Climate reporting: 13x new research regarding inequality, climate reporting, biodiversity, green bonds, external costs, private equity real estate, gold, equal weighting, correlations, tail risks, robo advisors and AI (# indicates the number of SSRN downloads on May 22nd, 2023)

Ecological and social research

Inequality: Climate Inequality Report 2023 by Lucas Chancel, Philipp Bothe, and Tancrède Voituriez from the World Inequality Lab as of Jan. 30^th, 2023: “The accelerating climate crisis is largely fuelled by the polluting activities of a fraction of the world population. The global top 10% are responsible for almost half of global carbon emissions and the global top 1% of emitters are responsible for more emissions than the entire bottom half of the world’s population. … within-country carbon inequality now makes up the bulk of global emissions inequality, i.e. about two thirds of the total, an almost complete reversal as compared to 1990. The carbon budgets needed to eradicate poverty below the US$ 5.50/day poverty line are equal to roughly one third of the current emissions attributable to the top 10% of global emitters. … Many countries in the Global South are significantly poorer today than they would have been in the absence of climate change. This trend is set to continue and result in income losses of more than 80% for many tropical and subtropical countries by the end of the century. Within countries, the poor suffer stronger losses from climate impacts than more affluent population groups. The income losses from climate hazards of the bottom 40% are estimated to be 70% larger than the average in low- and middle-income countries” (p. 9).

Responsible investment research: Climate reporting

Climate reporting (1): The MSCI Net-Zero Tracker by MSCI Research as of May 2023: “35% of listed companies have disclosed at least some of their Scope 3 emissions … 44% of listed companies have set a decarbonization target … 17% of listed companies have published a climate target that, if achieved, would align carbon emissions across the company’s total value chain with the ambitious 1.5°C goal of the Paris Agreement … Listed companies are on a path to warm the planet by 2.7° above preindustrial levels this century … Just over half (51%) of listed companies align with warming equal to or below 2°C, placing them at the high end of the Paris Agreement’s uppermost temperature threshold … Unlisted companies in four of the five most emissions-intensive industry groups were less carbon-intensive than their listed counterparts on aggregate …Real-assets funds held the most emissions-intensive industries per dollar of financing, followed by mezzanine- and distressed-debt funds … The carbon intensity of all three fund types was more than triple the carbon intensity of buyout funds” (p. 4/5). My comment: I try to engage with all my fund portfolio companies to report broad Scope 3 data, see Shareholder engagement: 21 science based theses and an action plan – (prof-soehnholz.com)

Climate reporting (2): The Climate Transition Is Increasingly about Opportunity by Chris Cote and Guido Giese of MSCI Research as of May 15^th, 2023: “We have found that in the most emissions-intensive sectors, for example, companies that had a higher share of revenue from alternative energy, energy efficiency and green buildings had significantly faster earnings growth than their sector peers over a period of roughly seven-and-a-half years that ended on March 31, 2023” (p. 3). … only 155 companies (1.7% of the listed universe), with a total market cap of USD 1.6 trillion, earned more than half of their revenues from such (SÖ: alternative energy or energy efficiency) activities, our analysis finds. … We found in our data that many of the more than 3,800 listed companies (42% of that universe) that have published a decarbonization target, for example, do not explain how they plan to meet their climate-related goals” (p. 6).

Biodiversity risks: Nature positive: How the world’s largest companies depend on nature and biodiversity by Esther Whieldon, Shirley Yap, Lokesh Raikwar, and Gautier Desme of S&P Global as of May 10th, 2023: “85% of the world’s largest companies that make up the S&P Global 1200 have a significant dependence onn nature across their direct operations … 46% of companies in this universe … have at least one asset located in a Key Biodiversity Area …”.

Control advantage: Corporate Green Bonds: The role of external reviews for investment greenness and disclosure quality by Tami Dinh, Florian Eugster, and Anna Husmann as of May 19^th, 2023 (#69): „Our results indicate that although companies with worse environmental performance are more likely to obtain at-issuance external reviews for their green bonds, their certified investments are more likely to be greener than companies that did not obtain a review at issuance. … Additionally, we develop a disclosure index for green bond reports and exhibit how post-issuance report assurance is associated with increased transparency” (abstract).

External costs: Auf dem netto-positiven Weg? Wie Unternehmen Wert schaffen – Messung und Integration von Nachhaltigkeit in die strategische Planung von Martin G. Viehöver at al von Positive Impacts vom 2. September 2022: „Im Allgemeinen erzeugen alle Industriesektoren im Durchschnitt einen positiven Gesellschaftlichen Wert, aber auch Gesellschaftliche Verluste aufgrund der entstehenden gesellschaftlichen Kosten (externe Effekte). Es wurde jedoch bestätigt, dass Unternehmen gesellschaftliche Erträge erzielen können, indem die von ihnen gezahlten Steuern höher als die gesellschaftlichen Kosten waren, wie es bei 20 Unternehmen in der Stichprobe der Fall war“ (S. 61).

General investment research

Bad PERE: Persistently Poor Performance in Private Equity Real Estate by Da Li and Timothy J. Riddiough as of May 14^th, 2023 (#629): “We compare Buyout (BO), Venture Capital (VC), and Private Equity Real Estate (RE) funds. RE funds underperform BO and VC, as well as the public market alternative. In RE, worse-performing fund managers survive at a high rate. They are also susceptible to diseconomies of fund scale, with no skill-based persistence to offset the negative scale effects. Analysis of noisy fund manager selection indicates that RE investors are not disadvantaged relative to BO and VC. LP investors in RE funds seem to be optimizing something other than, or in addition to, investment return when selecting fund managers” (abstract).

Good gold? The Safe Asset Shortage Conundrum and Why Gold is a Safe Asset by Dirk G. Baur as of April 19^th, 2023 (#29): “This paper demonstrates that gold is a safe asset based on existing definitions, central bank holdings, history, and risk characteristics such as default risk and currency risk. Changes in the safe asset pool during the 2008 financial crisis and its aftermath led to a safe asset triage that potentially led to the inclusion of gold in the safe asset pool. This is evident in the weakly symmetric opposite movements of gold and US government bond prices since 2008 and also in an increasing correlation especially since 2008. A simple safe asset test that analyzes whether a supposedly “safe asset” can be sold without a loss over different investment horizons or holding periods shows that gold is indeed relatively safe when compared with US government bonds. Finally, we also argue that the “safe asset shortage” is not a “natural” shortage but caused by central bank “QE” asset purchasing programs rendering this shortage rather narrow“ (p. 8).

Easy outperformance: Beating the S&P 500 at Its Own Game – The triumph of the equally weighted index by John Rekenthaler from Morningstar as of May 15^th, 2023: “… only 19 equally weighted U.S. equity funds of any flavor currently exist, and none except for Invesco’s funds possess significant assets … Since summer 1998 … a costless version of the equally weighted S&P 500 portfolio has thrashed the conventional index … Half the equally weighted portfolio is invested in firms with market caps exceeding $30 billion. But the comparable figure for the customary S&P 500 is $150 billion”. My comment: I use equal weight for all my direct equity model portfolios and my fund since many yearsm see e.g. Artikel 9 Fonds: Kleine Änderungen mit großen Wirkungen? – (prof-soehnholz.com)

Correlation criticism: Co-Occurrence: A New Perspective on Portfolio Diversification by William Kinlaw, Mark Kritzman, and David Turkington as of May17th, 2023 (#25): “Investors typically measure an asset’s potential to diversify a portfolio by its correlations with the portfolio’s other assets, but correlation is useful only if it provides a good estimate of how an asset’s returns co-occur cumulatively with the other asset returns over the investor’s prospective horizon. And because correlation is an average of sub-period co-occurrences, it only serves as a good estimate of prospective co-occurrence if the assets’ returns are multi-variate normal, which requires them to be independent and identically distributed. The authors provide evidence that correlations differ depending on the return interval used to estimate them, which indicates they are not serially independent. Moreover, the authors show that asset co-movement differs between regimes of high and low interest rates and between turbulent and quiescent markets, and that they are asymmetric around return thresholds, which indicates that returns are not identically distributed. These departures from multi-variate normality cast serious doubt on the usefulness of full-sample correlations to measure an asset’s potential to diversify a portfolio. The authors propose an alternative technique for diversifying a portfolio that explicitly considers the empirical prevalence of co-occurrences and thus the non-normality of returns“ (abstract).

Tail risks: Equity Tail Protection Strategies Before, During, and After COVID by Roni Israelov and David Nze Ndong as of May 10^th, 2023 (#124): “We investigate three common, yet different approaches to hedging equity drawdowns and a few themes emerge. First, hedging is expensive. … Second, the variable equity exposure embedded in option strategies is a source of risk and path dependence. … Third (and related to the previous point), a hedger’s decision on whether to delta-hedge their option exposure to isolate the option convexity or to maintain an unhedged position materially impacts performance in non-forecastable ways. …. Finally, there is enormous dispersion in the performance of tail risk hedging strategies. Well-reasoned arguments can be made in favor or against any number of decisions on how to implement a tail risk hedge. We only considered a few strategies (long options hedged or unhedged, long put protection, and long VIX futures) and the dispersion in outcomes is notable … those who implement hedging solutions should plan for the possibility – as remote as it might be – that their hedges make things worse in times of stress“ (p. 11/12).

Invest-Tech research (Climate reporting)

Robo-risks: Demystifying Consumer-Facing Fintech: Accountability for Automated Advice Tools by Jeannie Paterson, Tim Miller, and Henrietta Lyons as of May 10^th, 2023 (#12): “Currently, the most prominent forms of fintech available to consumers are automated advice tools for investing and budgeting. These tools offer advantages of low cost, convenient and consistent advice on matters consumers often find difficult. … the oft-stated aspiration … should not distract attention from their potential to provide only a marginally useful service, while extracting consumer data and perpetuating the exclusion of some consumer cohorts from adequate access to credit and banking. … Fintech tools that hold out to consumers a promise of expertise and assistance should genuinely be fit for purpose. Consumers are unlikely to be able to monitor this quality themselves …“ (p. 15/16).

AI Advantage? Can ChatGPT Forecast Stock Price Movements? Return Predictability and Large Language Models by Alejandro Lopez-Lira and Yuehua Tang as of May 12^th, 2023 (#32759): “We use ChatGPT to indicate whether a given headline is good, bad, or irrelevant news for firms’ stock prices. We then compute a numerical score and document a positive correlation between these “ChatGPT scores” and subsequent daily stock market returns. Further, ChatGPT outperforms traditional sentiment analysis methods. … Our results suggest that incorporating advanced language models into the investment decision-making process can yield more accurate predictions and enhance the performance of quantitative trading strategies. Predictability is concentrated on smaller stocks and more prominent on firms with bad news, consistent with limits-to-arbitrage arguments rather than market inefficiencies“ (abstract).

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