Sustainability

Impact on Capital Market Decisions

January 2011

FINE PRINT
Disclaimers All information and content presented here is subject to applicable statutes and regulations, furnished "as is," without warranty of any kind, expressed or implied, including but not limited to implied warranties of merchantability, fitness for a particular purpose, or non-infringement. Any overviews herein are intended to be general in nature and for current interest. These overviews are not a substitute for professional tax or professional legal advice. Neither Ativo Capital Management LLC, Ativo Research LLC nor its representatives is providing tax, financial or legal advice in this presentation. The firm has attempted to insure that all information provided via this presentation is accurate and error-free and makes no warranty that such information is accurate or error-free. Limited Li Li it d License This presentation may be transmitted or shared provided that it is not modified. Limitation of Liability This presentation is provided for informational purposed only and in no event shall Ativo Capital Management LLC or Ativo Research LLC be liable for any direct, incidental or consequential damages, including, but not limited to, (i) loss of anticipated profits, benefits, use, or data or (ii) injury caused by reliance upon the information contained within. Copyright Policy Ativo Capital Management LLC and Daniel T. Allen maintain a copyright of the text, logos and graphics contained throughout this presentation, except where specifically noted. All third party content and trademarks appearing within this presentation are the exclusive property of their respective owners. Unauthorized modification or extraction of any material contained in this presentation is prohibited.
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About the Ativo Group

The Ativo Group d Th A i G describes two separate, b affiliated fi ib but ffili d firms i l di including: Ativo Capital Management LLC, an SEC-registered investment advisor offering long-only equity asset management since 2001 in Separately Managed Accounts to both institutional and individual clients and as a sub-advisor for Model Portfolios and other structured products. Ativos approach begins with the principles originally developed by Merton Miller, Franco Modigliani, James Tobin and others at the University of Chicago. Ativos g , y f g unique contribution was the empirical validation that made these theoretical principles useful in making investment decisions. Ativo Research LLC, a Chicago based securities research firm that has been producing independent equity research since 1971. Ativo Research is consistently ranked as one of the top investment research firms in the industry by independent rating agencies such as Investars. Ativo Research is an industry pioneer in the practical real world application of valuation based finance theory (Chicago School) to real-world analysis of securities.
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Why is this topic relevant?

2006 2010 in just four years, around US$ 22 trillion of assets have been signed up to the Principles for Responsible Investment ( g p p p (PRI). ) This is more than 10% of total global capital markets
UNEP FI. (2010). A FI (2010) Annual Report of the PRI Initiative 2010. N Y k U it d Nations. lR t f th I iti ti 2010 New York: United N ti

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Religious Roots John Wesley, f J h W l founder of the Methodist d f h M h di Church, preached in his famous Sermon 50, The 50 "The Use of Money " that we must be Money, moral in all dealings with money so that we might g "gain all we can without hurting our neighbour."
John Wesley (1703-1791) Sermon 50, The Use of Money (1703 1791) 50 The Money The Sermons of John Wesley 1872 Edition (Thomas Jackson, editor)

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Civil Rights Movement The li i Th religious prohibition against hibiti i t sin stocks continued to be the main thrust until the 1960s when when, during the Civil Rights Movement, Dr. Martin Luther King, Jr. and others began to use economic power through boycotts as a means to create pressure f for change.
"Martin Luther King - Biography". Nobelprize.org. 23 Mar Martin Biography . 2011
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Angst Over Vietnam War

In 1972, Nick Ut won the Pulitzer Prize 1972 for his photograph of a naked and badly burned young Vietnamese girl, running from her village after a napalm attack.

Outrage over the incident led to widespread protests and investor revolts against Dow Chemical, the makers of napalm. The impact was so great that Dow Chemical stop manufacturing the chemical and vowed never to do so again.
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Broader Impact of Social Issues In th 1970 I the 1970s and 1980s, growing d 1980 i investor avoidance of South Africa eventually reduced international investments in South Africa by as much as 75% and is y believed to have added to the political pressure for that system to change. h

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Costly Environmental Disasters The E Th Exxon Valdez ran aground on Bligh V ld d Bli h Reef at 12:04 a.m., March 24, 1989. ($5 9 ($5-9 Billion) US EPA On April 20, 2010 the Deepwater Horizon explosion killed 11 men and was stopped finally capped after it had released about 4.9 million barrels, or 205.8 million gallons of crude oil. ($20 Billi Plus) GAO d il Billion Pl )
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Cost of Corporate Governance Misconduct Shareholders l t Sh h ld lost nearly $11 billion l billi when Enron's stock price, which hit a high of US$90 per share in mid 2000, mid-2000 plummeted to less than $1 by the end of November 2001 due to fraud. On July 21, 2002, WorldCom filed for Chapter 11 bankruptcy p p y protection after it was discovered that there financial records were fraudulent.

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More Irresponsibility in Governance

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Defining Sustainability S i ii

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Traditional Triple Bottom Line

Environmental Social Economic

John Elkington, (Sustainability, Inc.) 1984
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Broad Definition of Sustainability Development that meets the needs of the present without compromising the ability of future generations to meet their own needs.
(Brundtland Report 1987)

These definitions are accurate as societal definitions but are inadequate for organizations.
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An Organizational Definition

Sustainability i th bilit f S t i bilit is the ability of an organization to i ti t appropriately address direct and indirect risk factors hil i f t while increasing shareholder value. i h h ld l

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Sustainability is Primarily about Risk The hi t Th history of sustainability has been built upon f t i bilit h b b ilt recognizing both direct and indirect risks associated with behavior behavior. If sustainability is about risk then it must also be about return because risk and return are directly connected. In order to evaluate risk and return you, of necessity, must look at the cost of capital.

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Cost of Capital

Cost f C i l i h C of Capital is the expected return that is d h i required on an investment to compensate for the risk being taken. i kb i t k
The question is, how do we fully measure risk?

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How does Sustainability Impact Risk?

What is the risk premium/discount associated with the way an organization is managing indirect financial metrics (i.e. ESG)? p y What is the likelihood a company will suffer a tail risk event? Does the return on investment appropriately reflect the risk profile of the investment? Does the company operate in a way that reflects investor preferences? Is the company missing out on or alternatively taking advantage of emerging opportunities in the market?

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Measuring Risk

Direct Internal Criteria Indirect I di t Internal

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Direct External

Indirect I di t External
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How is Sustainability being integrated?

Most firms have struggled to make a compelling business case for sustainability initiatives.
1. Qualitative criteria variations of the right thing to do 2. Profitability Sustainable practices increase revenue and reduce costs, leading to improved long-term profitability 3. Investor Preferences & Stock Price Investors (equity markets) shift ( q y ) capital to firms with higher sustainability rankings, resulting in higher share prices and improved shareholder value performance Linking sustainability to stock price provides a persuasive (and quantitative) case that sustainability initiatives help executives achieve targets for creating shareholder value
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Impact on Cost of Capital

Preliminary research by CharterMast / Ativo indicates that there is a 50-70 bps impact (depending on industry and sector) surrounding adherence to ESG best practices for those areas in which there is economic opportunity for or risk to the company. Given th t only a little over 10% of the global capital market is Gi that l littl f th l b l it l k ti looking at these factors, it is highly likely that the impact will increase dramatically over time. Obviously, the exact amount will depend on the elasticity of the various capital markets.

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Summary The Th concepts surrounding sustainability are not new. t di t i bilit t The concept goes back thousands of years. What is new is that the capital markets are now seeking ways to quantify the opportunities and risks and y q y pp develop meaningful ways to measure the financial impact of corporate behavior. Sustainability will impact every business in every industry and in time will become the new norm. and, time, norm
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Questions and Answers

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Additional Information
For more information, please free to contact me: Daniel T. Allen Director ESG Initiatives Ativo Research LLC 312-263-7600 312 263 7600 x107 dallen@AtivoGroup.com You Y are i i d to join ESG I invited j i Investing on Li k dI i LinkedIn

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Fannie and Freddie

I do not want the same kind of focus on safety and soundness that we have in OCC [Office of the Comptroller of the Currency] and OTS [Office of Thrift Supervision]. I want to roll the dice a little bit more in this situation towards subsidized housing. . . . Representative Barney Frank House Financial Services Committee hearing, Sept. 25, 2003

It is not just corporations.

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