Approaches to Investment - CH9 Flashcards
What are the 3 approaches to Investment?
- ESG
- Passive
- Active
What is ESG Investing?
The level to which environmental, social and governance factors are considered when investing.
What is Traditional ESG?
Avoiding sin stocks, e.g. alcohol and weapons, altogether.
What is the issue with Traditional ESG investing?
The investor has no ability to create change in the industry - solution is activist investing.
What is Activist Investing?
Investing in a company and using your stake to influence and get the company to do ‘less bad’.
UN: Kofi Annan did what?
Created 6 responsible principles. Led to establishment of PRI.
What is the PRI?
Non-profit org that engages policy makers and investors to invest more sustainably.
What did the FSB do?
created the Task Force for Climate-related Financial Disclosures (TCPD) - after G20 asked what they could do about climate-related investing.
What 4 areas does TCFD focus on?
1) Governance disclosure.
2) Strategy disclosure.
3) Risk management disclosure.
4) Metrics and target disclosure.
What is Spectrum Investing?
Focuses on 5 levels of ESG:
1) Fully delegated, light touch - rely on managers ESG policies.
2) Ethical / Values based - avoid controversial sectors.
3) Integrated approach - managed ESG risk to seek positive ESG outcomes.
4) Impact investing - invest in companies that provide a solution + market returns.
5) Impact only - invest in solutions but no market returns (philanthropy).
Pros of ESG investing?
- Better returns.
- Lower risk - esp in periods of market volatility.
- Best reflects the changing attitudes of investors.
Cons of ESG investing?
- Ethics cloud judgement - may miss opportunities of greater profits.
- More research required.
- Greenwashing - companies claiming to be ESG to get funding but they’re not.
What is Passive management?
Following a benchmarked index. Not trying to outperform the market to get better returns.
What are the pros of passive management?
- Performance of the fund is not linked to manager’s ability to make investment choices.
- Investors only exposed to the systemic risks of the market (good too because majority of actively managed portfolios don’t outperform the index).
- Less fees for investors compared to actively managed portfolios.
- Lower expense ratios than actively managed funds (e.g. hedge funds).
- Innovative investment products (e.g. smart beta ETFs).
What are the cons of passive management?
- Investors must be satisfied by index returns - can’t be changed.
- Investors should accept returns of fund will be close to the returns of the index (acceptable relative returns but not absolute).
- Lack of control, especially if markets become volatile.
- No alpha generated (above market returns).
- Certain markets don’t have facilities to track markets (e.g Africa and Asia).
Why might investors choose not to invest in Passively managed funds?
Not satisfied by EMH - some market segments may generate better returns, thus invest in these:
- Greater beta stocks (more likely to return above market gains or losses).
- Stocks less correlated to the market (e.g. gold).
What is Beta?
Sensitivity of an investments movement in relation to the overall market.
What does market beta equal?
Beta = 1
Fund beta > 1 equals?
Fund is more volatile than the market.
Fund beta < 1 equals?
Fund is less volatile than the market.
What issue does smart beta aim to address?
Tracking market cap weighted index goes overweight in stocks that are ovrvalued, and underweight in stocks that are undervalued.
What does Smart Beta do?
Uses an alternate system that combines over performance (active) with lower costs (passive).
What are the 2 types of funds that use this smart beta concept?
1) Hedge fund replication.
2) Factor investing.
When are Passive Bond Strategies employed?
When the market is efficient (buy and hold) or when the bond portfolio is constructed around meeting a future liability fixed in nominal terms.
