Generating sustainability alpha in frontier equity markets

Kevin Macdonald, Managing Director

SUSTAINABLE CAPITAL

TBLI CONFERENCE 2011

Introduction

• Sustainable Capital: Africa ex-SA, sustainable investment, listed equities

• Research experience: June 2008 > 350 management interviews

• Investment philosophy: ESG integration = outperformance

• Sustainability Alpha: Exploit chronic security mispricings

• Practical feedback: Africa-specific challenges, case study

Why Sustainable Investment in frontier markets?• Long-term time horizon: 5-10 years, portfolio turnover, efficiency, engagement

• Downside risk focus: Country and company level

• Detailed due diligence: In-situ research

• Quality filter: Management, assets, earnings, operating environment

• Performance: Sustainability alpha = 7.74% since inception after trading costs

• Lower risk: Portfolio beta = 0.72, Sortino ratio = 2.01

• Unlock value: Direct, targeted, collaborative engagement

COPPER MINING

BANKS

Case studies of

sustainable

investment practice

in Africa ex-SA

(Source: Sustainable Capital,

proprietary in-house research)

Sustainability alpha: Case studies• Research: In-house, proprietary conducted in-situ by Sustainable Capital

• Company sustainability assessments: Detailed > 150 companies

• Country sustainability assessments: Pan-Africa

• Measuring ‘sustainability alpha’: Portfolio attribution

• Time periods: Since inception or event-driven

• Price data: Total returns in USD

Company Sustainability Analysis

• Corporate governance quality: Transparency, alignment, integrity

• Lending practices: Integration of material ESG factors

• Human capital: Management quality, sustainability intelligence

• Loan book exposure: Underlying sustainability footprint

• Stakeholder capital: Central bank, customers, competitors

Case study: Nigerian banking crisis

Nigerian Banking Crisis

Peak of the equities

bull marketUS / European

financial crisis

Nigerian banking crisis unfolds

-92%

-73%

377%

31%

  PRICE TO BOOK RATIO BOOK VALUE PER SHARE

  1 JAN 06 1 JAN 09 1 JAN 11 30 AUG 11 1 JAN 06 1 JAN 09 30 AUG 11

GUARANTY 1.7 0.9 1.9 1.5 5.4 11.7 8.8ACCESS 1.4 0.6 0.9 0.6 1.7 10.6 9.8OCEANIC 1.8 1.2 - - 3.3 9.7 -INTERCON 0.9 1.2 - - 9.7 11.2 -

 SUSTAINABILITY RATING (2008)

GUARANTY 85.0ACCESS 77.0

OCEANIC 9.0INTERCON 8.5

• Corporate governance: Severe conflicts of interest, misleading financials

• Lending practices: Prudence, material ESG risks ignored (NPLs 50%)

• Loan book exposure: Downstream oil and gas, margin lending

• Stakeholder capital: Regulatory intervention

• Human capital: Senior management and boards fired

• Financial impact: Asset quality deterioration, earnings collapse

Nigerian banking crisis

Nigerian Banking Crisis (2009-2011)

1%

131%

-95%

-90%

+1,000% return required to

recover capital loss

Acquisition of

Intercontinental

announced

31/12/10: 143%

31/12/10: 59%

Nigerian banking

crisis unfolds

  PRICE TO BOOK RATIO

  1 JAN 06 1 JAN 09 1 JAN 11 30 AUG 11

GUARANTY 1.7 0.9 1.9 1.5ACCESS 1.4 0.6 0.9 0.6OCEANIC 1.8 1.2 - -INTERCON 0.9 1.2 - -

 SUSTAINABILITY RATING (2008)

GUARANTY 85.0ACCESS 77.0

OCEANIC 9.0INTERCON 8.5

GUARANTY / INTERCON

Nigerian

banking

crisis

127 x

Long-term time horizon required to unlock chronic market inefficiencies

• Corporate governance: Wide divergence, company-specific

• Market inefficiencies: Chronic mispricing of material ESG risks

• Banking crisis: Catalyst for recognition of quality

• Shareholder value: ESG factors reflected in financial performance

• Stock selection: Sustainability alpha

Conclusions: Nigerian banking crisis

Case study: Copper Mining in Zambia / DRC• Business quality: Management ethics, anti-corruption / bribery practices

• Sustainability footprint: Life cycle impact, mining method, rehabilitation

• Country sustainability risk: ‘Title, title, title’ (contract enforcement)

• Materiality: Political stability, control of corruption, rule of law, infrastructure

• Stakeholder capital and licence-to-operate: Energy and water security

• Impact on society: Safety track record, community and government

Country Sustainability Analysis

EQUINOX (ZAMBIA) / KATANGA (DRC)

Kolwezi DRC USD787m asset

expropriated

Country

sustainability

alpha

Katanga moves into

loss-making position,

USD250m rights issue

DRC Government

‘reviews’ mining rights

815%

309%

-58%

COPPER MINING

SUSTAINABILITY RATING (2008)

FIRST QUANTUM 41.7EQUINOX MINERALS 56.8

KATANGA MINING 0.0

  PRICE TO BOOK RATIO BOOK VALUE PER SHARE

  JUL 07  JAN 09 JAN 11 SEPT 11 JUL 07 JAN 09 SEP 11

FIRST QUANTUM 6.3 0.7 3.4 0.7 5.0 20.4 35.3

EQUINOX MINERALS - 0.9 2.9 - - 1.2 2.2

KATANGA MINING 28.4 0.1 1.8 1.7 0.1 4.1 0.9

EQUINOX (ZAMBIA) / KATANGA (DRC)

Katanga Mining:

• Exceptionally high country risk

• Insecure title

• Poor sustainability practices

• Material value destruction

24 x

Equinox Minerals:

• Relatively low country risk

• Established licence-to-operate

• High-quality asset: 40-year mine life

• Low on cost curve: USD1.2/lb

• Well-managed, single operation

Copper Mining: Conclusions

• Country risk: Rogue governments and contract enforcement

• Corruption: Where ‘doing the right thing’ makes no difference

• Operating environment: Country and industry-specific analysis

• Downside risk protection: The case for selective negative screening

• Value destruction = Poor quality company + Peak of the cycle

• Sustainability analysis: Quality filter, long-term, capital protection

. %12 90

. %5 16

. %7 74

.0 0 .2 0 .4 0 .6 0 .8 0 .10 0 .12 0 .14 0

TOTAL ALPHA

FUNDAMENTAL ALPHA

SUSTAINABLE ALPHA

Alpha % since fund inception (relative to MSCI Africa ex-SA index)

AFRICA SUSTAINABILITY FUND: SUSTAINABILITY ALPHA ATTRIBUTION

% of60 the Africa Sustainability Fund's outperformance since its 

inception is attributable to the integration of country and company 

sustainability assessments into portfolio construction.

Reported alpha is based on total fund returns in

USD since inception (Sustainable Capital reports its

performance in line with the CFA Institute's Global

Investment Performance Standards)

Reporting period: 1 November 2009 - August 31 2011

0102030405060708090

AFRICA SUSTAINABILITY  FUND: Portfolio  Scoring  - Company Level

ASF Fundamental Portfolio Market Cap Portfolio

Portfolio Scoring: Measuring Impact

Conclusions• Major divergence in company sustainability performance

• Chronic and material market inefficiencies

• Unlock mispricings over long-term time horizons

• Integrating sustainability performance into portfolio construction

• Performance attribution: Measuring ‘sustainability alpha’

• Downside risk protection: Reflected in risk-adjusted returns

• The good news: greater ability to generate alpha, ends fiduciary duty debate

• The bad news: No stuffed chairs!

ありがとうございます。

THANK YOU

-10%

-5%

0%

5%

10%

15%

20%

Oct '09

Nov '09

Dec Jan '10

Feb Mar Apr May June July Aug Sept Oct Nov Dec Jan '11

Feb Mar Apr May June July Aug

Performance since inception (1 Nov 2009) to 31 August 2011 (GIPS)

Africa Sustainability Fund (0.57%)

MSCI Africa ex-SA (-12.33%)

3.7

1.4 1.3 1.41.7

-3.1

-2.1

-1.4

-0.7

-2.2-2.8

-0.7

0.5

-0.2

6.7 6.7

5.6

6.9

4.7

3.94.2

5.2

3.4

5.6

2.0

3.02.7

3.4

4.3 4.54.0

5.7

9.1

6.6

5.0

6.3

3.8

4.9 5.0

3.9

5.8

6.97.2

7.7

7.0 7.0

3.3

4.4 4.3

0.2

2.2

3.1 3.3 3.5

6.36.0

5.56.1

10.5

11.7

10.6 10.810.5 10.7

11.3

12.9

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

Alpha relative to MSCI Africa ex-SA (total returns, USD)

FUNDAMENTAL ALPHA

SUSTAINABILITY ALPHA

TOTAL ALPHA

AFRICA SUSTAINABILITY FUND: BREAKDOWN OF CUMULATIVE ALPHA SINCE INCEPTION

Period: November 2009 to August 2011

BENCHMARK MSCI AFRICA EX-SA

PORTFOLIO BETA 0.72

CORRELATION 0.90

TRACKING ERROR 6.6%

INFORMATION RATIO 1.09

RELATIVE DOWNSIDE STD. DEVIATION 3.6%

SORTINO RATIO 2.01

SINCE INCEPTION (annualised)

AFRICA SUSTAINABILITY FUND - RELATIVE RISK RETURN

Period: November 2009 to August 2011

FUND MSCI AFRICA EX-SA

STANDARD DEVIATION 11.9% 14.7%

DOWNSIDE STD. DEVIATION 8.0% 10.4%

AFRICA SUSTAINABILITY FUND - ABSOLUTE RISK