Complex RI: ESG
Strategic sustainability: Strategic sustainability management pays off – Paper No. 1 of the PI paper series “Demystifying the links between sustainability/ESG and performance” by Martin G. Viehöver, Carla Madueño and Myrna Van Vliet as of April 2022: “…. the present study introduces the PI view on how links between Corporate Sustainability Strategy and Performance (CSSP), including an evaluation of management quality, and Corporate Financial Performance (CFP), should be assessed. … A pilot study was performed using public information on Germany’s largest 100 stock listed companies under normal market situations, i.e., in pre-COVID19 times. … The findings show a significant positive effect of CSSP components on CFP of the same and subsequent years, thus reinforcing the idea that developing a sustainability strategy aligned with the business core activities and managed consistently generates positive (monetary) impacts for the company and society” (p. 8).
Climate logistics: Why industrial location matters in a low-carbon economy by Christopher James Day as of April 22, 2022 (#1): “The cost of transporting renewable energy is relatively high. This creates a significant competitive advantage for regions which can combine surplus clean energy resources with strong institutions and developed capital markets. My findings have major implications for the organisation of global value chains” (abstract).
Human rights deficits: Investing in human rights: overcoming the human rights data problem by Jaap Bartels and Willem Schramade as of April 6th, 2022 (#3): “Human rights concerns are hardly integrated in investment decisions. … This article investigates why human rights abuses by companies are so persistent. Explanations include the inherent complexity of global value chains; a lack of integration of human rights in business; insufficient legal enforcement; and inadequate data and limited pressure on corporations by investors. Although investors have launched several initiatives to improve their human rights performance they seem not yet able to solve the identified challenges and fulfil the requirements set out in the OECD guidelines and UNGP. We make suggestions to improve human rights data for investors by expanding the existing ecosystem … (abstract).
ESG publication effect: Information Content of ESG Ratings: Evidence from Unanticipated ESG Ratings Disclosure Events by Julia Meyer and Sebastian Utz as of March 15th, 2022 (#115): “Our empirical results show, that … ESG ratings contain private information. Stocks for which an ESG rating becomes publicly available exhibit a significant reduction in their levels of information asymmetry (abstract) … Liquidity increased significantly for companies that obtained newly available ESG ratings on Bloomberg ….” (p. 28)
ESG flow returns: ESG Investing: A Tale of Two Preferences by Paul Yoo as of April 27th, 2022 (#42): “What motivates ESG integration? I find both non-pecuniary and risk-mitigating preferences explain its prominence. Using widely endorsed ESG ratings, I show each preference induces sizable ESG equity premium identified through option-implied expected returns. Due to unexpectedly persistent demand growth for ESG-conscious assets, realized returns mask true ESG pricing effects, especially those attributable to non-pecuniary preference” (abstract).
Costly climate uncertainty: Climate policy uncertainty and the cross-section of stock returns by Kam Fong and Ihtisham Malik as of April 15th, 2022 (#56): “Recent asset pricing literature provides evidence that macroeconomic uncertainty, and political uncertainty, are priced cross-sectionally in equities and corporate bonds. … we find a statistically and economically significant negative relation between a firm’s exposure to climate policy uncertainty … and next-month stock returns … firms with low exposure to climate policy uncertainty are also green stocks with low growth potentials, low crash price risk, and weak price return momentum, and they are associated more with the Democrats” (p. 21/22)
Climate fund diversity: Investing in Times of Climate Change 2022 by Hortense Bioy, Boya Wang, Alyssa Stankiewicz and Amrutha Allad of Morningstar as of April 2022: “We identified 860 mutual funds and exchange-traded funds with a climate-related mandate at the end of last year. Assets in these funds doubled in 2021 to USD 408 billion … The climate funds universe represents a wide range of approaches, which we subdivide into five mutually exclusive categories: Low Carbon, Climate Conscious, Green Bond, Climate Solutions, and Clean Energy/Tech. … Low Carbon funds provide the greatest shield from carbon risk but offer little in the way of climate solutions. Conversely, Climate Solutions and Clean Energy/Tech funds offer high exposure to climate solutions but also currently carry high carbon risk. Many of these funds invest in transitioning companies that operate in carbon-intensive sectors such as utilities, energy, and industrials and that are developing solutions to help reduce their own carbon emissions and that of other” (p. 1). … the main approaches …. applying exclusions, limiting climate risk, seeking climate opportunities, practicing active ownership, targeting climate themes, and assessing impact” (p.27). … “Over 80% of Low Carbon, Climate Conscious, and Climate Solutions funds have lower Fossil Fuel Involvement than the index. However, only 37% of Green Bond funds and 59% of Clean Energy/Tech funds meet this criterion” (p. 35). … “Most notable is the high level of Thermal Coal Involvement with Green Bond funds, with only 36% beating the benchmark” (p. 37). My comment: I have a different approach than most otherss see Neues SDG Sozialportfolio und noch strengere ESG Anforderungen – Responsible Investments (Blog) (prof-soehnholz.com)
Good banks: Banks vs. Markets: Are Banks More Effective in Facilitating Sustainability? By David P., Steven Ongena, Ru Xie, and Binru Zhao as of April 19th, 2022 (#132): “This paper closes a gap in the literature by demonstrating that firms with a high ESG risk depend less on bank loans and more on public bonds. … First, firms facing higher ESG risk exposure may prefer public bonds over bank loans to evade scrutiny and to insulate themselves from bank monitoring. Second, firms suffering a greater number of negative ESG reputation shocks are less likely to continue obtaining bank loans in response to lenders‘ threats to „exit“ the lending arrangement. … Our results suggest that firm ESG risk decreases after borrowing from banks, demonstrating that banks are more successful at shaping and influencing borrowers‘ ESG performances” (p. 23/24)
Dirty profit: Does it Pay to Invest in Dirty Industries? – New Insights on the Shunned-Stock Hypothesis by Tobias Bauckloh, Victor Beyer and Christian Klein as of April 6th, 2022 (#34):“… we find firms operating in dirty industries are owned in lower proportions by institutional investors and receive less analyst coverage. We study financial effects of this market segmentation and find that stocks from dirty industries tend to outperform stocks from other industries in the cross-section from 1965 to 2020. The outperformance is particularly pronounced when the degree of shunning is high … Our long-short portfolio yields an abnormal annual return of 2.2 to 3.1% for the time period 1989 to 2020 that cannot be explained by common risk factors. … our results suggest that their impact on firms’ costs of capital is of economic significance” (p. 29/30). My comment: Other recent research reaches other conclusions compare Divestments bewirken mehr als Stimmrechtsausübungen oder Engagement | SpringerLink and this:
Divestment works: Global Carbon Divestment and Firms’ Actions by Darwin Choi, Zhenyu Gao, Wenxi Jiang, and Hulai Zhang as of March 15th, 2022 (#492): “our country-level result shows that the market as a whole is shifting institutions’ capital toward green firms, especially after 2015. … the institutional divestment in a country pushes down equity prices of high-emission firms in the same country. Using the number of natural disasters as an instrumental variable for the reduction in carbon exposure, we show that a carbon divestment of 1% is associated with a 4.4% decrease in prices. Under the price pressure, public (but not private) high-emission firms lower CO2 emissions and increase green innovation activities” (p. 23)
Complex RI: Impact
Critical impact: The impact of impact funds – A global analysis of funds with impact-claim by Lisa Krombholz, Timo Busch, and Johannes Metzler as of April 12th, 2022 (#56): “The aim of this article is to examine the extent to which (so-called) impact funds refer to financial products that contribute to real-world change. … We find that only a minority of funds meet the outlined impact requirements and that an Article 9 classification alone does not qualify a fund as an impact investment. … our analysis shows that the share of funds that meet the outlined impact requirements is considerably higher for private equity and private debt than for public equity and bonds. In private markets, investors can provide flexible capital to young companies that have limited access to other sources of funding. However, in public markets, investors can also influence companies through active ownership. Yet, many investors do not exercise their shareholder rights effectively because they either do not vote at all, or do not vote in favor of social and/or environmental proposals. … For impact generation, asset managers would have to demonstrate and measure what real-world change shall be achieved through the investment. For impact aligned investments, it is important to demonstrate for instance to which extent the invested companies contribute to achieving the SDGs. The former would be investor impact; the latter company impact – which are two fundamentally different considerations” (p. 10/11). My comment: I propose a somewhat different approach regarding public funds see Absolute and Relative Impact Investing and additionality – Responsible Investments (Blog) (prof-soehnholz.com)
Sustainable Startups: Startups as sustainability transformers: A new empirically derived taxonomy and its policy implications by Yasmin Olteanu and Klaus Fichter as of April 20th, 2022: “Based on a sample of 1674 startups and cluster analysis …. Our results confirm the existence of a clearly distinguishable subgroup with a particularly high transformation orientation, which we label as “sustainability transformers”” (abstract). … “The members of the cluster thus can be expected to not only aim at high market shares in the mass market, but also strive to have an impact beyond the market on society and the environment because sustainability is at the core of their business …. One hundred fifty-seven of the examined startups, or 9%, can be attributed to this cluster” (p. 11/12).
Clean venture bubble: The Role of Venture Capital and Governments in Clean Energy: Lessons from the First Cleantech Bubble by Matthias van den Heuvel and David Popp as of April 16th, 2022 (#22): “After a boom and bust cycle in the early 2010s, venture capital (VC) investments are, once again, flowing towards green businesses. … we use Crunchbase data on 150,000 US startups founded between 2000 and 2020 to better understand why VC initially did not prove successful in funding new clean energy technologies. Both lackluster demand and a lower potential for outsized returns make clean energy firms less attractive to VC than startups in ICT or biotech. However, we find no clear evidence that characteristics such as high-capital intensity or long development timeframe are behind the lack of success of VC in clean energy. … the ultimate success rate of firms receiving public funding remains small” (abstract).
General and traditional investment topics
Good themes? Morningstar Global Thematic Funds Landscape 2022 by Jackie Choi et al. of Morningstar as of March 2022: ”… we introduce an updated taxonomy for classifying these funds …. assets under management in these funds have grown nearly threefold to $806 billion worldwide. This represented 2.7% of all assets invested in equity funds globally, up from 0.8% 10 years ago. …. A record 589 new thematic funds debuted globally in 2021, more than double the previous record of 271 new launches in 2020. … Actively managed funds account for the majority of assets invested in thematic funds. Funds tracking multiple technology themes …. represent the most popular thematic grouping globally. …. More than a half of the thematic funds in our global universe both survived and outperformed the Morningstar Global Markets Index over the trailing three years to the end of 2021. However, thematic funds‘ success rate drops to just one in 10 when we look at the trailing 15-year period., … Thematic funds‘ lackluster long-term performance can be partly explained by the fact that their fees tend to be higher than those of their nonthematic counterparts” (p. 1/2). My comment: See Drittes SDG ETF-Portfolio: Konform mit Art. 9 SFDR – Responsible Investments (Blog) (prof-soehnholz.com)
Fund management wisdom statistic: Manager characteristics: Predicting fund performance by Andrew Clare, Meadhbh Sherman, Niall O’Sullivan, Jun Gao, and Sheng Zhu as of April 6th, 2022 (#122): “…. accumulated wisdom, however this is proxied, has a positive relationship with manager skill: the longer the manager’s tenure, the more experienced the manager is and the older the manager, the better the performance, other things equal. …. we find that more experienced fund managers tend to run portfolios that have: lower exposure to the market, size and momentum risk factors; higher exposure to the Value risk factor; and no significant exposure to idiosyncratic risks. We also find that when a manager has a stake in a fund they tend to have a lower exposure to all of these risk factors relative to managers without a stake in their fund. … we find that performance persistence is most evident among male managers, non-CFA managers, ‘quant’ managers, high SAT score managers, long experience and managers that have managed their fund for a long period of time”. (p. 10/11).
Costly teams: Team Disposition Effects: Vanity or Groupthink? by Daniel Dorna and Pramodkumar Yada as of March 14th, 2022 (#47): “… our study documents that fund teams are prone to making systematic mistakes in the form of costly disposition behavior; they tend to sell winning investments and hold on to losing investments, despite winners sold subsequently outperforming losers held by an economically meaningful margin. … Pride and regret is amplified in a team setting when a team member carries special responsibility for a position – as a result of specialization, for example. Intuitively, decision makers are loath to admit mistakes to self, let alone to their peers” (p. 34/35).
Bad effects of passive investing? How Competitive is the Stock Market? Theory, Evidence from Portfolios, and Implications for the Rise of Passive Investing by Valentin Haddad, Paul Huebner and Erik Loualiche as of Oct. 18th, 2021 (#981): “In the US stock market we find evidence that investors do react to each other but also that this response is much weaker than anticipated by classic views. The effects of changes in the composition of investors on the demand for stock is reduced by 50%. This implies for example that the rise in passive investing leads to substantially more inelastic markets” (p. 40). My comment: Why don`t active manager profit more from this market imperfection?
Expensive options: Payment for Order Flow And Asset Choice by Thomas Ernst and Chester Spatt as of Appril 4th, 2022 (#403): “In stocks, we show that PFOF is small. While many retail trades are executed off-exchange, we find that they receive meaningful price improvement, particularly when spreads are at their minimum. In single-name equity options, we show that PFOF is large … costing retail investors billions per year” (abstract).
Model criticism: The DCF Valuation Methodology is Untestable by J.B. Heaton as of April 22, 2022 (#114): “The discounted cash flow (DCF) valuation methodology is ubiquitous in finance, but as a single equation in a potentially-infinite set of unobservable unknowns, it is unfalsifiable and therefore untestable. While bonds can be viewed as examples of DCF pricing, this depends on their prices often being observable and their “expected” cash flows typically being bounded above by their promised cash flows. For capital projects, businesses, and common stocks, there is simply no way to determine whether a DCF valuation is a good representation of the causal mechanisms behind market values. The untestable nature of DCF may generate bad consequences for business decision-making, first by causing the rejection of otherwise good projects through heavy discounting of long-term cash flows, and second by making it more likely that only the most excessively optimistic cash flow forecasts make it through the capital budgeting process” (abstract).
Alternative Investments (Complex RI)
Inefficient REIT market: Systematic Mispricing: Evidence from Real Estate Markets by Shaun Bond, Hui Guo, and Changyu Yang as of April 14th, 2022 (#22): “… we apply recent developments in financial economics, which posit an important role for limited market participation and financial intermediaries, in understanding real estate returns. The risk factors motivated by these theories have significant explanatory power for the cross-section of REITs. However, this relationship is the opposite of what we expected, and the results point to a more complex set of findings that are difficult to reconcile with risk-based explanations. Our results suggest systematic mispricing of real estate assets that is heavily influenced by investor sentiment” (abstract). My comment: See Erstes konsequent verantwortungsvolles ESG-Portfolio aus Immobilienaktien – Responsible Investments (Blog) (prof-soehnholz.com)
Attractive VC: Return to Venture Capital in the Aggregate by Ravi Jagannathan, Shumiao Ouyang, and Jiaheng Yu as of April 20, 2022 (#21): “We examine ventures that had their first funding round in December 2006 or earlier, and follow them till 2018, … we measure the return to equity investors in all the 17,242 venture companies in our sample taken together as a group in several ways: the Kaplan and Schoar (2005) Public Market Equivalent (PME), the Korteweg and Nagel (2016) Generalized PME, and the Internal Rate of Return (IRR). We find that equity investors as group earned a substantial premium over the public market equivalent – with a PME of 1.42 and a GPME of 1.44. The IRR is 22% which is much higher than the IRR of 7% on the venture-mimicking portfolio that invested the amounts raised in the Fama-French industry portfolios till the venture companies’ exit. The higher IRR is compensation for the higher risks due to the higher leverage of venture companies relative to publicly traded firms in their industry as well as compensation for illiquidity. …. in the aggregate, investors have to wait five years from the first funding round for the discounted cash flows from the ventures to become positive. … There is a structural break in 1991Q1 in the return to investing in ventures, and venture returns come down after the break but still earn a premium over their public market equivalent investments” (p. 33/34).
NFT criticism: NFTs and the Art World – What’s Real, and What’s Not by Michael D. Murray as of April 17th, 2022 (#67): “NFTs as a concept and a technology are probably not going away soon because there are many people with lots of money invested in the emerging metaverse and NFTs are believed to be key to actual ownership of assets and access to services and governance in a virtual universe. NFT artwork, on the other hand, may continue to boom or it may wane in importance and enthusiasm. … NFT … allows digital works to be made scarce … What is for certain is we haven’t seen the end of the story of NFTs in the cryptoverse or metaverse” (p. 27/28).
40% ICO Scams? Trust, but verify: The economics of scams in initial coin offerings by Kenny Phua, Bo Sang Chishen, Wei Gloria and Yang Yu as of April 6th, 2022 (#34): “Losses from frauds and financial scams are estimated to exceed U.S. $5 trillion annually. … we investigate the market for initial coin offerings (ICOs) using point-in-time data snapshots of 5,935 ICOs. Our evidence indicates that ICO issuers strategically screen for naive investors by misrepresenting the characteristics of their offerings across listing websites. Misrepresented ICOs have higher scam risk, and misrepresentations are unlikely to reflect unintentional mistakes. Using on-chain analysis of Ethereum wallets, we find that less sophisticated investors are more likely to invest in misrepresented ICOs. We estimate that 40% of ICOs (U.S. $12 billion) in our sample are scams” (abstract).