UBS Wealth Management UK: Guide to Sustainable and Impact Investing UBS Forum 2018 2 Introduction

I’m thrilled to be touring the UK to talk to UBS investors about Sustainable and Impact Investing as part of this year’s UBS Forum.

When I coordinated the drafting of the UN’s Principles for Responsible Investing (UNPRI) in 2005, sustainable and impact investing were still on the margins. In fact, the Rockefeller Foundation had yet to coin the term “impact investing”.

The whole space of responsible, sustainable, ESG, values-based and impact investing has come a long way over the last 10 years.

Now, at the beginning of 2018, I believe we’ve reached a tipping-point where institutional grade investments are being made available at scale to more investors than ever across the world. The total assets invested using at least some form of sustainability criteria is estimated to be $23 trillion1.

Despite this, we are still coming from a relatively low base. Assets managed with environmental, social and governance (ESG) approaches represent just 8% of the overall global household wealth of $280trn2 – and most of this would be about simply avoiding so-called sin stocks such as tobacco and weapons3. Sustainable and impact As with any new investment approach, there are barriers in terms of familiarity and understanding. The amount of jargon and some (at times) unnecessary investment going complexity has meant that investors are often left confused. mainstream We want to help you navigate this brave new world of investing. That’s what this guide and this year’s UBS Forum is all about. We have divided it into sections devoted to some simple questions. What is it? Would I lose out financially? How do I go about it? What difference can I make?

We want everyone to be able to engage with an approach to investing that must become truly mainstream if it is to fulfil its potential and society is to address its biggest challenges.

We have a golden opportunity, collectively, to engage more people in investing sustainably and in ways that can make a genuine difference to society while also delivering comparable financial returns to traditional strategies. We want investors to simply think ‘why not?’

James Gifford Chief Investment Office, Head of Impact Investing UBS Wealth Management

1Global Sustainable Investment Alliance Report, 2016 2UBS House View Monthly Letter, 14 December 2017 3‘Doing well by doing good: Impact investing’, UBS Chief Investment Office WM, May 2016 3 What is it?

Flavours of sustainable investing ‘Sustainable investing’ is investing in ways that take into At its most simple, sustainable investing is about aligning account environmental, social and governance (ESG) factors your values and aspirations as a person with your money in investment decisions. It has three main flavours: as an investor. 01. Exclusions: this involves removing stocks from It also allows you to invest in sustainability as an portfolios based on sustainability criteria. The most increasingly important economic theme of the future, common exclusions are tobacco and controversial better manage risks and make a concrete difference weapons. in the world. 02. ESG integration: this uses ESG factors to seek out opportunities or manage risks better. The key difference is that ESG integration as a strategy is seeking to outperform using these factors, whereas exclusion strategies are simply seeking to align your portfolio with your values (typically without underperforming).

03. Impact investing: this is the subset of sustainable investing that aims to generate measurable, positive environmental or social impact, and help solve specific social and environmental problems, in addition to delivering returns comparable to traditional investments.

Impact investments tend to be made in private markets, such as private equity, private debt, venture capital and infrastructure. ESG integration tends to be done through stocks and bonds. Most impact investment is also seeking market-rate returns.

In other words, investors have different ways to invest sustainably and it is absolutely possible to have their cake and eat it too – it’s about delivering a ‘double-bottom-line’ of financial returns along with sustainability.

4 Why now? We have come a long way since the only approach was simply screening out so-called ‘sin stocks’ like tobacco. Adding a third dimension Sophisticated approaches to sustainable investing are fast becoming mainstream. to investing

This has been driven by the coming together of investor As illustrated below, impact investing adds a third interest and institutions’ growing ability to meet demand. dimension to traditional investing, namely the inclusion of non-financial criteria in evaluating The rising influence of the millennial generation – those opportunities. born between the early 1980s and early 2000s – is also driving this shift. Having grown up in a digital age with a constant flow of easily accessible information and increased transparency, millennials’ expectations of public and private organisations are higher than previous generations’. Younger wealth holders are more socially and environmentally conscious, and expect others to act accordingly. Social/ Environmental According to UBS and Oppenheimer Funds surveys with impact Campden Wealth in 2017, around 69% of Ultra High Net Worth millennials say they want to align their investments Financial return with their social values, along with 88% of women surveyed, and 40% of family offices.

We’re seeing many examples of how the market for sustainable investing is broadening and deepening in response. Green Bonds are becoming more and more popular ($80 billion in new issuance in 2017 alone4) and we’re seeing high profile new funds such as TPG Financial risk Rise, a $2bn impact investment fund backed by Bono, Richard Branson, and others.

4‘Sustainable investing Education primer: Green bonds’, UBS Chief Investment Office WM, October 2017 5 6 Our guide to ESG

Evaluating Environmental, Social and Environment

Governance (ESG) factors is a way What kind of topics? of determining whether companies Climate change, pollution and waste, environmental are sustainable. opportunities. What negative impacts can you avoid? Right we have set out some examples Sustainable investments are better able to respond of what they could mean for your to environmental or social risks, such as supply chain investments: disruptions caused by climate change or water scarcity. Examples of how you can benefit Investments growing market share due to favorable regulation and shifting consumer preferences. Investments that are able to drive competitive advantage through greater resource efficiency leading to lower costs.

Social

What kind of topics? Workplace safety, discrimination and diversity, supply chain, community controversies, human rights.

What sort of things can you avoid? Companies suffering from conflicts with local communities and investments suffering from customer boycotts.

Examples of how you can benefit Higher worker productivity leading to increased margins and financial out-performance.

Governance

What kind of topics? Corruption, tax gaps, anti-competitive behaviour, business ethics, board structure.

What sort of things can you avoid? Investments falling after receiving huge fines or lawsuits for anti-practice or back tax bill requests.

Examples of how you can benefit Investments attracting high quality institutional investors attracted to the good governance, resulting in lower investment volatility.

7 What about financial returns?

There is a misconception that sustainable Roughly 90% of the 2,200 peer-reviewed academic studies on the relationship between sustainability and financial investing means lower returns. When you performance found either a positive or neutral correlation compare sustainable investments with between the two. More than two-thirds of asset owners non-sustainable investments today, the say that explicitly integrating ESG criteria into their decision- making process has significantly improved returns. Such ESG evidence shows that there is little to no integration strategies have been growing at 17% per year and significant difference when it comes to are now used with nearly half of sustainable investments6.

financial returns. The average return since 1990 of the MSCI KLD 400 Social Index, which tracks a universe of more sustainable firms, In fact, according to Professor Timo Busch, has matched almost exactly the S&P 500 in terms of risk reviews of academic literature conclude and return.

that integrating sustainable factors The Bloomberg Barclays MSCI Green Bond Index, which improves financial returns, or causes no measures fixed income instruments whose proceeds are detriment to them5. earmarked for projects with environmental value, slightly outperformed the Bloomberg Barclays Global Aggregate between December 2013 and October 2017, with a return of around 17% compared with 15%.

And the bonds of the International Bank for Reconstruction and Development, the main lending arm of the World Bank, offer a yield advantage of 13 to 20 basis points over equivalent US Treasuries across the curve, while maintaining an AAA rating.

Most of the data on financial returns focuses on liquid markets. There is much less data when it comes to the financial performance of private market impact investing. One publication from Cambridge Associates and the Global Impact Investing Network, “The Impact Investing Benchmark” found that there was variation across regions and cycles, but that overall, returns are comparable to traditional approaches7.

5 ESG and financial performance: aggregated evidence from more than 2000 empirical studies’, Journal of Sustainable Finance and Investment, Gunnar Friede, Timo Busch, Alexander Bassen, 2015 6 GSIA Global Sustainable Investment Review, 2016 (“In the period since the last report was released, the global sustainable investment market has continued to grow, and in most of the regions covered by GSIA’s member organizations, its share of professionally managed assets has also grown.”) 7 ‘Introducing the Impact Investing Benchmark’, Global Impact Investing Network and Cambridge Associates, 2015 8 ‘Gender Diversity Matters’, UBS Global CIO, September 2016 8 Myth-busting impact investing

As with any new investment approach, there are a number If we are to really grow impact investing, larger institutions of myths around impact investing. Here’s our attempt to should focus on market-rate return strategies, as it has bust them: a much greater capacity to scale and address big issues.

“Portfolio profits and impact are mutually exclusive” “High returns imply low impact” Some individuals and institutions view their investment Higher financial returns need not have a negative effect portfolios in two distinct buckets: one dedicated to returns on the quality of the impact investment. For example, and one to philanthropy, the former subsidising the latter. a 2011 study by Grabenwarter and Liechtenstein found Impact investing offers an investment approach which that it cannot be implied that financial returns are inversely seeks to deliver both attractive returns and a defined social correlated with impact generation. Indeed, if a company is and environmental impact, negating the binary “make able to scale quickly with impactful products, and is highly impact or make profit” mentality. profitable, the problem it is seeking to solve may be solved much faster. “Impact investing is philanthropy” Impact investing is investing with an expectation of “Impact investing is only in poor countries” financial return. It is not giving money away to solve social While poverty is more glaring in rural Sub-Saharan or environmental problems. It is neither philanthropy, nor Africa than in Western Europe, developed countries based on grant-making. It is also not dedicated to funding also have challenges that impact investing can address. public sector projects. However, it can cater to different For example, the financial crisis resulted in high rates of risk appetites within the same structure and draw investors youth unemployment in parts of Europe, cut off capital to from both the public and private sectors to encourage many small businesses, and reduced investment in critical innovation. infrastructure. There are also significant environmental challenges in developed markets around the world, such “Impact investing means making financial sacrifices” as ongoing use of fossil fuels and an underinvestment in Impact investing need not entail sacrificing financial public transportation. These problems are often less visible returns for social or environmental benefits. A range of than contaminated water supplies or slum dwellings, but expected financial returns can be achieved depending on impact investing can focus on any social or environmental the particular investment, and the great majority of impact problem regardless of geography. investors and impact investments seek market-rate returns.

The power of gender diversity

Gender diversity is a good example of the value of good less gender-diverse peers8. Our gender-focused company corporate governance practices. We have found that basket outperformed the MSCI World Index by 2% a year firms with women in at least two board seats or 20% on average between 2011 to November 2017. of leadership positions were more profitable than their

9 How do I go about it?

The first step is to be clear about Ask yourself, for each different pot of capital, whether you want to align your portfolio with your values (implement your intention. some exclusions), leverage sustainability factors for risk/ return reasons (ESG integration), or actually make the world a better place, most likely through private market investments (impact investing). Shareholder engagement strategies in public equities can also deliver concrete impact.

The second step is to decide whether you’d like to do it through a carve-out from your main portfolio, implement a strategy gradually over time across your whole portfolio, or by jumping in 100%.

The answer to this will help you work with your financial advisor to build an investment strategy that delivers to what matters to you.

Once you are ready to invest and have worked out what proportion of your assets you’d like to devote to it, and which asset classes, there is already a wide and growing universe of products at your disposal.

10 What products are out there?

ESG Engagement Equities An approach where fund managers take active equity stakes in order to engage company management to improve their performance on ESG issues and opportunities.

ESG Thematic Equities Equity shares in companies that sell products and services that tackle a particular environmental or social challenge, and/or whose businesses are particularly good at managing a single ESG factor, such as gender equality, water or renewable energy.

Improving ESG Equities Equity shares in companies that are getting better at managing a range of critical ESG issues and opportunities, often correlated with ongoing ESG and financial improvements.

ESG Leaders Equities Equity shares in companies that manage a range of critical ESG issues and seize ESG opportunities better than their competitors.

World Bank Bonds Bonds issued by the World Bank, a multilateral development bank (MDB). MDBs are backed by multiple governments with the aim of financing sustainable economic development.

Green Bonds Bonds that finance environmental projects. Issuers include corporations, municipalities, and development banks.

ESG Leaders Bonds Bonds issued by companies that manage a range of critical ESG issues and seize ESG opportunities better than their competitors.

Single private equity funds Private equity funds are typically open for investment for a number of months, and then are closed for 8-12 years. Private equity – including impact funds – have the best risk/return profile of any asset class.

Single private debt funds Funds that may be evergreen (in the case of some microfinance funds) or closed- ended, in the case of other SME or infrastructure debt funds.

Funds of funds Funds of fund managers are often highly diversified, which means they can deliver strong returns with lower risk than if you invest in a small number of single managers. Funds of funds are a good way to build a diversified private equity or debt portfolio without having to wait a number of years.

Being clear on your intention – exclusion, integration and impact

Exclusion This traditional and still most commonly used approach costs or damage their reputations. It also involves assessing involves excluding individual companies or entire industries whether firms are well positioned to capture opportunities from portfolios if their areas of activity conflict with an arising from major sustainability-related themes and trends, investor’s personal values. which might give them a competitive edge.

This process, called exclusionary or negative screening, Impact investing can rely either on standard sets of exclusion criteria or This strategy differs from the previous two in its intention. be tailored to investor preferences. For instance, investors Impact investing explicitly aims to make a measurable may wish to exclude companies with 5% of sales or positive environmental or social impact through the more generated from alcohol, weapons, tobacco, adult capital invested. Impact investing invests directly in entertainment or gambling – so-called “sin stocks.” companies and/or funds that intend to create measurable positive social or environmental outcomes alongside ESG Integration financial returns. This approach combines environmental, social and governance (ESG) factors with traditional financial Shareholder engagement with listed companies that considerations to make investment decisions. It involves also delivers measurable impacts can also be considered understanding how companies handle environmental, impact investing. social and governance risks that could entail significant

11 What difference will I be able to make?

This is the key question, but unfortunately Three criteria for measuring sustainability First, we explore intent. Those structuring the investment there is no simple answer. It depends must have a stated intention to generate positive social on the ambition and nature of your and/or environmental impact, in addition to sustainable investment, whether you have gone for an financial performance. exclusion, integration or impact approach Next, we consider impact measurement. It is important and so on. that the outcomes of the investment be tied to specific metrics, and measured against a base case or benchmark. Examples of specific metrics might be the number of jobs However, there are some basic principles created or litres of water purified.

you can use to make sure your investment Last, we require verification. This means establishing is delivering a clear social, as well as proof that the invested capital or the investment approach financial, return. itself is positively correlated with the intended outcome. For example, if the stated benefit is cleaner drinking water, and measurement includes the number of litres of available clean water, supporting data showing proof that the investment made (i.e. in better quality pipes) led to this outcome, would be important.

Typically, most of the impact happens in the impact investing bucket. However there are some approaches to public equities, such as shareholder engagement which also deliver real impact.

If we can tick all these boxes, we can create genuine change. Below are some examples of what can be achieved.

12 Shareholder engagement driving change

Shareholder engagement is where investors use their This means that investors are in a much stronger position power and influence as shareholders to encourage to engage more effectively with businesses to drive positive companies to improve their sustainability performance. social, environmental, and therefore, financial, outcomes. This can be done via letter writing, calls and face-to-face To give two recent examples: meetings and, if all else fails, filing a shareholder resolution at the company‘s annual general meeting (typically known • Partly as a result of pressure from sustainability-focused as shareholder activism). investors, Mexico-listed multinational cement producer Cemex published 18 medium-term sustainability targets Increasing connectivity and big data have made our world linked to atmospheric emissions, use of alternative fuels, more transparent than before. As a result, it’s getting sales derived from sustainable products and materials, easier to measure companies’ impact on the world (also labor safety, and responsible supply chains. known as ‘externalities’). • In May 2014, Colgate-Palmolive explicitly acknowledged For instance, firms such as Carbon Delta are now able to the important influence of outside stakeholders in its quantify an individual company’s climate change risk, and decision to commit to reduce carbon emissions on an calculate its potential valuation impact for investors. absolute basis by 25% relative to 2002 levels by 2020, and by 50% by 2050.

Helping deliver the UN’s Sustainable Development Goals

In the past 40 years, the use of natural materials has tripled, across all forms of capital – physical, human, resulting in increased environmental degradation and urban and environmental. pollution. Current atmospheric carbon dioxide levels are the This demand for private capital within the SDG framework, highest they’ve been in 3 million years – a contributor to and the rapid growth of the sustainable investment industry, frequent and extreme weather events. And close to 1 billion means that investors now have an opportunity to make people today still suffer from undernourishment, lack access a positive impact on some of the world’s most pressing issues to clean water and live on less than USD 1.25 per day. without sacrificing risk-adjusted returns. Investors could have an important role to play in the solution. Impact investing in particular is a key means of mobilising In 2015, the UN created its Sustainable Development Goals private wealth to address pressing global challenges and (SDGs) resolving, among other things, to end poverty, achieve the UN SDGs by 2030. combat climate change, and fight injustice. It can be used, among other things, for alleviating hunger by The UN acknowledges that social and legal structures have a improving food production and distribution, improving access role to play, but also recognises that fulfilling this ambitious to and quality of healthcare and education, or in clean and set of 17 goals will require both public and private investment affordable energy.

13 Photo credit: Project Ujjwal

Improving maternal and newborn survival in Rajasthan – UBS Optimus Foundation launches the world’s first large-scale Development Impact Bond

As well as getting engaged in Impact investing with your Launched last year, the program seeks to save 2000 main portfolio, you can also engage in impact investing lives over five years by improving hospital standards with your Philanthropy. Many people give to gain impact, at 360 facilities. but we think it would be even better if we could give and recycle your donations. One way to do that is through It is funded on a payment-by-results basis, the core Development Impact Bonds. principle of Development Impact Bonds. Paying for outcomes rather than services encourages innovative Development Impact Bonds (DIBs) are a performance-based and effective delivery to maximise the social impact investment intended to finance development programmes and value for money. in low resource countries. In the DIB model, supporters of the UBS Optimus A DIB creates a contract between private investors and Foundation provide the upfront working capital, which donors or governments who have agreed upon a shared is repaid allowing it to be recycled to more good causes. development goal. Investors advance fund development programmes with financial returns linked to verified USAID and MSD for Mothers have committed up to USD development goals. 8 million funding for outcomes. The three organisations delivering the service have a proven track record of The Maternal and Natal Health Development Impact improving health outcomes in India, and will work closely Bond is a program in Rajasthan, India that supports the with local facilities to improve the quality of care. government’s efforts to improve maternal and newborn survival and health. The improvements in quality will be tracked and measured against Indian health quality standards, with a success Despite recent progress, India has one of the highest payment of USD 18,000 for each facility that reaches newborn mortality rates in the world (ranked 184th) the accreditation standard. owing, in large part, to poor-quality healthcare provision.

14 Conclusion

This report is intended to help you Time to start linking our values to our money Along the way, we have tried to convey the huge to navigate this exciting, fast-growing future potential and current momentum for a new world of sustainable and impact investing and exciting investment theme.

– helping demystify, define and Today there is still, broadly, a disconnect between debunk myths. people’s values and the behaviour of their money in the world around them.

Until they are confronted with it, most investors are not aware of where their money is invested. Few of us have scrutinised the small print of a fund portfolio or fully understand the values of all the companies we implicitly support.

Soon this may become a thing of the past. If it does, we will finally be able to establish a genuine link between people’s values and their money.

If we can achieve that, it will be truly transformative. We all have a chance to invest in the world we want rather than just the world we’re in.

The price and value of investments and income derived from them can go down as well as up. You may not get back the amount originally invested. Past performance is not a reliable indication for future results.

Important Information The information mentioned herein is not to be regarded as investment research, a sales prospectus, an offer, a recommendation, an offer or solicitation of an offer to buy or sell any investment or other specific product. It is for marketing and informational purposes only.

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