English RI research: Social aspects
China risks (1): China’s Corporate Social Credit System and the Dawn of Surveillance State Capitalism by Lauren Yu-Hsin Lin and Curtis J. Milhaupt as of March 30th, 2022 (#291): “… China’s corporate social credit system (CSCS) – a big data project to evaluate the “trustworthiness” of all business entities registered in the country … is linked to a system of corporate rewards and punishments, representing a futuristic strategy of automated screening to determine which enterprises are allowed market access and benefits. … We provide the first empirical analysis of the CSCS scoring system … A key finding is that while the CSCS is a facially neutral means of measuring legal compliance, politically connected firms …receive higher overall scores … The channel for this result is a “social responsibility” category that valorizes awards from the government and contributions to Chinese Communist Party (CCP)-sanctioned causes. We find no significant evidence that better-governed firms or more profitable firms receive higher overall scores, although highly leveraged firms, subject to higher default risks, are associated with lower total scores” (abstract). My comment: Since 2016 I exclude investments in China from my direct equity portfolios and thematic ETFs are only selected if they have <10% allocation to China.
China risks (2): The Rule of Law in the U.S.-China Tech War by Curtis J. Milhaupt and Michael Callahan as of March 31st, 2022 (#356): “… exploring how the legal regimes recently developed in both countries to wage the tech war … We fear that ironically, the rule of law necessary to maintain continued vibrancy in U.S. high-tech sectors is being compromised by some of the very actions ostensibly taken to protect these sectors from malign foreign influence. We conclude by offering some concrete policy suggestions to improve the transparency and effectiveness of national security and data protection regimes in the U.S. while advancing a second crucial objective – maintaining a regulatory environment conducive to technological innovation” (abstract).
English RI research: Ecology
Far away CO2 capture? Direct Air Capture A key technology for net zero by the International Energy Agency as of April 2022: “Capturing CO2 directly from the air and permanently storing it removes the CO2 from the atmosphere … In the IEA Net Zero Emissions by 2050 Scenario, direct air capture technologies capture more than 85 Mt of CO2 in 2030 and around 980 MtCO2 in 2050, requiring a large and accelerated scale-up from almost 0.01 MtCO2 today. Currently 18 direct air capture facilities are operating in Canada, Europe and the United States. The first large-scale direct air capture plant of up to 1 MtCO2/year is in advanced development and is expected to be operating in the United States by the mid-2020s. This report … considers the current status of these technologies, their potential for cost reductions, their future energy needs, and the optimal locations for direct air capture facilities. Finally, the report identifies the key drivers for direct air capture investment and priorities for policy action” (p. 3).
Unclear German climate goals: Ist Deutschland auf dem 1,5-Grad-Pfad? Eine Einordnung der Diskussion über ein nationales CO2-Budget Brigitte Knopf and Oliver Geden of the Mercator Institute as of March 9, 2022: „Während sich das CO2-Budget auf globaler Ebene unter bestimmten Unsicherheiten für verschiedene Temperaturniveaus prinzipiell beziffern lässt, ist die Ableitung eines nationalen Restbudgets (Budgetieren) daraus keineswegs eindeutig. … Nationale Ziele sind darüber hinaus oftmals als Langfristziele für Treibhausgas (THG)- Neutralität definiert, während sich das globale Budget nur auf CO2 bezieht. … Weiterhin bestehen bei der Berechnung einige Freiheitsgrade durch den Einbezug der CO2-Senken, deren Anrechnung aus dem Klimaschutzgesetz nicht eindeutig ableitbar ist. … das Klimaschutzgesetz enthält lediglich Zielbestimmungen – real sinken werden die Emissionen nur durch konkrete Maßnahmen und Instrumente. … Um glaubwürdig zu bleiben, sollte die Bundesregierung Kriterien nennen, an denen sie ihre Klimaschutzziele messen lassen will. Nur so wird das nationale Ambitionsniveau transparent und wissenschaftlich überprüfbar“ (p. 4).
Central Banks for climate: Central Banks and Climate Change. Fit, Opportunity and Suitability in the Law and Beyond by David Ramos Muñoz, Antonio Cabrales and Ángel Sanchez from the European banking Institute as of March 13th (#75): “Central banks … promising a more climate-based focus on matters ranging from communication to prudential regulation and supervision, and including monetary policy. This … resulted in an often-confusing mix of views for and against central banks’ active role in climate change …. we propose a methodology to analyze the problem, by dividing the arguments in three different types: arguments of “fit” that analyze whether central banks can tackle climate change, in light of their mandates; arguments of “opportunity” that analyze when central banks may, or should, act; and arguments of “suitability” that analyze how central banks may (and may not) intervene. … A further distinction offered here is between the arguments that central banks should weigh to decide whether, when and how to intervene (arguments of “duty” or “standard of conduct”) and the way these arguments could be weighed by courts deciding on the legality of central banks’ actions (“standard of review”) …. The arguments clearly favor a more active role by central banks in the fight against climate change, although courts are unlikely to force them to take it” (abstract).
Biodiverse Central Banks? Central banking and supervision in the biosphere: An agenda for action on biodiversity loss, financial risk and system stability – Final Report of the NGFS-INSPIRE Study Group on Biodiversity and Financial Stability as of March 24th, 2022: “…. economic activity and financial assets are dependent upon the ecosystem services provided by biodiversity and the environment …economic activity and financial assets in turn have impacts on biodiversity and could therefore face risks from the transition to a nature-positive global economy … These physical and transition risks can be transmitted through various channels (impacting households, firms and sovereigns alike) and could translate into various forms of financial risks such as credit, market, liquidity and operational risks. … Addressing biodiversity-related financial risks falls within the mandates of central banks and financial supervisors, as a consequence” (p.2/3).
Women for climate: Does gender diversity in the workplace mitigate climate change? By Yener Altunbas, Leonardo Gambacorta, Alessio Reghezza, and Giulio Velliscig from the European Central Bank as of March 1st, 2022 (#63): “We match firm-corporate governance characteristics with firm-level carbon dioxide (CO2) emissions over the period 2009-2019 … We find that a 1 percentage point increase in the percentage of female managers within the firm leads to a 0.5% decrease in CO2 emissions. … At the same time, we show that gender diversity at the managerial level has stronger mitigating effects on climate change if females are also well-represented outside the organization, e.g. in political institutions and civil society organizations. Finally, we find that, after the Paris Agreement, firms with greater gender diversity reduced their CO2 emissions by about 5% more than firms with more male managers“ (abstract).
Better soy: Increased soy certification would decrease deforestation risk by Planet Tracker as of April, 5th 2022: ”Planet Tracker believes supply chain traceability and transparency are essential to achieve Deforestation and Conversion-Free (DCF) soy supply chains. A strong certification system would help but soy lags behind other deforestation-linked commodities in this respect. …. It rarely appears on labels or on the back of packaging in the EU as for example, 90% of EU imported soy is used for livestock feed”. My comment: A reduction in animal based food can do a lot to improve the world.
English RI research: Responsible Investments
Categorical SRI Imperative Socially Responsible Investing in a Free and Democratic Society by Ruoke Yang as of February 24th, 2022 (#26): “By investing in accordance to their social preferences, investors … can also create a negative impact with respect to issues that are not deemed as important to the wealthy. This problem is worsened in the presence of growing wealth inequality. When socially minded investors are confronted with firms like Amazon and Exxon Mobil that are neither perfectly good nor bad, their investment decisions can go awry if they apply their individual tastes to decide whether Amazon’s lackluster social performance sufficiently outweighs its better environmental performance. Instead, each investor should take into account of the tastes of every individual and assign equal weight to them. To do otherwise would lead to socially responsible investors achieving outcomes that are inconsistent with the aims of a free and democratic society” (p. 13).
Climate tool tests: The Climate Risk Tool Landscape 2022 – Supplement by David Carlin and Alexander Stopp from the UNEP Finance Initiative as of March 2022: “… this report seeks to catalogue the actual experiences that financial users had while piloting different tools. The detailed case studies include insights into the process, challenges, outputs, and learnings related to using selected climate risk tools. These case studies should be seen as a companion to the categorizations provided within The Climate Risk Landscape. Together, the two reports begin the process of providing financial users with a resource for understanding both the theoretical attributes of different tools as well as how they function in practice” (p. 10).
Attention with Art. 8 SFDR: How green are SRI labelled funds? Insights from a Machine Learning based clustering approach by Yves Rannou, Mohamed Amine Boutabba and Mathieu Mercadier as of March 28th, 2022 (#102): “… this paper examines the portfolios of European funds, which hold the French SRI label at a stock level, in order to study their greenness. … We document a decarbonization trend for SRI labeled funds that has accelerated since 2019. … Dark green funds invest in a restricted number of equities while light green funds invest in a broader set of equities. … we report significant discrepancies between SFDR categories and their expected degree of greenness, implying serious greenwashing concerns“ (abstract). … the dark green cluster of funds related to SFDR Article 9 category appears to be homogenous because it invests in a limited number of equities and sectors in line with thematic investment and/or ESG integration approaches (p. 24/25)”. My comment: My Art. 9 fund focusses on social topics and midcaps, see Neues SDG Sozialportfolio und noch strengere ESG Anforderungen – Responsible Investments (Blog) (prof-soehnholz.com)
(ESG-)AI limits: Sweet spots or dark corners? An environmental sustainability examination of big data and AI in ESG by Beatrice Crona and Emma Sundström as of March 24th, 2022 (#34): “This chapter examines environmental aspects of ESG and risks and opportunities for using big data and AI to capture these in ESG ratings. It starts by outlining the difference between relative and absolute sustainability … we discuss the risks associated with a blurring of concepts relating to sustainability and materiality, and examine and contrast conventional ESG rating procedures with new approaches informed by big data (BD) and artificial intelligence (AI) … We note a current misalignment between stated ambitions of investors, and the ability to deliver on stated goals through the use of current ESG metrics and ratings. We therefore finish with suggestions for how to better align these and how those interested in ESG can become more ‘sustainability savvy’ consumers of such ratings” (abstract).
Anti-sustainable? ESG Momentum in Regional Equity Markets by Yuanfang Ma and Nicholas McLoughlin as of March 4th,2022 (#150): “We analyse a basic active allocation strategy within regional equity markets, assessing the usefulness of ESG information via two dimensions: the impact on active returns and the predictability of future ESG scores. Our results suggest tilting portfolios on the basis of ESG information can enhance both portfolio returns and future portfolio ESG scores” (abstract). My comment: Momentum strategies typically invest in low-score securities until they become high-score and then re-invest in low score securities. Simply put: Companies who have done little for ESG in the past (low-score) benefit, whereas good ESG companies are penalized. Therefore, I consider ESG-momentum strategies as anti-sustainable, see Absolute und Relative Impact Investing und Additionalität – Responsible Investments (Blog) (prof-soehnholz.com)
ESG factor effects: ESG is quality, it just isn’t really by Ann-Kathrin Behringer and Jascha Dahlhaus of DWS as of March 2022: “In Europe, ESG and governance show the highest risk adjusted returns, however the performance of governance significantly worsens when taking quality out of the equation … The worst performing factor here is environment, which seems to profit when neutralizing quality. In North America the picture changes with environment and ESG being the best performing factors while social and governance lose performance after taking out quality. Social is the factor within the determinants of ESG that sticks out most during our analysis, as it has the lowest return attributable to the quality factor, as well as the lowest score correlations coupled with the lowest return correlations, on average. Further, in our cross-sectional analysis, social is the one building block of ESG that shows almost no significant change in Sharpe Ratio when neutralizing for quality. … We see low score correlations between ESG and profitability … The highest score and return correlations can be found between ESG and safety” (p. 11).
Cost of good: Doing well by doing good? – Venture capital mission investments by charitable nonprofit foundations and university endowments by Maximilian Kremer, Ann-Kristin Achleitner, and Reiner Braun as of March 17th, 2022 (#22): “We research the preferences and outcomes of direct venture capital investment of charitable foundations and university endowments in the United States and the United Kingdom. Our analysis provides evidence that foundations‘ and endowments‘ venture capital direct investments are clustered in sectors adjacent to their fields of activity, i.e., mission-related investments (MRIs). We also show that these MRIs have a lower likelihood of success and take longer to exit when compared to the same organizations‘ non-mission-related investments (Non-MRIs)” (abstract).
Green bond cost: Beyond the Shades: The Impact of Credit Rating and Greenness on the Green Bond Premium by Toan Huynh, Nikolaus Ridder, and Mei Wang as of March 17th, 2022 (#73): “161 green bonds are matched with 322 conventional bonds from the same issuer that are also identical in terms of currency, rating, bond structure, seniority, collateral, and coupon type … based on 71,440 daily observations from January 2016 to March 2021. …. On a cross-sectional average, the green bond premium equals -3.1 bps. The negative premium is more pronounced for green bonds with a lower credit rating. It is also stronger in the presence of an ESG rating and for bonds with a higher shade of green” (abstract).
Bond herding: Asymmetric and cross-asset herding: Evidence from bond and equity markets by Sherrihan Radi, Antonios Alexandridis and Vasileios Pappas as of May 5th, 2022 (#175): “…. a growing number of behavioral finance literature examine the propensity of investors to surpress their own beliefs and follow the collective movements in the market. … Our empirical analysis is conducted on a unique dataset of corporate bonds and equities featured on the S&P 500 between January 2008 – December 2018 as well as three credit rating portfolios. Our initial unconditional tests provide limited evidence herding effects, only present in speculative grade bonds. However, when allowing for herding asymmetries (up/down markets, high/low liquidity and high/low volatility), we find significant evidences of herding in bond and equity markets. Our corporate bond and equity findings provide consistent results, suggesting that investors tend to collectively herd towards the consensus when the markets are more liquid and less volatile … the findings also suggest that investors follow their own opinions (adverse herding) during dry and highly volatile market conditions. Interestingly, we observe a substantially higher level of investor herding in corporate bonds in comparison to equities … We document cross-herding from US corporate bonds to US equities, which may be in part attributed to the different profile of investors. Specifically, stock market participants include a large percentage of retail investors that are more likely to mimic the trading patterns of the better-informed institutional investors that dominate the bond markets” (p. 14).
Poor real estate timing: Cyclical Transactions and Wealth Inequality by Jung Sakong as of February 22nd, 2022 (#19): “Why is wealth distributed so unevenly even among the bottom 99%, and even more so than income is? This paper gives one partial answer: Poorer households own more housing during booms when house prices are high and expected returns are low, and vice versa in busts. The return-differential generated from this channel is large: 60 basis points per year between the interquartile range of the wealth distribution” (p.37).
Active fund critic: How to improve institutional fund performance by Richard M. Ennis as of July 20th, 2021 (#1328): “Large institutional investors in the U.S. … use so many managers as to choke off the opportunity to beat the market. They incur annual costs of 1.3 (for public funds) to 2.3% (for endowments) of asset value. Those costs, taken with prevailing institutional preferences for diversification, are implausible on their face. It is no wonder that public pension funds and large endowments have underperformed properly constructed, passively-investable benchmarks by approximately 1.5% and 2.0% per year, respectively, in the modern era. … The Game has many participants. All of them — trustees, staff, consultants, investment managers and market-makers of all types — are agents of the stakeholders. The agents have incentives to maintain the status quo” (p. 10). My comment: Custom ESG Indexing Can Challenge Popularity Of ETFs – Asia Financial News
ETF savings plans: ETF-Sparplanmarkt 2026 – So investieren Privatanleger in ETFs by Michael Jordan from extraetf as of March 28, 2022: “Die Erfolgsgeschichte von ETF Sparplänen bei Privatanleger:innen im deutschen Markt weckt auch Begehrlichkeiten im europäischen Ausland. … Um dem generell steigendem Interesse in ganz Europa – insbesondere der Millennials-Generation – nach komfortablen, einfach verständlichen und diversifizierten „do-it-yourself“-Anlagelösungen mit niedrigen Einstiegshürden gerecht zu werden, expandieren nun vorwiegend Neobroker wie Scalable Capital, Trade Republic oder BUX ihre Angebote aus den Heimatmärkten quer in sämtliche Europäische Länder. Die Zielmärkte sind dabei hauptsächlich Frankreich, Italien, Österreich und Spanien. … Beschleuniger des bereits seit Jahren zu beobachtenden Trends hin zum Execution Only Brokerage durch sog. Selbstentscheider“ (p. 17).
US model growth: 2021 Model Portfolio Landscape by Jason Kephart and Adam Millson from Mornigstar from September 2021: “Approximately $315 billion in assets were following model portfolios as of June 30, 2021. … The number of model portfolios reported to Morningstar has more than doubled since 2020, with now more than 2,100 models reported …. BlackRock is the most popular provider, with almost $70 billion of assets. The 10 largest providers have around 75% of the overall market share … Allocation models continue to make up the bulk of options. …Model portfolios continue to offer a large fee advantage compared with similar mutual funds, driven by the greater use of low-cost exchange-traded funds as underlying components” (p. 1; 2). My comment: It is a pity, that the German model portfolio market is almost non-existing (see my offers Soehnholz ESG).
English RI research: Alternative Investments
Brain-poor universities? University Venture Capital – The Promise and Pitfalls of University Direct Investments by Maximilian Kremer, Ann-Kristin Achleitner, and Reiner Braun as of March 17th,2022 (#76): “… universities in industrialized countries have become increasingly active as venture capital financiers. … We use a hand-collected data set of 706 university portfolio companies in the United States and the United Kingdom to extend previous case-based evidence that investments in faculty and student-led start-ups are an elusive promise that rarely pays off commercially. Furthermore, we provide evidence that geographic proximity to a top venture capital ecosystem is a highly performance-relevant characteristic for university investors“ (abstract).
Behavioral Finance and Wealthtech
Behavioral research overview: Consumer Financial Decision Making by Abigail B. Sussman, Yusu Wang, and Anastasiya Apalkova as of March 28th, 2022 (#76): “Research in consumer psychology is essential for developing a deep understanding of how consumers make financial decisions as well as for creating solutions to improve this process. … The aim of the current chapter is to provide an overview of some of the most exciting developments in this area over the last decade …. In addition, we provide a call to action and roadmap for future research in the area” (abstract).
ML/AI sensitivity: Machine Forecast Disagreement and Equity Returns by Turan G. Bali, Ran Chang, and Bryan T. Kelly as of February 28th,2022 (#289): “We simulate differences in beliefs across investors by endowing them with different machine learning models for forecasting returns from the same set of inputs. … We document a significantly negative cross-sectional relation between investor disagreement and future stock returns” (abstract). My Comment: Please note that small changes in machine Learning/AI models – based on the same data – can lead to significantly different outcomes.
US robo developments: 2022 Robo-Advisor Landscape? Our take on the digital advice industry and the best options for individual investors by Amy Arnott, Alec Lucas and Ben Johnson of Morningstar as of March 31st, 2022: “This industry landscape report evaluates 16 leading robo-advisors while providing data on up to 20 … the top advice-oriented providers offer fairly comprehensive planning tools, ranging from online-only counsel to on-demand access to human financial advisors. … The median advisory fee among robo-advisors we surveyed was 0.30% of assets per year … the digital advice industry still accounts for a small percentage of investable assets in the United States. ×Dedicated digital advice firms often struggle to reach profitable scale, while the large brokerage firms and wealth managers that acquire them often struggle to integrate their digital advice capabilities … many providers add quasi-active strategies, such as factor tilts, strategic beta, and direct indexing. Transparency can be an issue as robo-advisors often fail to provide prospective clients with basic data about portfolio holdings and asset-allocation percentages“ (p. 1, 2).
German robo developments: Marktanalyse Digital Investieren by Sopra Steria next as of April 6th, 2022: „Für die vorliegende Untersuchung haben wir im vergangenen Jahr die Angebote und den Auftritt von insgesamt 40 Anbietern aus Deutschland und Österreich in Augenschein genommen. Mit 15 von ihnen haben wir ausführliche Interviews geführt (10 aus Deutschland, 5 aus Österreich). Die Erkenntnisse präsentieren wir in dieser Ausarbeitung. … Dabei lassen sich grundsätzlich über alle Arten von Anbietern hinweg viele Gemeinsamkeiten feststellen, wie zum Beispiel die große Bedeutung einfacher Onboarding- und Abschlussprozesse. …. Während etablierte Anbieter eher auf den Vertrieb schauen (grundlegende Ausrichtung: „Wie können wir mehr Produkte verkaufen?“), konzentrieren sich neue Anbieter auf das eigene Produkt (grundlegende Ausrichtung: „Wie können wir die beste Lösung zum Investieren schaffen?“)“ (p. 3/4).