ESG: coming into the mainstream May 2017

ESG and related types of investing are slowly but surely coming into the “To ignore ESG factors is to ignore risks and mainstream. Socially responsible investing (SRI), which involves screening out based on certain criteria, has been available for decades opportunities that have a material effect on the but investors are increasingly moving to a more nuanced approach of returns delivered to clients and beneficiaries.” integrating qualitative ESG considerations into analysis. Principles for Responsible Investment (PRI) The ESG approach aims to accurately identify the intrinsic risks and opportunities that an asset has to offer. ESG analysis differs from SRI, which aims to generate financial returns This note defines the many terms in this space and explains what has without compromising the investor’s personal values and preferences. driven the rise of ESG and SRI. The second part outlines Aberdeen's With SRI, the investor typically specifies screens that exclude companies, process for integrating ESG factors into our investment analysis across sectors or funds that are deemed controversial or unethical. Such asset classes, a key element of our stewardship approach. negative screening can exclude companies involved in areas such as munitions, alcohol, and tobacco production. Positive (or best-in-class) Defining terms screening is also possible where investors actively seek out companies that exhibit leadership in environmental conservation, employee policies, According to the United Nations, responsible investment is an approach that aims to incorporate environmental, social and governance (ESG) business ethics and other areas. factors into investment decisions, in order to better manage risk and aims to have a measurable and defined social or generate sustainable, long‑term returns. environmental benefit, alongside financial returns. It is based on the ESG is the identification of environmental, social and governance factors idea that the private sector can provide much needed innovation that have the ability to materially impact the financial prospects of an and resources to help efforts to solve global environmental and investment. When considered alongside standard financial metrics, ESG social challenges. focuses on a particular theme, forms part of a holistic understanding of an asset’s true value. like renewable energy, or social housing. Green investing meanwhile seeks to invest in environmentally conscious ESG issues cover a broad range of areas, some of which are: companies or business practices. The term is usually used in relation to Environmental bonds. For example, governments can issue green bonds that generate Carbon emissions, energy efficiency, biodiversity and land use, toxic revenue to fund conservation of natural resources, development of waste and emissions, clean technology and renewable energy renewable energy sources, or clean air and water projects. The market for green bonds is expanding rapidly – issuance in 2016 was around $93 Social billion, double that of 2015. Treatment of stakeholders, supply chain, employee training, talent retention, health & safety, product safety and privacy and data security Governance Company ownership, board structure and independence, executive compensation, business ethics and corporate culture

01 of 08 ESG: coming into the mainstream - May 2017 Why all the fuss? Concurrently, awareness of social and environmental issues is gaining ESG and SRI have been gaining international prominence in recent years. traction for various reasons. The United Nations’ 17 Sustainable According to the Global Sustainable Investment Alliance (GSIA), assets Development Goals to be met by 2030 agenda define global development invested in funds integrating ESG factors and applying SRI screens rose to priorities and aspirations. The establishment of the PRI was instrumental $22.89 trillion globally at the beginning of 2016, up 25% from the start in underlining the importance of integrating ESG principles in investment of 2014. In the U.S., assets under management in SRI funds grew to $8.7 management. The 2015 Paris climate agreement (COP21) helped to trillion, up 33% since 2014. unite the global response to the threat of climate change and will lead to significant reduction in carbon emissions. This sets a challenging Recent news stories underline the growth of ESG and SRI: regulatory backdrop for businesses around the world to adhere to. • “Over 95% of private equity investors believe their company National regulators and governments are increasingly focusing on portfolios contain significant untapped ESG opportunities, how appropriate and transparent governance structures can support according to a recent survey by global environmental a higher degree of integrity and ethical behavior. In some countries consultancy ERM.” Environmental Resources Management (ERM), (particularly in Europe), an increasing focus on corporate stewardship is March 2017 a central part of the public policy agenda. Corporate governance failures (like the Volkswagen emissions scandal) and concerns about rising • “The Swiss responsible investment association, SVVK-ASIR, has inequality in executive pay have driven ESG issues further up the agenda. identified 15 arms companies its members – major Swiss pension funds – should not invest in.” Investment & Pensions Europe, March There is also growing acceptance that incorporating ESG factors is a 2017 key element of investment analysis and therefore an integral aspect • “The HSBC Bank UK Pension Scheme has selected a multi-factor of investment managers' fiduciary duty to clients. Funds increasingly fund with a tilt towards low-carbon businesses as the equity need to actively integrate ESG considerations into their investment component of its default offering, a switch that will see £1.85bn of processes to be considered for pension mandates, particularly in Europe. defined contribution savers’ money invested in line with Many investment managers are marketing their knowledge of ESG factors green principles.” Pensions Expert, November 2016 and launching funds for competitive advantage. To stay competitive, asset managers have to respond to this trend.

02 of 08 ESG: coming into the mainstream - May 2017 Scandinavia has historically led the way in ESG integration and SRI Aberdeen’s stewardship approach investing, followed by Australia, the UK and Canada. The U.S. and Asia are ESG, SRI and thematic investing all sit within Aberdeen’s stewardship also starting to integrate ESG into investment decisions and apply SRI approach, which outlines the fiduciary role that we play as guardians of type criteria, but it will take time to fully develop in these regions. clients’ money. ESG is a key element in stewardship (which also includes From an investor perspective, millennials (the generation born between engagement and proxy voting). ESG integration focuses holistically on the 1982 and 2004) and women are driving much of the demand for ESG and intrinsic risks and opportunities of our investments and thereby helps us to SRI. Women already control over 50% of U.S. household wealth with better understand the quality of an asset, along with its key concerns. that proportion increasing, while millennials are set to inherit trillions of We may find that an asset has material risks with regards to governance, dollars in the coming decades. cybersecurity, labor standards, or even bribery and corruption issues. By The rising prominence of ESG analysis is good for investors – it allows a better considering all the risks and opportunities that an asset offers, we can appreciation of the risks and opportunities of a company, and may even better understand its true quality, how much we should pay for it, how improve performance. For example, a 2014 study by Harvard Business School much of it we should put in our portfolios, and where to focus our long- and London Business School found that "high-sustainability" companies1 term engagement on. significantly outperform their counterparts in the stock market over the long- We also offer a variety of screened portfolios which help clients avoid term. Additionally, analysis from HSBC shows that ESG improvement drives investment in certain areas, such as tobacco, alcohol, weapons, child labor or price outperformance, especially in emerging markets. animal testing. Finally, we have the capability to create thematic portfolios tailored to clients’ needs. For example, if an investor wishes to focus their investments on a specific theme such as renewable energy or lower carbon footprints, then we can create custom products to meet this need. Aberdeen’s stewardship capabilities by asset class

Active equities Property Alternatives Multi-asset Quant2 Fundamental - focused Blends multiple sources of Bottom-up approach Primarily via external Unconstrained, open- Systematic investments on identifying high- value to diversify risk focussed on asset quality, manager allocations architecture universe across traditional quality companies not regional or sector beta, smart beta and Disciplined approach to allocations Fundamental analysis Combines long-term active quant Contrarian – disciplined determining fair value to find best-in-class strategy with short-term on price Risk-focused hedge funds, PE and real tactical opportunities Focus on efficient Avoiding losers asset managers portfolio construction, Active – act as co-owners as important as Local presence in all Top-down and bottom- disciplined rebalancing of businesses, not traders picking winners markets in which we Aims for consistent up analysis and risk management are invested returns through the cycle ESG ESG is a key element of ESG analysis embedded ESG factors a part of the Due diligence of Tailoring of portfolios ESG fully integrated into Integrated all analysis in fundamental in-house investment process underlying managers’ ESG to meet client systematic investment credit research considerations ESG requirements processes at both universe Holistic company risk Holistic risk assessment, construction and portfolio assessment carried out, ESG risks categorized including ESG factors ESG metrics feed decision- ESG based on underlying construction stages including ESG factors according to severity, making funds’ and managers’ allowing them to be priced Engagement with ESG policies Engagement on Engagement with appropriately alongside key stakeholders on governance issues through management on risks, other credit risks risks, improvement proxy voting improvement and and opportunities opportunities Value or ethically-driven Screening available across Not applicable Screening based on Screens in underlying Controversial weapons exclusions a wide range of criteria third party ESG dataset products can be and companies with according to client needs can be offered incorporated according severe controversies to client needs excluded from SRI screens investable universe Thematic investing can Thematic investing can be Funds or mandates can be Specific themes /sectors/ Specific themes /sectors/ SMARTER Beta™ be offered in line with offered according to client weighted towards specific issues in underlying issues in underlying capability includes ESG

Optional client demand needs sectors or issues, according products can be products can be Multifactor Equity Index to client needs incorporated according to incorporated according family, comprised of Focus on carbon exposure client needs to client needs multifactor ESG indices

Thematic and climate risk for global, regional and local markets

Source: Aberdeen Asset Management.

1 Defined as companies with a substantial number of environmental and social policies adopted for a significant number of years (since the early to mid-1990s). 2 This product is not currently available for U.S. investors.

ESG: coming into the mainstream - May 2017 03 of 08 Active equities For our active equity business, our bottom-up stock selection process is to pose a material risk. Desks operate independently, but each has a long-established. With general average holding periods of eight years or model portfolio that contains its best ideas, forming the basis for retail more, we actively prioritize long-term value for potential and ongoing or institutional portfolios. All ideas are shared via formal committees investments. We are committed to the very active role we play, behaving and common databases, with desk heads enforcing consistency across as owners of our investee companies. the Group. Our approach to stewardship is focused on materiality and understanding Corporate engagement the specific risks and opportunities a company faces – both financial and A hallmark of our approach is ongoing engagement. We aim to visit ESG – prior to making any investment decision and then in our ongoing companies in our core portfolios at least once before investing, and aim due diligence. to revisit annually. This means we can respond pragmatically to their Portfolios are managed on a team basis, with investment managers individual needs and seek to consider what is in the best interests of the doing their own research and analysis. Each team has a investment company and its shareholders at the relevant stage of its development. analyst who is responsible for carrying out a holistic risk assessment of a company, and engages with them directly on any issues that appear

Positive engagement at a mining company We engaged extensively with an international mining group with operations in Latin America and Asia. The group has experienced a number of material ESG-related risks over the past 18 months, including an increasing fatality rate, severe health and safety related accidents which have impacted local communities, and a failure to reduce its GHG emissions. The issues we discussed constituted key, material concerns for the company. Our conversations focused on reasons for the worsening safety record and we recommended steps the company can undertake to improve its record. We also discussed at length the company’s management of its individual sites and suggested ways to improve how risk assessments are undertaken at its locations. We pushed for greater oversight on material health and safety concerns, and importantly, stressed the need for the group to link its ESG-related targets to executive compensation. We believe the best way to ensure progress in these areas is to link compensation to the progress being made.

04 of 08 ESG: coming into the mainstream - May 2017 Invest in good quality companies at a sensible price Proactive company engagement We invest for the long term – and only in companies that we believe that Ensures our holdings remain or become better companies we understand and can value Ongoing due diligence Frequent dialogue • Business performance • Senior executives Company visit note • Company financials • Board members • Corporate governance • Site visits Step 3: Step 1: Quality Aberdeen universe Step 2: Valuation • Key risks and opportunities Portfolio Pass or fail? of stocks Cheap or expensive? construction

Revisit Watch list Monitor • Ownership structure • Price/earnings • Risk controls Exercise rights Consider all options • Business strategy • Price to cash flow • Model portfolio • Always vote3 • Buy, Sell or Fight • Management • Price to book • Portfolio ‘balance’ • Explain voting decisions • Seek to collaborate • Financials • ROE • Attend AGM/EGMs • Legal action, if necessary • ESG • Dividend Yield as required

Source: Aberdeen Asset Management. Source: Aberdeen Asset Management. “In 2016 we held more than 4,600 meetings with Devan Kaloo, the companies in which we invest and voted at more Global Head of Equities than 4,400 shareholder meetings worldwide.”

Fixed income Within fixed income, we examine the material risks of an investment across a for the issuer and therefore the investor. As with our equity holdings, we spectrum of issues, including traditional financial metrics, governance issues, look to engage actively where we believe this can add value. country- and industry-specific considerations, and environmental and social Aberdeen also offers clients SRI screening, which includes or excludes certain risks. These are all taken into consideration, using information from many issuers based on client-determined values or norms, and custom thematic different sources before an investment decision is made on behalf of clients. solutions to suit client-specific ESG requirements. These customized Our ESG approach is to examine factors which have a potential, material capabilities include ESG score-based products, benchmark comparisons, impact on the credit risk of the underlying investment. We assess how such as a comparison of issuers’ carbon footprint in relation to an index, and they are managed and mitigated, as well as the opportunities they create impact investing, in which an investor may target a specific issue or sector.

Two-level research process ESG Integration ESG risk assessments are included in our credit Credit research Level I research process Integration All Credit mandates Engagement Our Stewardship Center coordinates our Stewardship center engagement across asset classes

Level II Negative Lists Exclusion list No controversial weapons Screening and thematic investment Norm-based exclusions UN Global Compact compliance No violation of Principle 2: working against corruption

Score-based inclusions Best-in-class Only the top 50% of companies by ESG score

Benchmark comparison 150 tons of CO2 per USDM of revenue vs 500 tons Footprinting in the benchmark

Customised Thematic investment Use of proceeds Targeting outperformance in health and safety universe definition

Preparedness Investment strategy designed to mitigate energy Climate risk management transition risks

3 Shareblocking in Germany and Switzerland can prevent us from voting.

ESG: coming into the mainstream - May 2017 05 of 08 Aberdeen Low Carbon strategy Alternatives Interest in carbon approaches by countries, companies, individuals For our indirect investment teams, our first step is to understand and wider stakeholders is increasing. To meet this demand, we are how external asset managers integrate ESG considerations into their able to provide clients with portfolios which have a lower carbon investment analysis and decision making. Integrating ESG factors footprint than the benchmark, both in terms of carbon output and into this process can provide additional insight into the quality of a intensity. In this way, we can offer a solution which enables clients company’s management, its culture and risk profile as well as identifying to capitalize on the trend towards a low-carbon world. We currently opportunities for growth and improvement. It is therefore important not manage over $1.3 billion in a low-carbon fixed-income portfolio. only for value protection but also for value creation. In some cases ESG issues will have a limited impact on the potential risks Property or opportunities of an investment. However, particularly for less liquid If both direct and indirect environmental and societal impacts are well- private markets and our investments in less developed markets, these managed, we can reduce the portfolio risk of our property investments, issues can be meaningful in our assessment. This means that we have, achieving higher rental growth and occupancy rates. and will, make decisions incorporating metrics other than just financial ones, including not progressing with an investment on ESG grounds even In our property division, the consideration of ESG factors is integrated when on financial metrics alone we would have chosen to proceed. into each and every stage of our investment process – from allocation to selection and management. In private equity, research and due diligence is carried out to identify all material risks and opportunities – financial and ESG. We actively engage “Our approach is not just about saving carbon with General Partners (GPs) of underlying funds and ESG questionnaires and energy; it is about managing our risks and are issued to all GPs. We are refining our process to incorporate ESG key increasingly operational efficiencies to the longer performance indicators and crisis escalation processes. term benefit of building occupiers and ultimately Within hedge funds, our new manager due diligence process incorporates strict governance standards across a range of issues. There is ongoing our investors.” engagement with approved managers on further ESG adoption and ESG risk assessment. We can also customize strategies to incorporate clients’ ESG requirements. Dan Grandage, In our property process, ESG issues of underlying 4 Head of Responsible Property Investment property funds are assessed via data from GRESBC , an investor-driven organization committed to assessing the integration of ESG factors in investment processes and stock selection of real assets globally.

In addition to the full integration of ESG factors into the investment ESG within infrastructure differs from that of other alternative teams. process, we also offer thematic solutions to clients’ ESG needs in which Aberdeen Infrastructure Funds (AIF) focus on Greenfield social infrastructure portfolios can be weighted towards specific sectors or issues. (relating to schools, hospitals, water treatment facilities, roads and rail), rather than wider economic infrastructure (e.g. airports, ports, and utilities). Building a renewable data center When bidding for Greenfield projects as part of consortia, ESG policies and We have worked with key stakeholders, Nokia, and the city of Tampere, practices are part of the assessment criteria used by a government to select Finland to build a world-leading data center in the city, which bidders that it would be willing to award contracts to. minimizes energy consumption and monetizes waste. The data center AIF currently have no formal negative investment restrictions relating will buy its energy from the nearby Tammerkoski hydroelectric power to ESG. However, governance is a key consideration in the investment plant, and coupled with solar panels on the roof, will produce 10% of process, and any environmental issues likely to impact value are the energy required to power the plant. The cooling is solely powered evaluated. Aberdeen has the ability to influence ESG outcomes because by renewable energy sources through district cooling. Rather than it takes substantial direct equity positions and appoints directors on considering the resultant heated water as waste, the plant will enable investee company boards. When it comes to managing investments it to be sold back to the city of Tampere for district heating of homes infrastructure seeks to ensure that governance has an appropriate level of and hospitals. Nokia has calculated that if all such centers around priority within the policies and strategies of its investee companies. the world worked as efficiently as their facility in Tampere, the global energy savings would be equal to the amount of power produced by 100 nuclear power plants.

4 Global Real Estate Sustainability Benchmark.

06 of 08 ESG: coming into the mainstream - May 2017 Integrating ESG in private equity In 2016, Aberdeen completed a co-investment into Ethypharm, an integrated pharmaceutical company providing complex generic and speciality pharma products across the globe, alongside Pan- European sponsor PAI Partners. Given the nature of the business and its global reach, ESG was an important consideration for management and incoming investors from PAI and Aberdeen.

Quantitative investments Multi-asset At Aberdeen, our quantitative investment team builds bottom-up Our multi asset funds are built around a clear philosophy of equity portfolios targeting factors which predict outperformance. diversification and utilizing the team’s expertise in managing the Our systematic investment process allows the integration of any market risks of traditional and alternative assets. Aberdeen Solutions ESG factor into a client’s portfolio. This can include a customized offers genuinely customized solutions to our clients, including tailored implementation targeting a positive exposure to any desired ESG factor approaches to ESG integration according to clients’ ESG needs. The team at the portfolio level versus the benchmark, such as overall ESG score, can also offer SRI-screened strategies. carbon profile, or gender diversity. The team also offers the more standard exclusion methodology (SRI screening) of not holding stocks and industries which do not meet the client’s requirements. Both controversial weapons (cluster bombs, landmines, depleted uranium weapons and chemical/ biological weapons) and companies with severe controversies (Level 5 controversies based on ratings from the Sustainalytics agency) are excluded from our investable universe. Finally, we have a thematic offering – SMARTER Beta™. Our capability includes an ESG Multifactor Equity Index family, comprised of multifactor ESG indices for global markets, developed markets, emerging markets, Europe ex-UK, UK, Asia ex-Japan, Japan, and Australia.

ESG: coming into the mainstream - May 2017 07 of 08 IMPORTANT INFORMATION PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RESULTS International investing entails special risk considerations, including currency fluctuations, lower liquidity, economic and political risks, and differences in accounting methods; these risks are generally heightened for emerging market investments. Concentrating investments in a particular region subjects an investment to more volatility and greater risk of loss than geographically diverse investments. Fixed income securities are subject to certain risks including, but not limited to: (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment ( issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase). Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information. The above is for informational purposes only and should not be considered as an offer, or solicitation, to deal in any of the investments mentioned herein. Aberdeen Asset Management (AAM) does not warrant the accuracy, adequacy or completeness of the information and materials contained in this document and expressly disclaims liability for errors or omissions in such information and materials. Important information for all audiences: Aberdeen Asset Management (AAM) offers a variety of products and services intended solely for investors from certain countries or regions. Your country of legal residence will determine the products or services that are available to you. Nothing in this document should be considered a solicitation or offering for sale of any investment product, service, or financial instrument to any person in any jurisdiction where such solicitation or offer would be unlawful. The information contained herein is intended to be of general interest only and does not constitute legal or tax advice. AAM does not warrant the accuracy, adequacy or completeness of the information and materials contained in this document and expressly disclaims liability for errors or omissions in such information and materials.AAM reserves the right to make changes and corrections to its opinions expressed in this document at any time, without notice. Some of the information in this document may contain projections or other forward looking statements regarding future events or future financial performance of countries, markets or companies. These statements are only predictions and actual events or results may differ materially. The reader must make his/her own assessment of the relevance, accuracy and adequacy of the information contained in this document, and make such independent investigations as he/ she may consider necessary or appropriate for the purpose of such assessment. Any opinion or estimate contained in this document is made on a general basis and is not to be relied on by the reader as advice. Neither AAM nor any of its agents have given any consideration to nor have they made any investigation of the investment objectives, financial situation or particular need of the reader, any specific person or group of persons. Accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of the reader, any person or group of persons acting on any information, opinion or estimate contained in this document. Notice to investors in the United States: In the United States, Aberdeen Asset Management (AAM) is the marketing name for the following affiliated, registered investment advisers: Aberdeen Asset Management Inc., Aberdeen Asset Managers Ltd, Aberdeen Asset Management Ltd, Aberdeen Asset Management Asia Ltd and Aberdeen Capital Management, LLC. Excluding Aberdeen Capital Management LLC, each of these advisers are wholly owned by Aberdeen Asset Management PLC. Aberdeen Capital Management LLC is a wholly-owned subsidiary of Aberdeen Asset Management Inc. “Aberdeen” is a U.S. registered service mark of Aberdeen Asset Management PLC. 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Aberdeen Asset Management Inc. is wholly owned by Aberdeen Asset Management PLC. © 2017 This material is owned by Aberdeen Asset Management or one of its affiliates. This material is the property of Aberdeen and the content cannot be reproduced or used in any way without our authorization.

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