Sustainability across asset classes

To optimise our long-term investment performance, LGS invests in a broadly diversified portfolio of different asset classes. LGS is aiming to introduce its sustainability policy across all these asset classes. Our approach to implementing differs for each asset class

Australian and International Listed Equities

Socially Responsible Investment Overlay

The Trustee has determined that the Scheme will not make investments in companies that derive more than 10% of their revenues in the following areas of activity:

1. Armaments
2. Gambling
3. Nuclear / Uranium
4. Old Growth Logging
5. Tobacco
6. Poor Mining Practices
7. Questionable Work-Place Practices
8. Questionable Environmental, Social or Corporate Governance Practices.

This policy has been in place for the LGS Australian equities portfolio since 2004 and in 2011 is being expanded to cover our international equities portfolio.

To ensure an objective process, LGS uses the services of dedicated external ESG research providers to determine which companies pose the greatest ESG risk.

Implementing the SRI overlay

Where possible, agreements with external investment managers will specify that companies in these restricted industries must be avoided. Where it is not possible for managers to do this, LGS will aim to eliminate the exposure to these activities by our internal investment team "shorting" the same number of securities. These shorted companies are then replaced by investments in companies that are rated highly on ESG issues.

LGS has applied investment constraints to the operation of the SRI overlay to ensure that investment performance is not adversely impacted during periods of excessive short-term market volatility. This may result in excluded company "shorts" being lifted, before being reapplied once market conditions settle.

Proxy voting and engagement

LGS employs its shareholder rights as an owner of companies by actively undertaking proxy voting at the shareholder meetings of all ASX200 companies and 500 of the largest listed international companies.

Click Here to download LGS' latest Proxy Voting Reports

Shareholder proxy voting is a way for superannuation funds to demonstrate their interest in the governance practices of companies and by exercising their right to vote, the funds can have an influence on the companies in which they invest.

One contentious issue that LGS has taken a strong stance is voting against company resolutions that are considered to grant excessive executive and director remuneration packages.

LGS is a Foundation Member and client of an external expert group the Australian Council of Superannuation Investors (ACSI) who provide LGS with voting recommendations for Australian and international shares. ACSI has developed Corporate Governance Guidelines that underpin its voting recommendations. These Guidelines are a set of practices that ACSI believes companies should follow to achieve best practice corporate governance. They cover 25 topics, including board structure and operation and executive compensation.

As a broad rule, LGS votes in accordance with ACSI recommendations, however LGS will also consider voting against additional recommendations where it believes there is significant investment and ESG issues at risk. All contentious issues are referred to the Investment Committee for approval.

Engagement

LGS also actively engages with companies to discuss material ESG issues with their senior management and board.

The engagement process aims to highlight and then obtain positive outcomes on ESG issues affecting companies. Engagement is typically conducted privately between investors and companies and is often the first step and preferred option prior to lodging public shareholder resolutions for proxy voting.

LGS is a foundation member of the Australian Council of Superannuation Investors (ACSI) and utilises ACSI to assist in ensuring that there is adequate scrutiny in the governance policies of listed companies. Click here to access ACSI's latest Engagement report.

LGS is also a part owner and subscriber to Regnan, a company dedicated to research and engagement services that promote improved ESG performance from Australian companies. Click here to access Regnan's latest Engagement Report.

Through these organisations, LGS is able to engage with companies using a collective voice with other institutional investors.

Direct Property

The business case for greening the LGS Property portfolio

Direct Property is an asset class where LGS believes that a clear and direct link between sustainability and long-term investment strategies is emerging and will only get stronger as management strive for energy, water, and recycling efficiencies.

Property has an enormous environmental footprint. It is estimated that the built environment consumes between 25% and 40% of the world's water and energy and contributes similar levels of carbon dioxide emissions. As such, property owners are subject to the cost impost of any environmental or climate change related regulations. We are seeing this in Australia already with discussions of a carbon price and rising energy prices exacerbated by inertia and uncertainty in wholesale electricity transmission markets (itself largely due to lack of clarity on carbon pricing).

There is also a growing amount of literature and business case studies of the commercial benefits of green buildings. Growing tenant demand for buildings with a high sustainability rating is being driven by major corporations as well as all levels of government. This is reinforced by recent regulations relating to the mandatory disclosure of buildings' energy rating and Governments stipulating that their own departments must occupy buildings with demanding energy efficiency rating levels.

LGS' award-winning sustainability initiatives across its entire direct property portfolio are an example of a "win win" situation, both environmentally and financially. The growing tenant demand for green buildings is starting to translate to the emergence of higher rentals and lower vacany rates, feeding into the valuations of our properties.

LGS history and approach to greening our Direct Property portfolio

LGS has developed and implemented a comprehensive environmental policy for Direct Property. This covers the following areas

• Waste Reduction And Recycling
• Water Conservation
• Energy Management
• Indoor Environment Quality
• Operation And Maintenance
• Materials And Resources
• OH&S And Liability Management
• Environmental Risk Management

LGS adopted its initial Property Environmental Policy in 2004 and since then LGS has regularly reviewed our practices in this area. A brief history of that process is summarised as follows:

• 2004 - Initial policy approved by Board leading to energy saving and sustainability practices being adopted throughout the portfolio.
• 2005 - First review and new targets were adopted - philosophy of continuous improvement in environmental performance introduced
• 2007 - Adoption of 100% GreenPower for all LGS buildings and all new tenants became mandatory. Target of converting 75% of all tenants to GreenPower by December 2012. As at 31 December 2010, we are at 53% participation and on track to meet the target.
• 2010 - Grant funding received from the Australian Government's Green Building Fund, which made it economic for LGS to install leading Australian lighting and air conditioning technologies.

From this LGS has set the target to its base building NABERS rating average of 4.5 stars by January 2012 across the entire portfolio. We are also involved in exemplar projects that will aim to showcase leading Australian made technologies that are able to achieve significantly higher energy ratings in existing buildings.

Please view LGS Property environmental performance and case studies for more information of the work that we have completed on some of the buildings in the LGS portfolio. We will continue to add to our case studies and, as part of receiving the grant funding from the Green Building Fund, will report on our findings on the financial and commercial benefits of greening the LGS Property portfolio.

LGS Property awards and industry Involvement

2009 - NSW Government Green Globe Award - Commercial Buildings - awarded a Green Globe Award for Commercial Property Sustainability recognising our efforts to actively reduce our environmental footprint.

LGS is actively involved in the following property related industry groups:

• Australian Direct Property Investment Association (ADPIA)
• Australian Property Institute (API)
• Property Council of Australia
• Green Building Council of Australia
• Business Treading Lightly
• Total Environment Centre (Existing Buildings Project)
• Cityswitch Partnership
• Earth Hour (WWF)
• Facility Managers Association (seminar presentations)

LGS Property environmental performance and case studies

Click here to read about individual property Case Studies

LGS Property Portfolio's environmental performance

Other asset classes

Fixed interest securities

Fixed interest securities (such as government and corporate bonds) are an asset class that has multiple issues involved in integrating ESG concerns. This has resulted in fewer strategies and products currently being available for superannuation fund investors. LGS continues to look at options in this area in accordance with its Sustainable and Responsible Investment Policy and is encouraging external managers to develop products. We are looking also considering applying the SRI Overlay to our fixed interest mandates where appropriate

Private Equity, Infrastructure, Absolute Return, Defensive Illiquids

LGS allocates a small proportion of its portfolio to assets referred to as 'private equity', 'infrastructure', 'absolute return' and 'defensive illiquids'.

We are continuing to develop strategies to incorporate our Sustainable and Responsible Investment Policy in these asset classes. Generally, these assets classes are a higher risk-return and longer term propositions and as such can be suitable for investments in emerging technologies and services.

This in turn enables LGS to be able to look at technologies often called "clean tech" that offer commercial solutions to address climate change and other environmental issues.

To date LGS has invested approximately $50m across these asset classes in clean tech related product opportunities. This is giving LGS members exposure to investments that address climate change - an area where we believe there will be significant investment opportunities over the longer term.

External manager selection and monitoring

When selecting new investment managers, our due diligence includes a demonstration of how an assessment of ESG risks is incorporated into their investment process. The investment manager is asked to specify the resources available to analyse ESG risks, including personnel and their expertise, and their use of any external research services.

Managers are encouraged to discuss ESG and other risks in their investment reports to LGS. The LGS internal investment team monitors the investment portfolios of its investment managers to ensure that LGS' investment and ESG guidelines are adhered to. The team holds discussions with investment managers who do not adhere to LGS policy to reiterate the importance of these policies. If there are continual breaches of the investment policies, LGS may withdraw the investment mandate.

LGS is ensuring the ESG considerations are included in Investment Management Agreements with our external managers. These are already in place for managers in that are involved with LGS SRI Overlay and are being rolled out to other managers as Investment Management Agreements are being reviewed.

Asset Consultant to LGS

Our agreement with one of the external asset consultants (private equity) specifically states that they must review ESG risks and capabilities with every new manager/investment that they forward to LGS for consideration.