and, to a lesser extent, Netflix, which faces important corporate

governance challenges despite beating analyst expectations for Q4 2014.

Our analysis can be used to supplement existing security selection models,

through tilting and other measures, or inform new investment strategies.

From asset allocation to asset selectionForward-looking, scenario-based

approach

As the Danish physicist and Nobel laureate Niels Bohr once famously remarked,

“prediction is very difficult, especially if it’s about the future.” We could not agree

more. Hence, in this report we take the approach of discussing possible scenarios for

the global economy and their implications from an ESG perspective. In addition, we

provide a dedicated Asian view regarding the economic background and ESG trends in

the region.

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In the spirit of a top-down approach, we finally shift from the asset allocation focused

macro view to the asset selection micro view by presenting 10 company stories to

watch in 2015, taken from our core coverage universe of roughly 4,500 corporates. In

our view, all of these stories address key ESG issues that are likely to have a material

impact on companies from a business perspective. Our portfolio of ideas contains

stories from different regions and sectors and is well balanced, providing five storieswith a positive tilt and five with a negative tilt.

Macro View – Sustaining the unsustainable

Quantitative easing – The silver bullet to save the Euro?Is a new financial crisis looming on the

horizon?

Financial markets seem to be torn between hope and fear these days. Apparently, the

new historic highs for equity markets are not the result of conviction and confidence

on the part of investors, but rather appear to signal the lack of investment alternatives

and the hope of prolonged expansionary monetary policy. In this chapter we take a

look at the possible consequences of the recently announced quantitative easing (QE)

programme of the European Central Bank (ECB). We conclude that this programme is

trying to sustain the unsustainable, and that investors do not have many options to

hedge themselves, due to already existing and exacerbated or newly emerging bubble

situations in many asset classes. We also reflect on the possible default of Greece and

the risk of a breakup of the Eurozone becoming more tangible in 2015. Furthermore,

we elaborate on a contrarian, thought-provoking scenario that assumes an oil-price-

induced positive growth surprise and describe how this could eventually lead to a new

financial crisis with social unrest as a possible consequence.

Fixed income markets – When will the bubble burst?

Source: Robert J. Shiller (2015)

Pondering the consequences of a “lower

oil price world”

Oil price drop – A double-edged sword for the global economy

Last but not least, we ponder the consequences of the new “lower oil price world” and

the current economic and political environment for the climate negotiations that will

culminate at the end of the year with the COP21 convention in Paris. We have doubts

that the odds are good to achieve an effective multilateral consensus. In the absence

of political leadership, we expect the focus to shift to companies and private

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households, which will be moving ahead with climate-friendly technologies based on

economic self-interest.

Crude oil price history (1930 –2014) – The pendulum is swinging back

Source: Bloomberg

Investment implications – Some easy wins

As ESG analysts, we have neither the mandate nor the inclination to give

comprehensive investment recommendations. This is simply not our job and is done by

others. However, the macro picture we outlined above certainly has some obvious

implications at the strategic and tactical asset allocation level.

Don’t divest from high-quality fixed

income instruments too early, and don’t

overweight Oil & Gas or Banks

We draw four basic conclusions: (1) Investors are probably well advised not to divest

from high-quality fixed income instruments as long as there is hope that the QE

programme is going to work and uncertainties around Greece and the Ukraine conflict

prevail, despite the massive bond bubble they are sitting on. (2) The risk profile of

equities seems to be still attractive only if the oil price continues to show weakness and

as long as the crisis situations in Greece and the Ukraine do not completely get out of

control. (3) At the sector level it is clear that a low or even further-falling oil price and

a new financial crisis situation certainly do not invite investors to overweight Oil & Gas

and Banks in their portfolios. (4) Over the mid- to long term, the financial risks for

investors are high and cannot be fully hedged, due to the bubble situations that have

been emerging in many asset classes and the empirical fact that asset prices tend to be

positively correlated in down-market situations. Should markets turn into crisis mode

again, cash will certainly be king, but negative overnight rates may well become the

rule, not the exception.

The Asian View – Modest growth, high vulnerability

China’s soft landing and another round of

“Abenomics”

Overall, we do not expect Asia to become the world’s growth engine in 2015. Economic

momentum in China is likely to ease further due to continued structural reforms and

efforts to slow credit expansion. For Japan, we expect another round of “Abenomics”,

after the renewal of the prime minister’s mandate in December’s elections. A

continued aggressive monetary easing and fiscal stimulus will probably at least avoid

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Crude Oil Price (nominal) Crude Oil Price (real) S&P 500


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Japan drifting into the much-feared deflationary downward spiral. On the other hand,

growth in India is expected to recover further in 2015 from historically low rates in the

years before.

ESG perspective – A mixed bag

With regard to these three countries’ ESG agendas, we expect a focus on bribery and

corruption (China and India), measures against anti-competitive corporate behaviours

(China), air pollution and water risk in India, and nuclear safety and the building up of

a renewable infrastructure in Japan. We also expect China and India to uphold the

principle of “common but differentiated responsibility” in international climate

negotiations. For Japan, we foresee that the new Stewardship Code will make listed

companies more active in incorporating ESG factors into their business practices.

10 for 2015 – A platform for ESG analysis

The value-add of ESG analysis If our global and Asia-specific macro views form the basis of our conviction for asset

allocation, the 10 for 2015 move further into the investment process and provide

insight into asset selection. Covering eight countries and ten industries, the 10 for 2015consist of ten salient mainstream business stories where ESG factors can be shown to

be driving potentially material financial impacts. Our analysis exemplifies the type of

enhanced risk and opportunity identification that is increasingly being used by

investors to either supplement existing security selection models or inform new and

innovative standalone investment strategies. In the table below and the summaries on

the next page, we outline the key findings of our assessment.

Our analysis supports a positive view of Intel, GlaxoSmithKline, Lafarge and Holcim,

Telenor and Pemex, with value drivers ranging from innovative remuneration models

and energy efficiency programmes, to human rights policies and health and safety

improvements. We take a generally negative stance on DuPont, Lonmin, National

Commercial Bank, Coca-Cola and, to a lesser extent, Netflix, which faces important

corporate governance challenges despite beating analyst expectations for Q4 2014.

Companies cover ten industries, eight

countries and include a balance of

positively and negatively tilted stories

Company overview

Source: Sustainalytics


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Impact DuPont. We take a contrarian view and argue that the company’s busines s model in

the African seed market may be misaligned with the needs of smallholder farmers. We

also suggest that DuPont’s focus on a limited array of hybrid seeds could contribute to

biodiversity loss and Monsanto-type reputational risks for investors.

Negative

Impact Intel. We present a favourable review of Intel’s plan to build a “conflict-free” supply

chain by 2016. While we question whether Intel’s customers will be willing to pay more

for conflict-free electronics, we are intrigued by the possibilities for brand building.

Positive

Impact GlaxoSmithKline. We acknowledge that groundbreaking changes to the company’s

sales representative remuneration strategy may drag on short-term profitability, but

believe that they will help the company rebuild regulator and investor trust in the wake

of a record bribery charge in China.

Positive

Impact Lafarge and Holcim. We are bullish on the proposed merger of the world’s two largest

cement manufacturers, pointing to potential ESG synergies in energy and GHG

performance, as well as improved positioning in the growing market for sustainable

building materials.

Strongly positive

Impact Lonmin. We analyse the company’s exposure to the findings of the Marikana

Commission (expected in March 2015) and take a strongly negative stance, arguing that

the repercussions could range from reputational and brand effects to short-term

pressure on the company’s share price.

Strongly negative

Impact National Commercial Bank (NCB). We review the opening of Saudi Arabia’s equity

markets to foreign investors (beginning in 2015) and NCB’s attractiveness as a vehicle

to play the market for Shariah-compliant financial products and services. We highlight

risk factors related to NCB’s governance and project finance activities.

Negative

Impact Telenor. We find that the company’s advanced ESG practices may provide a hedge

against country risk in Myanmar, and argue that the lessons learned could potentially

be leveraged in future expansion to emerging markets in Sub-Saharan Africa.

Positive

Impact Pemex. While we question the extent to which the recent slump in oil prices may

discourage foreign investment in Mexico’s newly liberalised energy sector, we argue

that interaction with the world’s oil majors may ultimately lead to improvements in

Pemex’s health and safety performance and exposure to corruption issues.

Positive

Impact Coca-Cola. We show that the company’s recent entry into the energy drinks and milk

niches creates new and potentially under-appreciated ESG risk exposure. We gauge the

company’s strategic awareness of these risks to be low, although we find some pocketsof optimism.

Negative

Impact Netflix. We paint a picture of substantial shareholder discontent, pointing to corporate

governance challenges, including a non-responsive board of directors. We argue that

investors will be faced with a difficult choice if a takeover offer emerges in 2015, as

they have been largely rewarded to date for sticking with the board’s strategy.

Negative


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Thematc Research

sustainalytics: 10 for 2015 executive summary

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