Mobilizing Institutional Investors to Tackle Climate Change Frédéric Samama Deputy Global Head of Institutional Clients March 2015 Low carbon Indexes:

Mobilizing Institutional Investors to Tackle Climate Change

 Frédéric Samama Deputy Global Head of Institutional Clients

 March 2015

Low carbon Indexes: “A free option on a mispriced asset”

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Executive Summary Asset owners approach to climate change is paradoxical:

– Wide recognition of climate risk as a long-term threat to their asset;– With very little being done so far.

There are three reasons:– Issue that does not match with investment horizons;– Complexity;– Lack of scalable solutions.

A different approach can be set-up: decarbonization of indexes– Low carbon index : a free option on a mispriced asset;– US$10tn market.

Amundi is a leader in that field:– Launch of innovative low carbon indexes;– Founding partner of the Portfolio Decarbonization Coalition ($35bn already achieved);– Academic partnership (with Columbia University);– Partner of the French Government (COP21);– Best practices sharing events : Columbia workshop and Bellagio Seminar.

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Climate Change: A Debate Becoming more Intense

(1) See article of Martin Wolf article in the Financial Times, June 17 th 2014

(2) See article of Henry Paulson in the New York Times, June 21st 2014

(3) Hearings at the Bank of England

“If that happened, fossil fuel reserves would indeed be stranded. Investor beware: the risk of that cannot be zero.” 1

Martin Wolf (17th June 2014)

“We’re staring down a climate bubble that poses enormous risks to both our environment and economy.” 2

Henry Paulson (21st June 2014)

AP4 (Fjärde AP-fonden) has developed a strategy where it underweights high carbon assets. “It’s an intelligent way of motivating behavior than directly divesting out of oil,” “Divesting out of oil is a bit like a blunderbuss, it doesn’t give any incentives for companies.“With the AP4 way you get incentives from companies in industry to perform better. AP4 has found that performance has improved in straight vanilla finance’ 3

Lord Stern (26th February 2015)

Climate Change: a Need for Solutions

A major threat AndComplex situation

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A real need to: (i) analyze and disclose the risks and (ii) develop new solutions

Lack of Action

Long-term issue (that does not match with investment horizons);Complexity (technologies and incentives);

Lack of scalable solutions.

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Low Carbon Investment Solutions

• * Can also include Stranded assets• ** Hierarchization of objectives, exclusion policy, fine tuning depending of geographical area, etc.

Carbon reduction target: – Active security

selection**– Low carbon

economy focus

Change portfolio weights:– Reduce carbon

exposure*– Minimize tracking

error

Active Passive

Stock Picking Overlay

Advisory/analysis of the risks

Short-selling of portfolio securities with the highest carbon footprint*

Standard Indices New Indices

Low carbon index

Low CarbonStrategies

Two Major Risks

Polluting And Stranded Assets

Fossil fuels companies: mainly valued on their reserves.

Reserves exceed the budget of the planet:

Reserves : 2,795 GtCO2;

Budget : 1,437 GtCO2 (2)

No taxation

No cost for negative externalities: impact on the planet, assets, bodies…

Direct subsidies

Fossil fuel : $480bn ( 1)

(1) IMF (2013)

(2) For a 50% probability to stay under a 2° increase scenario

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Products: Low Carbon Indexes

* For illustration purpose

Provider’s Selection

Then RiskReduction

Carbon footprint:X% reduction of companies with the highest carbon footprint (intensity)

Stranded assetsZ% reduction of carbon reserves (intensity).

Index Provider (MSCI)*Carbon Data Provider (MSCI)*

Then TE Reduction

Optimization of the weights Regular rebalancings

Simple, Transparent and Ruled Based Approach.

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Products: A Straightforward Message

NB: Random simulations with annual volatility at 20%, annual expected return 7% and a 0,5% TE.

Generates a Free Option:• Either no climate change impact : same performance;

• Or a climate change impact : outperformance.

1 2

Benchmark Low Carbon Low TE Benchmark Low Carbon Low TE

If no repricing: same performance

If repricing: Outperformance

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Focus on MSCI Europe Low Carbon Leaders

Source: MSCI

* Gross returns annualized in EUR for the 11/30/2010 to 08/29/2014 period.

** Annualized one-way index turnover for the 11/30/2010 to 06/30/2014 period.

Key metricsMSCI

EuropeMSCI Low Carbon

Leaders

Total Return* ‘(%) 11.1 11,7

Total Risk* (%) 11.7 11.6

Sharpe Ratio 0.91 0.97

Active Return* (%) 0 0.6

Tracking Error* (%) 0 0.7

Information Ratio NA 0.89

Turnover** (%) 1.9 9.9

Securities excluded NA 91

Market cap excluded (%) NA 23.5

Carbon Emission intensity reduction (tCO2/mm USD) (%)

NA 62

Carbon Reserves intensity reduction (tCO2/mm USD) (%)

NA 81

A major reduction of:– Carbon Emissions (-62%);– Stranded Assets (-81%).

A low tracking error: 0.7 %

A return over performing the benchmark: – 12.1% vs 11.5%– Even if supposed to be

forward looking

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Concrete Decarbonization by Institutional Investors MSCI Low Carbon indices developed alongside

AP4 and FRR and Amundi1:– FRR and AP4 announced they plan to invest up to

EUR 2bn to seed these strategies;

Tailored decarbonization approach with ERAFP2:– Keep the same reference index;– Change portfolio weights to decarbonize;– Announced the decarbonization of EUR 750M with

Amundi.

(1)http://www.msci.com/insights/responsible_investing/msci_launches_innovative_family_of_low_carbon_indexes.html

(2) http://www.lesechos.fr/journal20140923/lec2_gestion_d_actifs/0203782634292-philippe-desfosses-lerafp-va-decarboniser-son-portefeuille-dactions-de-la-zone-euro-1045591.php

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Academic: Paper Co-Written with Columbia and AP4

Andersson, Bolton & Samama (2014)

Methodologies are not ‘equal’:– Signaling is key to generate right incentives;– And get effective decarbonization on the

ground.

One of the 10 most downloaded papers over the last month (available on SSRN):http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2499628

High visibility:– “Long-termism, the problems with capitalism

and other holiday reading” (Dec 2014)– http://www.top1000funds.com/opinion/

2014/12/18/long-termism-the-problems-with-capitalism-and-other-holiday-reading/

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Portfolio Decarbonization Coalition

High-level coverage:– President Hollande (press conference);– Ban Ki-moon (op-ed in WSJ).

Supporting entities:– Joined : AP4, Church of Sweden, FRR, Australian

Ethical Investment, University of Sidney;– Grant : Government of Norway.

 http://unepfi.org/pdc/

Portfolio Decarbonization Coalition:– Created by Amundi, AP4, CDP, UNEP/FI;– Ambitious targets:

 $500bn of assets risks assessed; $100bn of assets decarbonized.

$35bn already committed

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2015 Sharing of Best Practices among Asset Owners March 9th 2015: Columbia University workshop:

– A. Stausboll, CEO of CalPERS;– B. Litterman, , Investment Committee, WWF;– M. Eriksson, Deputy CEO, AP4;– P. Desfosses, CEO, ERAFP;– C. Grossman, World Bank Group, Director, Climate

Change;– I. Perry, IMF, Principal Environmental Fiscal Policy Expert

April 7th: Rockefeller seminar at Bellagio:– M. Andersson, CEO, AP4;– P. Canfin, Senior Advisor for Intern. Climate Affairs, WRI;– P. Desfossés, CEO, ERAFP;– H. Huang, Global Head of Research, CICC;– B. Litterman, Investment Committee, WWF;– J. Oppenheim, Director, McKinsey;– O. Rousseau, CEO, FRR;– S. Tortajada, Head of Financing, EDF

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Conclusion

(1) Source: www.CDP.net as at 2014. “CDP Initiative is backed by more than 767 institutional investors representing an excess of US$92 trillion in assets.”

(2) Boston Consulting Group , Global Asset Management 2014 – Steering the Course to Growth

Carbon investment is a real challenge for most investors and they:

– Must analyze and disclose their risks

– Consider carbon as an investment opportunity

In sum: investors can generate a free-option on a mispriced asset.

Such solutions could be a base for further developments:– Country selection based on political sensitivity to climate change; – Replication on other themes (e.g. water, waste, etc.).

Possible mobilization of a vast amount of money:– Investors with a green interest represent $92 trillion1;– Passive management sums up to $10 trillion 2.

Portfolio Decarbonization Coalition: – Sharing of best practices to mobilize investment flows toward the low carbon economy;– $35bn commitment already achieved.

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