This document discusses how environmental, social, and governance (ESG) factors can impact investment portfolios if not properly managed. It uses two case studies of oil companies, BP and Petrobras, to illustrate how ESG risks materialized in major accidents and affected share prices. The document also summarizes Mercer's research on ESG integration among asset managers, finding that leading managers have dedicated resources, structured processes, and long-term investment horizons to systematically identify and address ESG risks. Effective stewardship of ESG factors is an important part of protecting shareholder value over the long run.

1. 25th November 2010
Managing ESG Risks in
Portfolios
Will Oulton,
Head of RI - EMEA
Mercer Limited is authorised and regulated by the Financial Services Authority
Registered in England No. 984275 Registered Office: 1 Tower Place West, Tower Place, London
EC3R 5BU

2. Agenda
Introduction
ESG Risks – Case Study, Oil & Gas
ESG & Regulatory Risks - Stewardship
Manager ESG Integration – Case Studies
Summary
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3. BP Strategy Presentation to Analysts March 2010
& Sarasin
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4. Delivered strong financial results
& Sarasin
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5. And then disaster struck – 20th April 2010
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6. Are analysts watching the “right” indicators...
& Sarasin
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7. Management quality is a key indicator
& Sarasin
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8. Cost pressures........deliver higher margins
& Sarasin
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9. Petrobras – P36 Platform – May 2000
“Petrobras has established new global benchmarks for the generation
of exceptional shareholder wealth through an aggressive and
innovative programme of cost cutting on its P36 production facility.
Through an integrated network of facilitated workshops, the project
successfully rejected the established constricting and negative
influences of prescriptive engineering, onerous quality requirements,
and outdated concepts of inspection and client control.
The P36 platform shows the shape of things to come in unregulated
global market economy of the 21st Century.”
(Petrobras, P36 Inauguration)
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10. 15 – 20th March 2001
Going.....
Going.....
Gone.....
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11. Safety compromised - sound familiar?
11 people died on the P-36 rig.
“Family members of oil workers on the P-36 say they believe pressure
by the company for increased production may have led to corners
being cut on safety procedures.”
Source: BBC News March 2001
In 2009, Petrobras announced a market capitalization plan to finance its future
investments in ultra-deep oil exploration. The share offering in the Brazilian
Stock Exchange took place in September 2010, becoming the largest market
capitalization in history, with US$ 69,97 billion in shares issued.
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12. Forecasting
"We don't like their sound, and guitar music is on the way out."
Decca Recording Co. rejecting the Beatles, 1962.
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13. Forecasting and anticipating risk
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14. Mapping Key Industry Codes – expect further developments
What codes relate to who?
Name of Industry Code Sponsor Aimed At
UK Stewardship Code FRC Asset managers*
Dutch Stewardship Code Eumedion ?
UK Corporate Governance Code FRC Corporates
Corporate Governance Policy and Voting NAPF Corporates and investors**
Guidelines (UK)
ABI Remuneration Guidelines (UK) ABI Corporates and investors
UN Global Compact United Nations Corporates
UN Principles for Responsible United Nations Investors
Investment
Global Corporate Governance Principles ICGN Corporates and investors
OECD Corporate Governance Principles OECD Corporates
* Note all institutional investors are encouraged to comply with the Code
** Investors refers to both investment managers and asset owners
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15. Why is Stewardship Relevant to our Clients?
Mercer supported the introduction of the UK Stewardship Code.
Protect and enhance shareholder value.
Consistent with application of fiduciary duties.
Helps “typical” schemes strengthen their investment policies.
Meet the expectations of beneficiaries and other stakeholders.
Demonstrate investor responsibility and leadership.
Useful additional information for manager selection and monitoring.
Enhance transparency and accountability from managers.
Enhance the wider investment system.
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16. Mercer’s ESG ratings – Proxy for a View on Current Practice
Equity strategies by ESG rating
ESG4
ESG3
ESG2
ESG1
Number of rated strategies
0 200 400 600 800 1000 1200
ESG manager research has been integrated into Mercer’s
manager research capabilities since April 2008.
Over 4,000 strategies rated ESG1 (the highest rating).
Extensive coverage of all asset classes.
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17. ESG integration in action
BP oil spill – case studies
Asset manager 1
– Resources: In-house team dedicated to identifying ESG factors that impact
particular sectors.
Analysis undertaken on all equity holdings and assign scores for use in fundamental
analysis.
– Prior to oil spill: ESG analyst responsible for oil and gas assigned BP a score
slightly above average. The ESG analyst discussed this rating and concern over
company health & safety statistics with the financial analyst counterpart, and
determined the concern was ‘valuation-neutral’ (i.e. it was not significant enough to
impact the valuation) although there was additional concern about BP’s past five
years of remuneration reports. As a result, in March 2010, the manager continued to
underweight shares of BP compared to the index.
– Immediately after oil spill: Following the Gulf of Mexico spill, the ESG analyst
downgraded BP to reflect reduced confidence in the company’s health and safety
management, which resulted in an adjustment to the weighted average cost of
capital and, thereby, a reduction in the target valuation. At this point, the manager
began to close its historically underweight positions.
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18. ESG integration in action (2)
BP oil spill – case studies
Asset manager 2
– Resources: Combination of in-house specialists and third party research to gather
information about companies’ ESG performance. Information available across the
firm for integration into the stock selection and valuation process. The manager also
uses an engagement process as an input into the investment decision-making
process.
– Prior to oil spill: Historically, had “minimal or zero exposure to BP across all funds
in our group” partly due to ESG-related concerns. Based on fundamental research
and engagement activities, including conversations with other companies involved
with offshore drilling and conversations with BP’s management, the manager
determined that the level of risk associated with execution of health and safety
management was not reflected in the company’s stock price.
– Immediately after oil spill: No change
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19. Mercer’s ESG Ratings
Common characteristics among leaders
A policy stating a firm-wide commitment to ESG integration
Dedicated resources or expertise to facilitate ESG integration
Structured process for voting and engagement
Process for building ESG factors into valuation metrics
Willingness to collaborate with other investors
Long-term investment horizon
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20. Summary
ESG factors can comprise risks to long term value protection and
therefore overall portfolio performance
“Conventional” investment analysis is not sufficient
We are not good at forecasting systemic risks
Understand differences between manager approaches
Monitor managers over time and be clear in investment policy
Better informed managers should be “better” investors
Effective stewardship is an integral aspect of investor responsibility
and can be an important element in both protecting and enhancing
long term shareholder value.
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21. Mercer Limited is authorised and regulated by the Financial Services Authority
Registered in England No. 984275 Registered Office: 1 Tower Place West, Tower Place, London
EC3R 5BU