Responsible Investment Report Q4 2016 Contents 4 10 Japan: The truth about ESG:

How companies can thrive through sustainability Debunking the myths

6 13 Financial consumer awareness: Lower-cost healthcare:

Regaining the trust The investor’s role 9 14 Viability statements: Energy storage:

Don’t hide behind disclosures Leading the charge for a greener future Responsible investment at Schroders

We believe well-run companies that act responsibly are not only good for society; they can be good for shareholders’ pockets too.

We repeatedly hear from clients that case Clients also tell us of their struggle to studies bring environmental, social and understand social issues. Helping to bridge governance (ESG) to life. It is through this gap is a summary of our work on hearing how ESG research and analysis fi nancial consumer protection, which has feeds into investment decisions and the gained increasing public interest following ownership process that they begin to the revelations of fake accounts at Wells understand how the work done by the Fargo. On the thematic side we also take a team impacts their portfolios. In our latest look at the energy storage market. Quarterly Report we aim to provide you with evidence that takes the theoretical Finally, we also include an article on into the practical. debunking ESG myths. Given ESG is a relatively new and fast changing area of Jessica Ground One of this quarter’s case studies is written investment; we feel it is helpful to address Global Head of Stewardship by Nathan Gibbs, a long-standing investor some of the issues that we are commonly in Japanese markets. We are proud of asked about. our ESG resources at Schroders, but our real goal is to ensure that ESG is taken At Schroders, we believe well-run into account in every investment product companies that act responsibly are not across geographies and asset classes. only good for society; they can be good for Nathan talks us through some of the ways shareholders’ pockets too. Research has in which Japanese companies are getting demonstrated that companies that score ESG issues right, and the areas in which highly on ESG factors benefi t from a lower corporates need to improve. cost of capital and are more likely to deliver superior returns over time¹. That’s why ESG Equally important to us is being seen forms an integral part of our investment as owners, not renters, of capital. process across asset classes. Engagement is a cornerstone of this process. We are often asked how As always, this report brings you details much of our engagement is down to of our ESG engagements this quarter. Schroders alone and how much is done in Client interest in how we exercise our collaboration with others. stewardship duties is on the rise and we remain committed to increased This report contains good examples of transparency here. both. We present the work we did with Médecins Sans Frontières and some of the key players in the pharmaceutical sector, as well as the engagement work we undertook on our own: trying to improve the quality of viability statements and long-term planning among UK FTSE 100 companies.

1 Sustainable investing: Establishing Long-Term Value and Performance, Fulton, June 2012 and “Can investors do well while also doing good?”, Schroders Investment Horizons, issue 3, 2015.

3 Responsible Investment Report | Q4 2016 Japan: How companies can thrive through sustainability

Schroders is proud to be one of a very small group of UK companies with a corporate history stretching back more than 200 years. Astonishingly, Japan is home to as many as 3,146 companies that were founded more than 200 years ago; some of which can be traced back more than 1,000 years

Of course most of these are small, family- While the current management and run and operate in niche areas, such as governance structures in Japan have hotels and restaurants. Nevertheless, evolved over centuries to align with local we can consider whether this Japanese culture, from a global perspective the aptitude for corporate longevity can tell system can often appear to lack dynamism us anything about the sustainability of and effectively restrict any real challenge Japanese business models in the future, to management decisions. and their ability to reward shareholders At the same time, advances in technology over time. and information fl ows also mean that Building sustainability successful business models can now Sustainability, in an investment sense, can become obsolete much faster. Nathan Gibbs have a variety of meanings but in recent An established company’s market position Client Portfolio Manager years investors’ approach to sustainability can be rapidly undercut by new entrants has coalesced around the principle of with a radically different business model environmental, social and governance or the value of a brand can be (ESG) factors. Companies’ attitudes to permanently impaired by a scandal. the stakeholders represented under As a result, more than ever before, Ongoing developments these headings – employees, regulators, companies need to innovate to survive in Japan are helping to shareholders and the environment and to embrace transparency. In this – are now broadly viewed as indicators sense, it may now be dangerous for ensure that investors of future sustainability. management thinking to be infl uenced by Among these factors, Japanese companies the same social factors that have enabled with such a long-term typically have strong social characteristics companies to endure for centuries. approach will ultimately as the principles of lifetime employment Investors now need to build into their and community support have always decisions an analysis of the factors that be rewarded. been part of corporate ethos, long before allow sustainable business models not anyone ever thought of attaching an only to survive, but also to grow over time. ESG label. Gradual progress being made Behavioural changes needed Although progress had been relatively Conversely, Japan is regarded as a slow, it is already possible to fi nd individual signifi cant laggard in governance issues examples of good governance behaviour compared to other developed markets in Japan. For example, Ryohin Keikaku, globally. In recent years the specifi c the operator of the “Muji” brand and one examples of Olympus and Toshiba have of fastest growing speciality retailers suggested corporate cultures which around the world, already has one wrongly target “survival at all costs”, third of its board comprised of external leading management to fraudulently directors while the separately constituted disguise loss-making activities in order to nomination and remuneration committees preserve the status quo. These individual are both chaired by independent directors. instances highlight the need for better We should expect such cases to attract governance at the board level but this increasing attention going forward and to in itself will be insuffi cient without be used as examples of “best practice” fundamental changes in behaviour, both for other companies. within companies and towards outside shareholders.

The companies mentioned above are for illustrative purposes only and are not a recommendation to buy or sell.

4 Responsible Investment Report | Q4 2016 Japan: How companies can thrive through sustainability (continued)

Clear communication and engagement For example, whether these external Central to a broader development of this directors are truly independent, whether theme is a need for companies to explain they understand their fiduciary duty their position to investors. This in turn as directors and whether the company requires a legal and regulatory framework provides adequate training to enable them that makes the rights and responsibilities to fulfil this role. both of companies and investors clear. These specific issues, as well as a broader Surprisingly for such a developed country, assessment of the underlying changes in Japan has muddled through without such a behaviour within companies, will form an framework, which has arguably prevented increasingly large proportion of Japanese the stockmarket from truly fulfilling its role as research going forward and this can’t be an efficient mechanism for capital allocation. fully replicated by using only third party So, in terms of changing behaviours, data or quantitative approaches. While the Governance and Stewardship Codes improved governance is unquestionably introduced by the current government are positive for the stockmarket in aggregate, significant steps in the right direction and by enabling clearer analysis of differentials these will help to establish the principle between companies, it also argues in of engagement between investors and favour of active management and ongoing companies. This is particularly important engagement in order to fully reflect these in Japan where some instances of differences in client portfolios. overaggressive activism have tended to Conclusion: long-term thinking required make company management wary of Investing in sustainability therefore any form of investor engagement. Now, requires long-term thinking in order however, there are good reasons to be to identify companies with sustainable optimistic that real progress is underway business models that are capable not just in this area. of surviving, but thriving and growing This engagement ultimately leads to a into the future. The recent volatility in much better dialogue between companies Japan’s currency and stockmarket makes and investors in terms of the uses of it particularly important for investors to capital and the returns that can flow from maintain a focus on these positive longer- it. This is also closely tied to principles term stories. of sustainability as academic studies Ongoing developments in Japan are consistently show that companies with helping to ensure that investors with such higher ESG scores have better operational a long-term approach will ultimately be performance and benefit from a lower cost rewarded. Identifying these opportunities of capital. at the company level requires not only In Japan this latter distinction may seem an awareness of measurable factors, but less relevant as interest rates have been also an increased research effort and so close to zero for so long that virtually a consistent application of qualitative any corporate capital expenditure decision analysis of corporate behaviour. looks like a good idea. But investors must not be complacent on this issue and it is still important not to confuse short-term conditions with the structural issues. Qualitative factors as important as quantitative Establishing a more rigorous framework for governance also allows investors to place more faith in quantitative scoring of particular factors, such as the number of independent directors. While such quantitative measures are important, there are also vital qualitative judgements to be made.

The companies mentioned above are for illustrative purposes only and are not a recommendation to buy or sell. 5 Responsible Investment Report | Q4 2016 New financial consumer awareness: Regaining the trust

The trust problem persists Financial services have suffered a long- Since then, there has been a steady stream running trust problem. Trust deteriorated of headlines highlighting financial services further and understandably so – in the companies’ misdemeanours, culminating aftermath of the global , in a series of uncovered failings, fines, where blame was firmly laid on the industry falling public confidence, increased for creating a ‘culture of excess’ that lead to regulatory scrutiny and discoveries of the worst global this century. yet more failures.

Figure 1: Deteriorating confidence in financial institutions, 1975–2012 Solange Le Jeune 45 Sustainable Investment Analyst 1977 Community Reinvestment Act 40

35

30

Although we cannot 25 predict every future Early 80s Recession 2001 Recession 20 (Increased Interest rates, (Tech bubble burst) ) misdemeanour, 15 1986 – 1988 (Fed increased we believe we can rates making it more difficult 10 to borrow money) Early 90s Recession 2008 – 2012 (Financial mitigate investment (inflation, oil price shock, Crisis and Great Recession) 5 debt accumulation) risks by examining 0 the underlying 1975 1980 1985 1990 1995 2000 2005 2010 drivers of scrutiny. Source: General Social Survey (GSS) USA. Accessed at: http://wheatoncollege.edu/sociology/2014/04/24/turning-numbers-pictures/

Consumer protection is key Investors cannot ignore the implications The steady increase in failure to protect As investors, identifying those companies customer interests has shifted the balance most or least susceptible to major fines has of regulation in major economies from taken on greater importance. Although we facilitating market functioning towards cannot predict every future misdemeanour, increased consumer protection. In the UK, we believe we can mitigate investment regulator mandates to protect consumer risks by examining the underlying drivers interests were reiterated and given new of scrutiny; the types of institutions likely to powers in the financial services regulation face the greatest pressures and the steps reshuffling that followed the financial crisis. individual companies have taken to manage In the US, the Dodd-Frank Act sets out to their exposure to tougher standards of achieve similar protections. ‘Consumer consumer protection. protection’ has become the watchword of regulator mantras. Against that backdrop, pressures on the industry continue to build.

A full report can be found on our website under the insight section at http://www.schroders.com/en/about-us/corporate-responsibility/esg-at-schroders/ The companies mentioned above are for illustrative purposes only and are not a recommendation to buy or sell.

6 Responsible Investment Report | Q4 2016 New financial consumer awareness: Assessing the risks

The need to be customer-centric well as significant disclosure issues. UK Our analysis of the financial services banks have already faced government industry has shown that the banking and pressure that has driven stronger customer credit segments are most exposed to protection standards. consumer protection regulation and the In the US, the industry shows a mixed enforcement of tighter standards. picture: only a few credit providers have We think that banks and credit providers established relatively strong practices but should refocus their strategies back towards this demonstrates the industry has started their customers, ensuring their interests are to evolve towards customer centricity. prioritised and rights protected rather than The Wells Fargo scandal that emerged this vulnerability exploited. year (in which employees allegedly created Geographical disparities in unauthorised accounts in customers’ developed markets names without their knowledge) might well Our research and engagement with a accelerate this trend. In Europe, banks have group of European and North American also been slower in adapting to the new companies has shown geographic regulatory backdrop. disparities within those developed markets and gaps in companies’ approaches, as

Simpler products Clear marketing Customer Mistrust of Misselling and communication engagement Financial financial customer corporations Customer Customer trust detriment financial education Where Product are we? misunderstanding

Figure 2: How can financial services companies regain consumer trust? Source: Schroders

A full report can be found on our website under the insight section at http://www.schroders.com/en/about-us/corporate-responsibility/esg-at-schroders/

7 Responsible Investment Report | Q4 2016 New financial consumer awareness: Assessing the risks (continued)

We assess key financial ȂȂ Increasing product transparency services companies by clarifying marketing materials We developed a framework to analyse ȂȂ Simplifying product and service financial companies’exposure to, and portfolios themselves mitigation of, the customer protection issue. ȂȂ Improving customer engagement We assessed companies’ exposure to higher levels and disclosing customer social risk credit products in their markets satisfaction scores (such as high leverage, controversial and complex products) as well as their ȂȂ Mitigating customer complaint management of customer protection. issues and improving complaint handling We evaluated the latter primarily through mechanisms engaging with companies, and the dialogue Engaging with our investee companies focused on a few key areas: also helps us push them towards best Reviewing marketing and selling culture practice. Encouragingly, many of the by removing sales targets for customer- companies we have contacted have been facing employees open to dialogue.

Companies we have spoken to Companies contacted but not yet responded

HSBC DNB

Lloyds Banking Group US Bancorp

Discover Financial Services Wells Fargo

Royal Bank of Scotland Citigroup

Virgin Money Bank of America

Barclays

Provident Financial

JP Morgan Chase

BNP Paribas

A full report can be found on our website under the insight section at http://www.schroders.com/en/ about-us/corporate-responsibility/esg-at-schroders/ The companies mentioned above are for illustrative purposes only and are not a recommendation to buy or sell.

8 Responsible Investment Report | Q4 2016 Viability statements: Don’t hide behind disclosures

Case study

Introduced by the Financial Reporting The choice of a three-year time horizon Council (FRC) to the UK in 2014, viability means that viability statements rarely cover statements were an exciting development a period beyond the existing management designed to enhance the quality of team’s term. The average tenure of a FTSE information about the long-term health and CEO is 5 years, and shortening. strategy of listed companies. We believe As long-term investors we would encourage that viability statements, and the process boards to look beyond the tenure of one of constructing them, are an excellent management team. We are dismayed opportunity for boards to sense check that that all too often we see dividend policies every strategic and financial decision being cut, exceptionals rise, and hear of historic undertaken by a firm is in line with its long- underinvestment when new management term goals. Two years on, however, and come in. in the FRC’s view, only 15% of companies across the FTSE 350 that they surveyed Better disclosure needed Jessica Ground provided a “comprehensive” statement. Global Head of Stewardship Against this backdrop we have written to It is essential that when producing a viability all of our FTSE 100 holdings, asking them statement, boards consider how companies to consider a more robust approach when will perform through an entire business they compile their 2016 Annual Report and cycle. Particular attention should be paid Accounts. In addition, we have spoken on to gearing levels, loan covenants, and off- panels sharing our views with Company The choice of a balance sheet liabilities to ensure that the Secretaries. To be clear, we are not calling three-year time horizon balance sheet is as robust as possible. for more disclosure; the focus should be It is helpful when companies provide details on better disclosure. Last year we wrote means that viability on the processes and possible mitigating to all of our UK holdings asking them to actions that form part of their discussions. consider stepping away from or reducing statements rarely their quarterly disclosure in favour of cover a period Time horizons are too short concentrating on their longer-term strategic However, 75% of companies choose a objectives. We hope our engagement work beyond the existing three-year time horizon. We have been sends a clear message to companies and surprised that when we have questioned boards about the importance we place on management management teams about their chosen the long term. team’s term. time frame, the majority reply that it coincides with existing strategic planning. Indeed a survey done by KPMG2 confirms this, with over half of companies saying their viability statements are based on existing budgeting processes.

2 https://home.kpmg.com/content/dam/kpmg/pdf/2015/10/longer-term-viability-statements.pdf

9 Responsible Investment Report | Q4 2016 The truth about ESG: Debunking the myths

Case study

Over the last decade, environmental, 2012 to $21.4 trillion at the start of 2014, social and governance (ESG) factors have and from 21.5 percent to 30.2 percent of moved quickly up the investment industry’s the professionally managed assets in the agenda, developing from niche interest regions covered4. Over 1,500 signatories to ubiquitous presence, to become one with over $60 trillion under management of the most topical areas of investment have signed the United Nations-backed management today. Principles for Responsible Investing (PRI) since their launch in 2006 – doubling the In early 2013, the Global Sustainable assets pledged to PRI5. Investment Association (GSIA) released the Global Sustainable Investment Review 2012, Furthermore, there has also been a data the first report to collate the results from explosion underway in ESG, with more the market studies of regional sustainable and more data available at more points investment forums for Europe, the United along the value chain, most recently with Jessica Ground States, Canada, Asia, Japan, Australasia and ESG fund ratings being announced by Global Head of Stewardship Africa. In the period since the launch of Morningstar and MSCI. Below clearly shows the inaugural study, the global sustainable that customers of the financial analytics investment market has continued to grow and information provider Bloomberg are both in absolute and relative terms, rising increasingly using more and more ESG data, from $13.3 trillion3 at the outset of with an enormous 126% rise between 2012 The trends that and 2015. have underpinned Figure 1: Number of Bloomberg customers using ESG data the rise of ESG 14000 12000 investing 10000 will continue. 8000

6000

4000

2000

0 2009 2010 2011 2012 2013 2014 2015

Source: Bloomberg Sustainable Business & Finance. Accessed at: https://www.bloomberg.com/bcause/ customers-using-esg-data)

The trends that have underpinned the As with any new investment trend though, rise of ESG investing will continue. As a even one that has seemingly been around result, understanding their impacts and in some form for well over a century, integrating them into investment decisions misconceptions can be rife and some have is becoming increasingly important to our been passed all over the world, like a game ability to manage funds for our clients. of Chinese whispers. This paper will attempt Customers, regulators, the media and to debunk some of these myths and other stakeholders are scrutinising our challenge some common misconceptions. efforts in this area more and more closely, and turning their attention to the depth, integrity and impact of our work.

3 All figures expressed in US dollars. 4 http://www.ussif.org/Files/Publications/GSIA_Review.pdf 5 UN Principles for Responsible Investment website: https://www.unpri.org/

10 Responsible Investment Report | Q4 2016 The truth about ESG: Debunking the myths (continued)

Case study

Myth 1: Sustainable investing is just Myth 3: It’s all about green investment avoiding “sin stocks” Although environmental issues, such as The phrase “sin stocks” describes firms water scarcity and climate change, are linked to industries perceived by some to important, there are other issues investors be unethical, such as tobacco, alcohol or should be looking at too. For example, rising gambling. However, sustainable investing inequality and increasingly cash-strapped has a much wider definition than just the governments have led to the introduction avoidance of sin stocks. Rather than merely of living wages in a number of regions, screening out certain stocks, sustainable putting pressure on company costs. Social investing is about closely evaluating a trends such as changing consumer tastes range of environmental, social and and new regulation has resulted in the governance issues. introduction of sugar taxes and ongoing declines in sugary drink consumption, with This could be analysing a company’s track consequences for company profits. CEO record on managing the pollution from pay and boardroom issues are rarely out of its factories, how socially responsible it is the headlines. in the communities in which it operates, or how well the interests of shareholders, At Schroders, we believe successful ESG customers and staff are managed from investment processes take a holistic a governance perspective. Sustainable look at the changing world companies investment is really about integrating a have to navigate and assess investment variety of wide-ranging ESG considerations performance across a number of factors. into the investment decision-making Myth 4: It only works in the most process, with a view to enhancing returns. developed markets Myth 2: Returns will be hit if you Some data is more readily available in invest sustainably developed markets so investors need Numerous academic and investment industry to look harder for data, particularly that studies have shown through consistent, which pertains to environmental and social performance-based evidence that an ESG- change, in emerging markets. Even though focused investment approach can perform the bulk of ESG data is disclosed by large as well as, or even outperform, the market companies operating in developed markets, based on the product and manager. this does not mean that ESG considerations are not pressing for those in emerging Studies by Friede, Busch & Bassen6 (2015) markets. and Morgan Stanley found that companies focused on ESG had, on average, enhanced The landscape is changing and a 2013 report financial performance. by UBS, analysing the World Economic Forum (WEF) Corporate Governance Index By examining ESG issues, investors gain and emerging market equity valuations, a better understanding not just of what concluded that companies that score well companies do, but how they do it. ESG on governance are valued more highly and analysis puts companies into a wider global enjoy lower volatility. context, and helps to identify which ones have the most resilient models.

6 Friede, G., Busch, T. & Bassen, A. 2015. ESG and financial performance: aggregated evidence from more than 2000 empirical studies. Journal of Sustainable Finance & Investment, 5:4, 210-233. Accessed at: http://www.tandfonline.com/doi/full/10.1080/20430795.2015.1118917

11 Responsible Investment Report | Q4 2016 The truth about ESG: Debunking the myths (continued)

Case study

Myth 5: It only works for stocks The below chart is from the 2016 US Trust ESG investing works across asset classes Insight on Wealth and Worth Survey and investors should not think sustainable and quashes the misconception that investing applies just to equities. With “investors don’t care” about social, political bonds, for instance, ESG analysis helps and environmental issues when making identify risks to a borrower’s ability and investment decisions. willingness to repay debts. Put simply, a Conclusion well-managed company should be less likely Demand for ESG investments is growing to stumble into value-destroying disasters and the need for all asset managers and be better positioned to repay investors to be able to articulate their approach who lend them money. to considering ESG-related risks and Myth 6: Investors don’t care opportunities is becoming mainstream. The reality is that many investors do care This is because companies do not operate about how the companies they invest in in a vacuum; global industries face social, approach environmental and social issues economic, environmental and industrial and they do value strong governance. Each changes on a larger scale and faster pace day, more investors are coming to believe than ever before. The gap between the that focusing on ESG principles can help values of companies on the right or wrong deliver what everyone wants: superior sides of those trends may grow ever-wider risk-adjusted performance over the long as a result. By investing in sustainable term. Assets under management in ESG businesses able to navigate those trends, investments are growing steadily, as both investors should be better placed to ensure the number and type of options increase more of the holdings in their portfolios are across asset classes. on the right side of that bifurcation.

Figure 2: % who agree social and environmental impact is important to investment decisions % 100

80

60

40

20

0

Millenials Gen X Baby Boomers Mature

2014 2016

Source: 2016 US Trust Insights on Wealth and Worth - Annual survey of high-net-worth and ultra-high-net-worth Americans

12 Responsible Investment Report | Q4 2016 Lower-cost healthcare: The investor’s role

Case study

Access to vaccines – supporting MSF research and development (R&D), local This quarter, we hosted an event with manufacturing, or tiered pricing schemes humanitarian aid organisation Médecins Sans – all factors that can generate long-term Frontières (MSF) and ShareAction, a group success in these markets. promoting responsible investment. The event set out to distil the challenges corporates face Company rankings in providing low-cost access to drugs and Also this quarter, the Holland-based non- vaccines in developing countries. profi t group Access to Medicine Foundation released its 2016 Index8, which ranks the MSF has been leading a targeted campaign, 20 top pharmaceutical companies on their #AskPharma, to reduce the price of efforts to improve access to drugs in low- pneumonia vaccines. Pneumonia is the to-middle income countries. The Index largest cause of child deaths globally. provides investors with a useful, credible Since our event in September 2016, the and science-based , which two key providers of pneumonia vaccines, Seema Suchak Schroders has helped to infl uence and GlaxoSmithKline and Pfi zer, have both Sustainable Investment Analyst support over recent years. committed to providing lower cost vaccines, by introducing a new pricing tier for civil As the bar is constantly raised by society organisations including MSF. stakeholders, so too are pharma companies’ efforts to improve access strategies, which Why access to healthcare is material for have seen an evolution over the past few The provision of investors years from mostly philanthropy-based to better healthcare At the event, Schroders took to the panel business-based. We continue our work to convey an investor view to the audience, advocating more transparent pricing in access in providing insights on our wider ESG both developed and developing countries, developing markets engagement with pharmaceutical companies. and applying this to our investment process. In our view, the provision of better is a source of healthcare access in developing markets competitive is a source of competitive advantage for healthcare companies. A study advantage. from Accenture7 shows that 75% of pharmaceutical growth in the coming years will come from developing markets. With increasing competition from local low-cost generics, we believe the big pharma brands will benefi t the most from untapped emerging market potential if their “access to healthcare” strategy is both responsible and commercially-aligned. Such a strategy could involve supporting local healthcare infrastructure, tailored

7 Accenture, “Access to Medicines: The Next Growth Frontier”, December 2014. 8 2016 Access to Medicine Index Overall Ranking. The companies mentioned above are for illustrative purposes only and are not a recommendation to buy or sell.

13 Responsible Investment Report | Q4 2016 Energy storage: Leading the charge for a greener future

Case study

Changing the batteries: Agency (IEA), Exane BNP Paribas, and other opportunities in lithium-ion forecasters estimate that electric vehicle Much has been made of the potential for stock will see compound annual growth electric vehicles (EVs) to reshape the global (CAGR) of around 44% through to 2030 from automotive industry and the opportunities a base of around 600,000 vehicles today. this will create for manufacturers and Electric vehicles are also set to become a suppliers. We believe opportunities in far bigger share of the automotive market lithium-ion (Li-ion) batteries will prove going forward. Multiple broker estimates particularly attractive given dual tailwinds of vary significantly, but point to penetration growth in vehicle-installed batteries, and a levels reaching 25% or more of car sales rising need to store grid power. Technology, by 2030. We have used forecasts by the scale and resource barriers should allow International Energy Agency in its latest better positioned companies throughout Global EV Outlook in our analysis, which lie the industry’s value chain to convert that close to the middle of the various forecasts Felix Odey opportunity into shareholder value. Sustainable Investment Analyst we have reviewed. EVs set to take off That trajectory is in line with national While the Li-ion market today is dominated targets already announced, but below the by consumer electronics, we expect this to level likely required to limit global warming change quickly. The International Energy to the internationally agreed 2oC limit. This will provide Figure 1 Deployment scenario for the stock of electric cars to 2030 a multiplier effect to the demand 140 120 for batteries over 100 and above the 80 pace of electric 60 40 vehicle sales. 20 0

Electric cars in the vehicle stock (millions) Electric cars in the vehicle stock 2010 2015 2020 2025 2030

Historical IEA 2DS Paris Declaration IEA 4DS EVI 2020 target Cumulative country targets

Note: 2DS = 20C Scenario; 4DS = 40C Scenario. Source: IEA analysis based on IEA (2016), UNFCCC (2015B), the EVI 2020 target and the country targets assessment.

Rising EV demand: the multiplier effect Currently, transport uses account for While attention has focused on the 25%9 of global energy demand, whereas batteries that will be used in those cars, power generation accounts for 13%10. the secondary effects on the power grid The projections for growth in the electric will prove as important. This will provide vehicle market – which will shift demand from a multiplier effect to the demand for the former category to the latter – imply an batteries over and above the pace of approximate 3.5%11 boost to global power electric vehicle sales. demand by 2030 and a 2.2%12 drop in demand from non-electric transport, mostly for oil.

9 US Energy Information Administration, International Energy Outlook 2016. 10 Global Energy Statistical Yearbook 2016. 11 Source: Schroders, Total global power consumption (20568TWh) + implied boost from Li-Ion (714GWh). 12 Source: Global Energy Statistical Yearbook 2016, 714TWh (Li-ion demand)/31952TWh (transport total). The companies mentioned above are for illustrative purposes only and are not a recommendation to buy or sell. 14 Responsible Investment Report | Q4 2016 Energy storage: Leading the charge for a greener future (continued)

Case study

Growing reliance on renewables Li-ion market set for dramatic change Investment opportunities Meeting that incremental power demand While we recognise that we are looking in energy storage will likely rely disproportionately on into an unknown future, we believe the The lithium-ion battery value chain is well renewable energy technologies. Over the potential impact of that multiplier effect placed to benefit from growing demand, coming decades, Bloomberg New Energy of energy storage on overall Li-ion bolstered by both direct growth in electric Finance (BNEF) predicts a major shift from demand will be significant. If we assume vehicles, and growth in renewables fossil fuels to renewable energy, reflecting an average EV battery size of 85KWh required to meet additional power political pressures and decreasing costs. (kilowatt hours) and an average annual requirements on the grid. Unlike many In order to meet the 2oC target set by the energy consumption of 5,100KWh per other markets associated with EVs, most Paris Agreement, BNEF expects renewable EV then we can calculate the battery industries along the lithium-ion battery energy will be required to generate storage capacity required at 25% market value chain benefit from consolidated around 60% of power by 2040, with most penetration of sales by 2030. We estimate markets with strong barriers to entry. of the growth expected from variable approximately 60% of additional power In the short term at least, improved renewable sources (such as wind and will be met by renewables, which will revenues are likely to occur alongside solar). Political impetus in turn has helped require storage equal to approximately resilient margins, especially amongst cell push down costs for these alternative 10% of energy output. Of this total storage producers and lithium extractors, where sources, leaving hydro and wind already we estimate that 2% will come from Li-ion scale, technology and access to resources cost competitive with fossil fuels in many batteries (sourced from IEA). provide natural barriers to competition. countries. Based on our calculations and analysis, Photovoltaic13 cells, one of the main we believe that by 2030, approximately components in solar panels, have seen 4,200 GWh (gigawatt hours) of Li-ion will prices fall from $76 per watt in 1977 to be required to meet the demand from $0.36 per watt in 2016, bringing solar both electric vehicles and grid storage, quickly into line with traditional fuels. which equates to 146KWh of additional Li-ion demand per vehicle. As renewables become a larger share of the energy mix, the need for energy This is only an estimate but the order storage will increase. Whereas coal and of magnitude promises to be sizeable, gas plants can be turned on and off as with the potential to reshape the Li-ion demand fluctuates, wind and solar use is battery market. Currently, the market is determined by the weather. dominated by consumer electronics, but As a result, the power generated when the growth lies in grid and automotive operating must be stored to meet demand markets, which although small could during periods of peak use. The effect is quickly become major contributors. exponential; as renewables’ share of the energy mix grows, demand for storage Figure 2: Li-ion demand from EV and grid storage requirements will increase disproportionately faster as traditional fossil fuel plants become Source: IEA Global EV Outlook 2016. Note: GWh (gigawatt hours) less able to meet fluctuations in demand. Storage capacity requirements will GWh therefore increase relative to growth in 5000 total power demand. 4000 Insofar as a significant proportion of the new power demand created by electric 3000 vehicles will be met with renewables, and 2000 those renewables will impose significantly higher energy storage demands on grid 1000 infrastructure, overall demand for energy 0 1 2 3 4 5 9 0 6 7 8 9 0 1 2 3 4 storage capacity will grow even more 5 6 7 8 quickly than EV use. 20 1 20 1 20 1 20 1 20 1 20 2 20 3 20 1 20 1 20 1 20 1 20 2 20 2 20 2 20 2 20 2 20 2 20 2 20 2 20 2

Li–on expected demand from EV’s (direct and indirect) assuming 25% market penetration Li–on demand from consumer electronics (assuming CAGR 8%)

13 Source: Schroders, The process of converting into electricity.

15 Responsible Investment Report | Q4 2016 Total company engagement

Our ESG team had 429 engagements this quarter with the 396 teleconferences, written correspondence and collaborative companies listed below, on a broad range of topics categorised engagements. under “environmental”, “social” and “governance”. They included For further details about the issues discussed and company one-to-one meetings, joint investor meetings, conferences, responses, please contact your Client Director.

Company E S G Company E S G

Consumer Discretionary Granada

Aisin Seiki H&R Block

Alibaba Haier Electronics

Bajaj Auto Harley-Davidson

Barratt Developments Haseko

Bed Bath and Beyond Hi-Lex

BorgWarner Home Depot

Bridgestone Host Hotels

Burberry Howden Joinery

Carnival Informa

Charter Communications Intercontinental Hotel

Chipotle Mexican Grill Interpublic

Compass ITE Group

Darden Restaurants Kingfisher

Debenhams Kohl's

Delphi Automotive Macy's

Dixons Carphone Marks and Spencer

Ford Marriott International

Garmin Mattel

General Motors Merlin Entertainments

Genuine Parts Mohawk Industries

GKN Netflix

Newell Brands

Key: E: Environment S: Social G: Governance

The companies mentioned above are for illustrative purposes only and not a recommendation to buy or sell. Source: Schroders as at 31 December 2016

16 Responsible Investment Report | Q4 2016 Total company engagement (continued)

Company E S G Company E S G

Next Consumer Staples

Omnicom AG Barr

O’Reilly Auto Altria

Paddy Power Betfair Anheuser-Busch

Pearson Associated British Foods

Persimmon British American Tobacco

Priceline Britvic

PVH Coca Cola

Ralph Lauren Costco

RELX Diageo

Ross Stores Estee Lauder

Sky General Mills

Staples Greencore

Starbucks Gruma

Target Hormel Foods

Taylor Wimpey Imperial Tobacco

Tegna Indofood

Trinity Mirror Sainsbury

Truworth Kellogg

TUI Kerry

Urban Outfitters McCormick & Company

VF Mead Johnson Nutrition

Walt Disney Mondelez International

Whitbread Nestle

WPP Group plc Pepsico

YUM! Brands Reckitt Benckiser

Tate & Lyle Key: E: Environment S: Social G: Governance

The companies mentioned above are for illustrative purposes only and not a recommendation to buy or sell. Source: Schroders as at 31 December 2016

17 Responsible Investment Report | Q4 2016 Total company engagement (continued)

Company E S G Company E S G

Tesco

Unilever

Wal Mart Sasol

Walgreens Boots Alliance

Morrisons

Woolworths Spectra

Energy

Baker Hughes Tenaris

BP Tesoro

Cabot Total

Chevron

Cimarex Valero

CNOOC Weatherford

Diamond Woodside

ENI Financials

EOG 3i Group

Exxon ACE

Halliburton Admiral

Kinder Morgan Affiliated Mangers

Marathon AFLAC

Murphy Ameriprise

Newfield AON

Lukoil Aviva

Petrofac Bank of America

Phillips 66 Barclays

Repsol BB&T

Berkshire Hathaway Key: E: Environment S: Social G: Governance

The companies mentioned above are for illustrative purposes only and not a recommendation to buy or sell. Source: Schroders as at 31 December 2016

18 Responsible Investment Report | Q4 2016 Total company engagement (continued)

Company E S G Company E S G

BlackRock Lloyds

BNP Paribas London Stock Exchange

Boston Properties M&T

British Land Marsh & McLennan

Capital One Metlife

Capital Morgan Stanley

Chesnara Old Mutual

Cincinnati PNC Bank

Citigroup Principal Financial

Close Brothers Provident Financial

Comerica Prudential

Credit Agricole Public Storage

Direct Line Royal & Sun Alliance

DNB Royal Bank of Scotland

Empiric Sampo

Essex Property Trust Charles Schwab

Extra Space Storage Simon Property

Fifth Third Bancorp Societe Generale

Goldman Sachs St Jamess Place

Hammerson Standard Chartered

Hargreaves Lansdown State Street

HSBC Synchrony Financial

Intesa Sanpaolo Ventas

JP Morgan Chase Waddell & Reed

Land Securities Weyerhaeuser

Legal & General Worldpay

Key: E: Environment S: Social G: Governance

The companies mentioned above are for illustrative purposes only and not a recommendation to buy or sell. Source: Schroders as at 31 December 2016

19 Responsible Investment Report | Q4 2016 Total company engagement (continued)

Company E S G Company E S G

Healthcare Medtronic

Abbott Patterson

Abbvie PerkinElmer

Alexion Pfizer

Allergan Quest

Amgen Regeneron

Ansell Shire

AstraZeneca Smith & Nephew

Baxter Thermo-Fisher

Biogen Universal Health

Boston Scientific Varian

Bristol Myers Squibb Waters

Celgene Zoetis

Centene Industrials

Cooper Companies 3M

Dentsply International ABB

Eli Lilly Air

Gilead Ametek

GlaxoSmithKline Ashtead

HCA BAE Systems

Henry Schein Boeing

Humana Bunzl

Illumina C.H. Robinson

Johnson & Johnson Capita Group

LabCorp Caterpillar

Mallinckrodt Chemring

China Communications Key: E: Environment S: Social G: Governance

The companies mentioned above are for illustrative purposes only and not a recommendation to buy or sell. Source: Schroders as at 31 December 2016

20 Responsible Investment Report | Q4 2016 Total company engagement (continued)

Company E S G Company E S G

China Railways Keppel

China State Kuroda Electric

CSX Larsen & Toubro

Cummins Lincoln Electric

DCC Lockheed Martin

Deere Nippon Densetsu Kogyo

DP World Paccar

Dun & Bradstreet Quanta

EasyJet Raytheon

Emerson Electric Republic Services

Equifax Robert Half

Expeditors Rolls-Royce

Experian Royal Mail

Fastenal Shanghai Electric

Fortive Smiths

Fortune Brands Snap-on

GEA Travis Perkins

Honeywell Union Pacific

IMI United Parcel Service

International Consolidated Airlines United Technologies

Intertek WEG

JB Hunt Weir Group

Johnson Electric Wolseley

Kansas City Southern Xylem

KBR

Keller

Key: E: Environment S: Social G: Governance

The companies mentioned above are for illustrative purposes only and not a recommendation to buy or sell. Source: Schroders as at 31 December 2016

21 Responsible Investment Report | Q4 2016 Total company engagement (continued)

Company E S G Company E S G

Information Technology Sage

Adobe Systems Salesforce.com

Amphenol Skyworks

Applied Materials Symantec

Automatic Data Processing Tencent

Broadcom Teradata

Cisco Systems Instruments

Citrix Xerox

Cognizant Xilinx

Corning Materials

Electronic Arts Anglo American

Fidessa Antofagasta

Google Avery Dennison

Hewlett Packard BASF

IBM BHP Billiton

Intel CRH

Linear Dominion Diamond

Micro Focus Dow Chemical

Microchip Technology Dowa

Micron DSM

Microsoft Du Pont

Motorola Ecolab

Nvidia Fresnillo

Oracle Gerdau

Paychex

Red Hat GMK

Goldcorp Key: E: Environment S: Social G: Governance International Paper

The companies mentioned above are for illustrative purposes only and not a recommendation to buy or sell. Source: Schroders as at 31 December 2016

22 Responsible Investment Report | Q4 2016 Total company engagement (continued)

Company E S G Company E S G

Johnson Matthey Utilities

LG Chemical Alliant Energy

Linde CenterPoint Energy

LyondellBasell Centrica

Mitsuboshi Belting CMS

Mondi Dominion

Petronas Drax

Pohang Entergy

Polymetal Eversource

PPG Industries Exelon

Randgold National Grid

Rio Tinto NextEra

Rusal Pacific Gas & Electric Co

Sealed Air Public Service Enterprise

Sherwin-Williams Scottish and Southern Energy

Sinofert Dominion Diamond

South32 Sempra

Symrise United Utilities

T & K Toka

Zhaojin

Telecommunication Services

AT&T

BT Group

CenturyLink

KDDI

Verizon

Vodafone

Key: E: Environment S: Social G: Governance The companies mentioned above are for illustrative purposes only and not a recommendation to buy or sell. Source: Schroders as at 31 December 2016

23 Responsible Investment Report | Q4 2016 Engagement in numbers

Companies engaged by region

136 233 30

36 4

UK 136 North America 233 4 Asia Pacifi c 36 Europe (ex-UK) 30 Middle East and Africa 4 Latin America 4

Source: Schroders as at 31 December 2016

Engagement type Engagement by sector

2% 3% 1% 3% 4% 18% 8% 9% 33%

58% 10% 16% 10%

15% 10%

One-to-one call Other (e.g. letter) Telecommunication Services Healthcare Group meeting Email Utilities Materials One-to-one meeting Information Technology Industrials

Consumer Staples Financials Energy Consumer Discretionary

24 Responsible Investment Report | Q4 2016 Shareholder voting

We believe we have a responsibility to exercise our voting rights. This quarter we voted on 546 companies and approximately We therefore evaluate voting issues on our investments and vote 95% of all our holdings. We voted on 5 ESG-related shareholder on them in line with our fi duciary responsibilities to clients. resolutions, voting with management on all 5. We vote on all resolutions unless we are restricted from doing The charts below provide a breakdown of our voting activity so (e.g. as a result of shareblocking). from this quarter. Our UK voting decisions are all available on our website at www.schroders.com/responsibleinvestment under “Voting”.

Companies meeting voted

94 70 117

216

93

UK 94 North America 70 Asia Pacifi c 216 Europe (ex-UK) 117 Rest of the world 93

Source: Schroders as at 31 December 2016 Direction of votes Reasons for votes against this quarter this quarter

0% 3% 1% 3% 1% 7% 8% 10% 41%

12%

88% 25%

For Abstain Reorganisation & mergers Routine business Against Other* Anti-takeover Allocation of capital Other Director related

Shareholder proposals Remuneration *Includes withheld or unvoteable resolutions, for example due to shareblocking. Note: Proxy voting in certain countries requires share blocking. If shareholders wish to vote their proxies in these countries, then the stock will be blocked from trading usually one week before the meeting until the meeting has taken place.

25 Responsible Investment Report | Q4Q1 2016 2016 Engagement progress

This section reviews any progress on suggestions for change we made a year ago, in this case the fourth quarter of 2015. There are four possible results: “Achieved”, “Almost”, “Some Change” and “No Change”. Of a total number of 41 “change facilitation” requests made, we recorded 10 as Achieved, 5 as Almost, 4 as Some Change and 22 as No Change.

24%

54% Engagement progress from Q4 2015 12%

10%

Achieved Almost Some change No change

The chart below shows the effectiveness of our engagement over a five-year period. We recognise that any changes we have requested will take time to be implemented into a company’s business process. We therefore usually review requests for change 12 months after they have been made, and also review progress at a later date. This explains why there is a higher number of engagement successes from previous years.

Achieved Almost Some Change No Change No Further Change Required*

Source: Schroders as at 31 December 2016. * This refers to requests that are no longer valid, for example if a company has been acquired or has changed its business activities.

26 Responsible Investment Report | Q4 2016 Responsible Investment Report Q4 2016

Schroder Investment Management Limited 31 Gresham Street, London EC2V 7QA, Tel: +44 (0) 20 7658 6000

schroders.com @schroders

Important information: The views and opinions contained herein are those of the consider to be reliable. No responsibility can be accepted for errors of fact obtained Environmental, Social and Governance (ESG) team, and may not necessarily represent from third parties, and this data may change with market conditions. This does not views expressed or reflected in other Schroders communications, strategies or funds. exclude any duty or liability that Schroders has to its customers under any regulatory This material is intended to be for information purposes only and is not intended system. Regions/sectors shown for illustrative purposes only and should not be as promotional material in any respect. The material is not intended as an offer or viewed as a recommendation to buy/sell. The opinions in this document include some solicitation for the purchase or sale of any financial instrument. The material is not forecasted views. We believe we are basing our expectations and beliefs on reasonable intended to provide and should not be relied on for accounting, legal or tax advice, assumptions within the bounds of what we currently know. However, there is no or investment recommendations. Reliance should not be placed on the views and guarantee than any forecasts or opinions will be realised. These views and opinions information in this document when taking individual investment and/or strategic may change. To the extent that you are in North America, this content is issued by decisions. Past performance is not a guide to future performance and may not Schroder Investment Management North America Inc., an indirect wholly owned be repeated. The value of investments and the income from them may go down subsidiary of Schroders plc and SEC registered adviser providing asset management as well as up and investors may not get back the amounts originally invested. All products and services to clients in the US and Canada. For all other users, this content investments involve risks including the risk of possible loss of principal. Information is issued by Schroder Investment Management Limited, 31 Gresham Street, London, herein is believed to be reliable but Schroders does not warrant its completeness EC2V 7QA. Registered No. 1893220 England. Authorised and regulated by the Financial or accuracy. Some information quoted was obtained from external sources we Conduct Authority. RC61558.