Intro to ESG Investing Flashcards

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1
Q

What is ESG Investing?

A

An approach to managing assets where investors aim to incorporate E, S, & G into their investment decisions bearing in mind long-term returns

Can also be thought of identifying, evaluating and pricing E, S, & G risks and opportunities

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2
Q

Examples of E, S, & G?

A

Environment - Social - Governance
Climate Change - Human Rights - Bribery
Waste - Modern Slavery - Executive Comp
Resource Depletion - Child Labor - Board Diversity
Pollution - Employee Relations - Taxes
Biodiversity - Working Conditions - Trade Associations/Lobbying

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3
Q

What is Triple Bottom Line Accounting?

A

Also known as the Three P’s - People, Profit and Planet: TBL suggests that long-term sustainable value creation is dependent on stable and well-managed social, environmental and economic systems.

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4
Q

What is CSR?

A

Corporate Social Responsibility: Company commitment to conduct business in an ethical way.

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5
Q

What is Responsible Investment?

A

Can be an “umbrella term” for all investment approaches that capture various aspects of ESG. At minimum its a practice that mitigates risky ESG practices in order to protect value.

In other words - how does ESG influence risk adjusted returns of an asset or the stability of an economy, etc.

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6
Q

Define SRI?

A

Socially Responsible Investing is an approach that applies social and environmental criteria, usually in conjunction with sector specific weightings.

A hurdle could be established for qualification within an investment universe

Can be used in conjunction with other strategies such as Best in Class, Thematic Funds, etc.

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7
Q

Best In Class Investing = Responsible Investing?

A

Not necessarily - Best in Class Involves selecting only companies that overcome a specific ranking hurdle established using sector or industry specific ESG criteria.

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8
Q

Compare Sustainable Investment to Thematic Investment?

A

Sustainable Investment refers to the selection of assets that contribute to a sustainable economy. Its a broad term that could also include a best-in-class approach or negative screening and/or ESG integration. Could refer to companies that positively impact or companies that will benefit from a positive impact.

Thematic investing is a subset of sustainable investing where investors select assets that fall under a certain sustainability theme such as smart-grid technology or EV’s. Not all these subsets are considered responsible investments.

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9
Q

What does Green Investment consist of?

A

Allocating capital to assets that mitigate climate change, biodiversity loss, resource inefficiency, or other environmental challenges.

Thus can be considered a sub-category of thematic investing and/or impact investing.

Note that Green bonds/loans are a big part of green investing.

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10
Q

What is the aim with Social Investment?

A

Allocate capital to assets that address the bottom of the pyramid (BOP -
BOP refers to the poorest 2/3rds of the economic human pyramid = over $4 Billion people)

Broadly speaking BOP investing is a market based model of economic development that seeks to alleviate poverty while providing profit to businesses that serve the underserved communities. Can include everything from micro-finance to accessibility of sanitation or clean energy.

Can also include social impact bonds.

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11
Q

What is achieved with Impact Investing?

A

Specific intent to generate positive and measurable social/environmental impact alongside financial return which differentiates it from philanthropy.
Typically it is achieved through direct investments in debt, equity, RE, or even public markets.

GIIN - Global Impact Investing Network estimates size of market to be $502 Billion with different investors expecting different levels of returns.

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12
Q

Differences between Ethical, Value Driven or Faith Based Investing?

A
They are the same! Referring to the same type of investment principles based on negative screening to avoid products and services deemed morally objectionable by the investor or a religion,  or a convention or through any agreed upon principles. 
Examples include: 
Guns
Tobacco
Pornography
Alcohol
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13
Q

Watershed Moments in ESG acceptance?

A

2005 - UN Environment Programme Finance Initiative commissioned the Freshfields report arguing that integrating ESG into investment analysis is permissible and arguably required.

2015 - Governor of BOE Mark Carney - chairman of Financial Stability Board said to regulators that “…once climate change becomes a a defining issue for financial stability, it may already be too late..”

2019 - PRI states that failing to consider long-term investment value drivers including ESG is a failure of fiduciary duty

2020- Larry Fink of Blackrock stated intention to step up consideration of climate change in investment considerations. Also the divestment from companies that generate more than 25% of revenue from coal production and mandated reporting from investee companies on plans on climate related plans and risks for operating under Paris Agreement ( limit global warming to less than 2 degrees C)

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14
Q

Name some ESG Investment Perspectives?

A

Fiduciary Perspective - Understand and incorporate material ESG factors into investment decision making in order to mitigate risk and safeguard assets.

Economic Perspective - Understanding that unless negative trends such as the increasing scarcity of natural resources (water, land) and the prevalence of health and income inequalities does not reverse, economies will be weakened and greater exposed to bubbles and spikes. This is particularly concerning for asset owners.

Impact and Ethics: Belief of some investors that investments can/should serve society along with providing financial returns.

Client Demand Perspective - Greater understanding that ESG factors influence company value, returns, reputation aka positive impact investing and negative screening

Regulatory Perspective - Across 50 of the largest economies, 48 have some form of policy designed to help investors consider sustainability risks, opportunities, and outcomes encouraging investors to consider long term value drivers.

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15
Q

What are the benefits of integrating ESG into corporate behavior?

A

1) reduced cost and increased efficiency: sustainability once perceived as requiring sacrifices, perception now is cost reductions/improved operational efficiency by better mgmt of resources, improved supply chain, minimized waste ( mckinsey estimates 60% increase in operating profits)

2) Reduced risk of fines and state intervention: Federal govt’s are enacting regulations to protect environment, improved sustainability will position companies to react to to changing regulations (mckinsey estimates 1/3rd of profits are at risk from state intervention)
- most at risk are automotive, banking and tech with their large govt subsidies

3) reduced negative externalities: (situations where the production/consumption of goods creates costs/benefits not reflected in the prices charged for them) Pollution creating a reduction in tourism or lowering life expectancy is an example.
- or when private costs are lower than societal cost, or market failures If INTERNALISED then cost to society needs to be reflected in price/cost

4) improved ability to benefit from sustainability megatrends: integrating a response to economic implications of social challenges( inequality, poverty, etc) and environmental issues

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16
Q

Instruments for Internalizing negative externalities?

A

1) Market based instruments: charges, taxes and permits
2) Regulatory Instruments: vehicle emissions, safety standards, traffic restrictions
3) Voluntary Instruments: Agreements with industries to reduce CO2 or emissions

The uncertainty surrounding the timing and extent of internalization is a critical component of the overall risk landscape

17
Q

What are the four largest sustainability megatrends?

A

1) Emerging markets and urbanisation: estimated that half of global GDP growth will come from 450plus megacities in emerging markets
2) Tech innovation: accelerated adoption invites accelerated innovation. Also continued rise of social media and AI
3) Demographic Changes: 60% of word’s population lives in countries with fertility rates below replacement rates. This will have multiple effects including caring for large number of elder people, stress on govt finances, social strains,
4) Climate Change and Resource Activity: As world becomes more urbanized and prosperous the demand for energy, food and water will rise creating scarcity. This combined with reduced agricultural productivity from climate change could amplify the impact.

18
Q

Challenges of Integrating ESG in investment?

A

Lack of understanding creates lack of support

Misconceptions that is will have negative impact on performance

Lack of resources: expertise, technology, technical expertise

Gaps between marketing and delivery of funds

19
Q

Does tilting investment portfolios in favor of companies with higher ESG scores lead to increase tracking errors or below market performance?

A

No - ACWI example:
Utilities, materials, and energy sectors account for less than 15% of portfolio weight and over 80% of overall carbon footprint. So does reducing emissions of portfolio mean a reduction of exposure to these industries?

Low Carbon ACWI maintains a tracking error of 30 bps by overweighting companies with low carbon emissions (CE) relative to sales and those with low CE per dollar of market cap.

20
Q

Name some resource challenges for ESG focused investors?

A

High quality standardized data sets - increasing number of specialized providers but challenges remain in materiality, corporate disclosures and standardization. Especially outside of equities.

Modeling capabilities - Financial models typically use inputs from historical data, this is less useful for forecasting ESG outcomes than understanding past and current CE. Furthermore its hard to estimate viability or impact of tech developments

Valuation Techniques - How do you adjust valuation for ESG risks?
Discounting future cash flows bring into question what level of discounting is sufficient, higher or lower multiples could lead to miscalc if ESG factors are partially priced by the market

Without some or all its difficult to extrapolate ESG risks/opportunities from performance

21
Q

Do sustainable business practices deliver higher positive financial performance?

A

Yes, mounting evidence indicates this but this does not hold true for fund performance. Asset mgmt has not been able to consistently translate ESG analysis into alpha.

2012 study by DB: Strong correlation in medium and long term outperformance of companies rated highly in ESG.

2015 - Highly exhaustive study confirmed above

22
Q

What are all the UN SDGs?

A

1) End Poverty 9) Industry, Innovation, & Infrastructure
2) Zero Hunger 10) Reduce Inequalities
3) Good Health 11) Sustainable Cities
4) Quality Education 12) Responsible Consumption/Production
5) Gender Equality 13) Climate Action
6) Clean Water 14) Life Below Water
7) Affordable and Clean Energy 15) Life on Land
8) Decent Work and Economic Growth 16) Peace & Justice
17) Global Partnership for Sustainable Development

23
Q

What is one of the MAIN reasons for ESG integration in investing? What are the financially material aspects?

A

Because responsible investment can reduce risk and enhance returns.
Financial Materiality includes;
Reduced cost and increased efficiency
Reduced risk of fines
Reduced Externalities
Improved adaptability to sustainability megatrends