Indoor-climate: Value of co-benefits from energy saving ventilation systems —Contingent valuations on Swiss home owners by Nina Boogen, Massimo Filippini and Adan L. Martinez-Cruz as of March 28nd, 2022 (#6): “… in addition to savings in energy costs, buildings equipped with energy saving and comfort ventilation (ESV) system provide co-benefits such as improved indoor air quality (IAQ), thermal comfort, and noise reduction. … This paper estimates the value of these co-benefits by inquiring willingness to accept (WTA) compensation … Average monthly WTA is CHF 181” (abstract).
Hydrogen problems: Atmospheric implications of increased Hydrogen use by Nicola Warwick, Paul Griffiths, James Keeble, Alexander Archibald, John Pyle, and Keith Shine, as of April 8th, 2022:“Use of hydrogen (H2) as a substitute for carbon-containing fossil fuels such as natural gas would prevent emissions of carbon dioxide into the atmosphere, with significant climate benefits. Nevertheless, any leakage of hydrogen will affect atmospheric composition (with implications for air quality) and have an indirect warming effect on climate (p. 7) … We have developed a new approach to calculating Global Warming Potentials (GWPs) … Our estimate of the hydrogen GWP for a 100 year time horizon is 11 ± 5, which is more than 100% larger than previously published calculations” (p. 10).
Profit or planet? Paying plastic packaging companies for transition by John Willis and Peter Reilly from Planet Tracker as of April 2022: “The plastic container and packaging companies (PC&P), also called converters, are a vital part of the plastic supply chain. … They source plastic resins and turn these into an array of packaging products. … These corporates are barely cyclical with profit margins and return on capital employed (ROCE) rising. They have the financial firepower to adapt and with the addition of investor support could rapidly invest in a transformative business model. But will investors prefer to take the short-term returns – through dividends and share buybacks – or award a higher valuation premium to those PC&P companies that position themselves for a more sustainability-driven future?” (p. 1)
Profitable climate regulation: Economic Geography and the Efficiency of Environmental Regulation by Alex Hollingsworth, Taylor Jaworski, Carl Kitchens, and Ivan Rudik as of April 7th, 2022 (#14): “We … examine the welfare implications and distributional consequences of National Ambient Air Quality Standards under the Clean Air Act. In particular, we estimate the direct costs for firms and workers in polluting sectors from increased regulatory scrutiny and benefits to residents from reduced emissions. …. We find that the Clean Air Act delivers net benefits of $23 billion annually, which substantially reflects the positive effect on amenities relative to the negative effects on real wages. In present value terms, this amounts to total benefits of over $700 billion” (p. 35).
Taxonomy presentation effects: Does the EU Taxonomy for Green Investments affect Investor Judgment? An Experimental Study of Private and Professional German Investors by Sandra Chrzan and Christiane Pott as of March 29th, 2022 (#40): “Our results indicate that private investors reward additional taxonomy-aligned environmental information with greater trust, independent of the content. In contrast, professional investors assess the long-term investments based on the content to determine risk and return. However, we do not find evidence for an additional impact of taxonomy-aligned information as compared to commonly disclosed environmental information for investor judgment. Additionally, if attention is not drawn to taxonomy disclosures, we see that this information has limited effects on the investment-related judgment of private investors” (abstract).
Social (Impact investing)
More industry concentration: Concentration and Competition: Evidence from Europe and Implications for Policy by Gábor Koltay, Szabolcs Lorincz, and Tommaso Valletti as of March 15, 2022 (#460): “We present new evidence that European industry concentration increased in the period 1998- 2019. In particular, the share of high concentration industries grew by more than 60%. High concentration industries, industries where the four largest firms account for more than 50% of turnover value, are the most likely to contain antitrust markets where firms have market power. … a joint look at EU merger intervention and concentration trends suggest that they moved in opposite directions after the financial crisis. In particular, the share of high concertation industries was increasing after 2008, while the merger intervention rate was decreasing below its historical average. … Meanwhile, estimates of aggregate profitability indicate a trend increase over the last decades” (p. 31/32). My comment: My direct equity investments are about half in mid-caps and half in large-caps and almost no mega-caps.
Political gender problem: The Gender Recontest Gap in Elections by Thushyanthan Baskaran and Zohal Hessami as of April 11th, 2022 (#7): “Using hand-collected data on 116,185 candidates in four consecutive local council elections (2001-2016) in a German state …“ (abstract).“Women are on average 3.7 to 5.0 percentage points less likely to re-run than men. This recontest gap is a phenomenon that prevails irrespective of the electoral performance of candidates and across almost all parties. We also show that this gap is presumably an important reason for women’s underrepresentation in politics. … we find that gendered family duties may partially explain the recontest gap. In addition, our results indicate that the recontest gap may be driven by male dominance in local politics and the ensuing gender dynamics, which ostensibly result in an implicit anti-female bias even if parties do not explicitly discriminate against recontesting women in their (re-) nomination decisions” (p. 29/30).
ESG Investing (Impact Investing)
Female discrimination: Intersectional Bias in Prosocial Lending: Methods and Application to Microcredit by Anastasia Cozarenco and Ariane Szafarz as of Feb 15th, 2022 (#26): “In our European microcredit dataset, the tests reveal that the positive—and socially consistent—intersectional bias toward migrant women hides the striking fact that European Union women’s loan applications are handled more harshly than those of their male counterparts” (abstract).
Satisfiying returns: Employee Satisfaction and Long-run Stock Returns, 1984-2020 by Hamid Boustanifar and Young Dae Kang as of April 11th, 2022 (#1357): “Economic theory predicts that (in the absence of mispricing) the excess return to socially responsible businesses is negative in equilibrium. In contrast, using the state-of-art empirical models and a sample spanning four decades (1984-2020), a portfolio of companies that treat their employees the best earns an excess return of 2% to 2.7% per year. The estimated alphas are positive in all periods within the sample (with no upward or downward trend) and are particularly large in “bad” times. Overall, the results suggest that the stock market still undervalues employee satisfaction” (abstract).
ESG rating problems: Deconstructing ESG scores: How to invest with your own criteria by Torsten Ehlers, Ulrike Elsenhuber, Anandakumar Jegarasasingam and Eric Jondeau of the Bank for International Settlement as of April 6th, 2022 (#162): “… devising investment strategies based on an amalgamation of three fundamentally different topics underpinning ESG investing has been a practical hurdle, especially given the potential for weak scores in one pillar to be offset by strong scores in another pillar. … Given the methodological choice of Refinitiv to assign a negative score when firms fail to disclose ‘yes’ or ‘no’ information, these categories suffer from a high proportion of scores equal to 0, which makes it difficult to differentiate among firms. … regarding the financial characteristics of the screening portfolios, we find that they do not suffer from a lower risk-adjusted performance compared to a wide stock market benchmark” (p.23/24). My comment: Instead of aggregated best-in-class ESG ratings I suggest to use separate best-in-universe ratings see Nachhaltige Portfolios: Warum Best-in-Class schlecht sein kann, aber Best-in-Universe selten genutzt wird (wertpapiertreuhand.de)
ESG underperformance? ESG Investment Performance: Evidence from Global Markets by Thanh Nam Vu, Heikki Lehkonen and Juha-Pekka Junttila as of March 24th, 2022 (#119): “Among our key findings is the underperformance of high ESG-rated portfolios compared to low ESG-rated portfolios in developed markets. … In contrast, the long– short strategy generates insignificant or even positive outcomes for the emerging markets when using the MSCI ratings, but not for the ASSET4 dataset. … The ESG ratings of firms in some countries might be higher on average than those of firms in other countries. For example, North American firms seem to have relatively low average ESG ratings compared to European companies. … our findings suggest that the large market capitalization and value stocks are dominant in terms of performance when the MSCI ESG data are used, while the best performing portfolios based on classification using the ASSET4 ratings are characterized by small and growth stocks“ (p. 39/40). My comment: Part of the difference may be attributed to the different treatment of missing data between MSCI and Refinitiv (Asset 4, see “deconstruction” research above).
Upside ESG risk? Responsible investing: upside potential and downside protection? by Yumeng Gao, Andreas G. F. Hoepner, Marcel Prokopczuk, and Christoph Wuersig as of March 18th, 2022 (#43): “A large body of research investigates either the performance or risk exposure of responsible investors using the conventional risk–return measures under the mean–variance framework, which assumes investors treat positive and negative return deviations as undesirable and mix up upside potential with downside risk. Therefore, conventional risk measures fail to precisely gauge the upside rewards and downside risks of responsible investing. … Our findings suggest that financial services companies with highly rated responsible investment practices (from MSCI) are associated with enhanced upside potential as well as lowered downside risk exposure. However, we do not observe the same significant effect for the PRI members“ (p. 31).
Low ESG cost: Performance and Costs of EU Retail Investment Products – Annual Statistical Report by ESMA as of April 5th, 2022: “A ten-year retail investment of EUR 10 000, in a hypothetical portfolio of equity, bond and mixed assets funds, provided a value of EUR 15 400 net of EUR 2 600 paid in costs. Active equity and bond UCITS underperformed compared with passive and exchange-traded-funds (ETFs) in net terms at the ten-year horizon, but they outperformed at one-year horizon. Top-25% active equity UCITS underperformed passive funds in net terms at the ten-year horizon, even though they outperformed them in 2020. This cohort of top-performing funds changes significantly over time, complicating the choice for retail investors. ESG funds on average performed well in 2020 and, overall, were slightly cheaper than their non-ESG peers” (p. 4). My comment: I have similar experiences see Q1-2022 Performance: Relativ gute konsequent nachhaltige und passive Portfolios – Responsible Investments (Blog) (prof-soehnholz.com)
Greenwashing alert: In Holdings We Trust: Uncovering the ESG Fund Lemons by Lachie McLean, Ivan Diaz-Rainey, Sebastian A. Gehricke and Renzhu Zhang as of April 11th, 2022 (#55): “our survey of retail global equity funds offered in Australasia … highlighted that RI was largely driven by expected value (performance-based expectations and client demand) rather than values (having an ethical responsibility to make a positive difference) … We found that funds with U.S. headquarters tended to place a relatively greater level of importance on environmental themes within the investment process … In contrast, funds with Australasian headquarters prioritised environmental, social, and governance themes more equally. Across all ESG subthemes, fund managers tended to place the highest importance on climate change, followed by corporate behaviour. … We documented a divergence between the stated and actual carbon performance of respondents, highlighting that fund managers were overstating their commitment to global emission objectives … We found that portfolio carbon intensity was significantly higher for respondents that were members of a climate initiative, and not significantly different for those that prioritised climate change themes or engaged in a decarbonisation strategy. This finding does not appear to be driven by actively engaging or activist funds, rather, it is consistent with greenwashing funds seeking to attract responsible investment flows. … We also found that ESG named funds only obtain significantly better portfolio ESG scores, relative to non-ESG named funds, using ratings from MSCI and Sustainalytics, but not Refinitiv” (p.30/31). My comment: See e.g. ESG first or „Responsible investments: No excuses left“ – Responsible Investments (Blog) (prof-soehnholz.com)
Green or social impact investing? The environmental performance of UK-based B Corp companies: An analysis based on the triple bottom line approach by Adriana Liute and Maria Rosa De Giacomo as of Oct. 26th, 2021: „The B Corp certification recognizes high social and environmental performance in business. This performance is measured in five pillars—Governance, Workers, Community, Environment, and Customers—but with no minimum threshold per pillar. This allows companies to choose those impact areas where they want to perform well. This study … analyses the environmental performance of 68 UK-based B Corps from two environmentally sensitive sectors: manufacturing and wholesale/retail. … Our results show firstly that companies in the two sectors tend to perform better socially than environmentally; secondly, that prioritizing one social impact area generally leads to below-average environmental performances compared to certified peers; and thirdly, that to rule out greenwashing, B Corp should ensure certified companies display high levels of environmental performance and that they align their “green” claims to their performance” (abstract). My comment: See e.g. Absolute and Relative Impact Investing and additionality – Responsible Investments (Blog) (prof-soehnholz.com)
Engagement limits (Impact investing): The Future of Investor Engagement: A call for systematic stewardship to address systemic climate risk by the UN-convened Net-Zero Asset Owner Alliance Investment Leadership Programme as of April 2022: “This paper provides an overview of the climate engagement landscape and expounds five limits that bound the ability of corporate engagement alone to catalyse the systemic change necessary for decarbonising the real economy on its own. These limits are: 1. The significant resources needed for effective corporate engagement 2. A narrow, single company focus 3. The inefficiencies of focusing on voluntary, company-by-company disclosure 4. An uneven investor focus across companies and asset classes 5. The boundaries set by the rules of the game The Future of Investor Engagement … investors committed to real-economy decarbonisation can address them by expanding the breadth of their efforts with increased efforts in sector/value chain engagement, policy engagement, and asset manager engagement. …. Asset manager engagement with asset owners is pivotal to ensure asset managers align their stewardship activities and public messaging with asset owners’ longterm interests. This alignment asks asset managers to represent, as fiduciaries, that climate risk is not only a systemic financial risk to portfolios but an existential risk to the fundamental businesses of their asset owner clients” (p. 5/6). My comment: See e.g. Divestments bewirken mehr als Stimmrechtsausübungen oder Engagement | SpringerLink
German activists targets (Impact investing): Den Blickwinkel aktivistischer Aktionäre einnehmen: Eine Chance für Unternehmen? by Rüdiger Wolf, Johannes Burkhardt, Sophie Gao, and Patricia Picco of the Boston Consulting Group as of Fe. 24th, 2022: „Ende 2021 sind 160 Unternehmen in Deutschland, Österreich und der Schweiz einem äußerst hohen oder sehr hohen Risiko einer aktivistischen Kampagne ausgesetzt. Das sind 37 Prozent der analysierten Unternehmen – zwei Prozentpunkte mehr als im Vorjahr. .. Ende letzten Jahres waren aktivistische Investoren in 129 Unternehmen aus der DACH-Region investiert (zum Vergleich: 2020 lag diese Zahl bei 114). Dabei wurden nur 16 Unternehmen öffentlich mit den Forderungen aktivistischer Investoren konfrontiert (zum Vergleich: im Vorjahr 23). … International sind vermehrt ESG-motivierte Kampagnen zu beobachten. Wir erwarten eine solche Entwicklung auch für die DACH-Region, da sich unter den am meisten gefährdeten Unternehmen besonders viele mit einem schlechten ESG-Rating befinden. .. Aktivistische Aktionäre legen oft den Finger in die Wunde. Unternehmen, die sich die Perspektive aktivistischer Investoren zu eigen machen und eine Attacke simulieren, um die eigene Strategie zu reflektieren/optimieren, können oft neue Werthebel ziehen und Aktivisten dadurch einen Schritt voraus sein“ (p. 2).
Decision model choice criticism: Behavioral and heuristic models are as-if models too— and that’s ok by Ivan Moscati as of April 7th, 2022 (#23): “…. models that are currently used in decision theory, not only neoclassical models, but also behavioral and heuristic models, are best understood as as-if models. … different decision models perform differently not only with respect to their ability to account for observed choice behaviors but also with respect to other, less empirically-oriented desiderata, such as simplicity, tractability, parsimony, and possibly other “morphological” virtues of scientific theories. … the widespread habit of promoting the favored decision model as a model that captures the actual psychological mechanism generating choice behavior should be seen as belonging more to the rhetoric of decision theory than to its actual scientific practices. Accordingly, abandoning this habit and, correspondingly, acknowledging the as-if character of the models currently used in decision theory would free the field from a significant amount of methodological noise” (p.22).
Equity premium puzzle: Expected Stock Returns When Interest Rates Are Low by David Blitz from Robeco as of March 28th, 2022 (#281).: “Using long-term historical data for the US equity market our statistical tests strongly reject the hypothesis that a higher risk-free return implies higher total expected stock returns. Instead, total expected stock returns appear to be unrelated (or perhaps even inversely related) to the level of the risk-free return, which implies that the equity risk premium is much higher when the risk-free return is low than when it is high” (p. 11/12).
Underperforming narcicissts? Fund manager narcicissm by Dominik Scheld, Oscar Anselm Stolper, and Anna-Lena Bauer as of March 4ht, 2022 (#131) … “… we first find that narcissistic fund managers are as much as 34% more likely to deviate from the advertised investment style. Second, we document that, adjusting for risk, highly narcissistic fund managers underperform their non-narcissistic peers by an average 1% annually. …. we fail to observe a moderating effect of teamwork when it comes to the negative impact of narcissism on fund performance” (p. 23/24).
Equity herding: Herding Behavior and Systemic Risk in Global Stock Markets by Iftekhar Hasan, Radu Tunaru, and Davide Vioto as of March 28th, 2022 (#30).: “Using … data for 33 countries, we investigate herding during the Eurozone crisis, China’s market crash in 2015-2016, and in the aftermath of the Brexit vote. We find significant evidence of herding behavior driven by negative tail market conditions for most countries. Analyzing the spillover of herding during these three events, our results show cross-country herding effects from the Eurozone, China and the United Kingdom, with Brexit playing the most significant role in the negative co-movement of world stock exchanges. This study also investigates the relationship between herding and systemic risk, suggesting that herding increases when systemic risk increases” (abstract).
Foundation investments: Doing Good and Doing It With (Investment) Style by Matteo Binfarè and Kyle E. Zimmerschied as of March 21st, 2022 (#65): “We document large variation in the asset allocation and investment performance of private foundations over time and across size groupings. Private foundations reach for yield by shifting their asset allocation towards increasingly “risky” assets in response to the declining yield environment and mandated distribution rate. We find that foundations with greater than $500 million in assets generate positive risk-adjusted returns. … The infinite life of foundations has been inefficiently shortened as many foundations have let their spending decisions drive their asset allocation” (p. 30).
Alternative Investing (Impact investing)
Unattractive illiquid investments: Estimating Illiquid Asset Class Alpha and Beta using Secondary Transaction Prices by Alexander Godwin as of March 28th, 2022 (#31): “Reported returns of .. illiquid asset classes, based on estimated valuations, are at risk of being distorted by stale (or managed) prices. Such stale pricing can lead to an understatement of market beta. … we present a methodology for utilizing secondary transaction prices to obtain estimates of alpha and beta of the true economic returns of illiquid asset classes. …. Our results indicate that illiquid asset classes have true economic betas substantially higher than those obtained using reported returns. We estimate betas of 2.1, 2.1, 1.8 and 1.8 for private equity, venture capital, private real estate and private natural resources respectively. … Consequently, we estimate alphas that are either insignificant, in the case of private equity or venture capital, or significantly negative, in the case of real estate and natural resources. Our estimates of (annualized) asset class volatility are also meaningfully higher than those obtained from reported returns, with estimates ranging between 0.331 and 0.421. All four asset classes exhibit a high degree of stale pricing, with between 75% to 82% of reported prices being stale” (p. 19-21).
Token differences: Tokenomics Designs and their Parallels in Traditional Finance by Afonso Carvalho as of April 4th, 2022 (#182): “… a comprehensive list and analysis of the different types of token economics designs currently being employed can be a useful starting place either for people getting into the space or for teams considering their own implementations. Furthermore, many if not most people outside of crypto still have the mental model of a currency as what all tokens are trying to be. In 2022, this way of thinking is too reductionist and leads great investors and builders to underestimate or even dismiss the space” (abstract).