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Sustainable Investing > Lecture 4 > Flashcards

Lecture 4 Flashcards

1
Q

What is ESG integration?

A

Targets reducing portfolio risks or volatility, increasing returns, or adding value to the portfolio’s effect on society or the environment

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2
Q

How is ESG integration implemented?

A
  • ESG score based analysis
    + Picking individual firms (active)
    + Positive screening (passive)
  • Thematic screening (pick a topic for selecting stocks)
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3
Q

Evidence of ESG

A
  1. ESG performance
  2. Value drivers
  3. Stock performance
  4. Investor performance
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4
Q

ESG integration into fundamental equities

steps Value driver adjustment (VDA) approach

A
  1. Identify & focus on the most material issues
  2. Analyse the impact of these material issues on the individual company
  3. Quantify competitive (dis)advantages to adjust for value driver assumptions
  4. Have an active dialogue
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5
Q

Corporate social responsibility effect (not directly SI)

A
  • Higher sales, lower financial volatility
  • Better access to funding
  • Higher trust and resilience
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6
Q

Blitz & Swinkels

Does excluding stocks cost performance?

Conclusion

A
  • Exclusions involve risk relative to the market and peers

- It is unlikely that excluding sin stock generate a higher cost of capital for them (no ESG results)

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7
Q

Dimson

Goal

A

Does engagement work? Does it affect financial performance? Does it affect returns?

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8
Q

Dimson

Conclusion

Success in engagements is more probable if:

A
  • the engaged firm has reputational concerns
  • has higher capacity to implement changes
  • has been engaged successfully before
  • there is collaboration
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9
Q

Blitz & Swinkels

Does excluding sin stocks cost performance?

Solutions

A
  • Tracking error may be minimized and expected portfolio return restored by filling the gap left by excluding sin stocks with non-sin stocks that offer similar hedging properties and factor exposures
  • Mimic the Sharpe ratio of the market
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10
Q

Dimson

Conclusion

Successful engagements, particularly on environmental/social issues, generate:

A
  • improved accounting performance
  • better governance
  • increased institutional ownership
  • better financial performance (not very strong results)
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11
Q

Goals of ESG integration

A
  • Optimizing the portfolio risk/return trade off by taking account of ESG factors (1.0 optimize F subject to E&S)
  • Achieve a compromise of optimal portfolio outcomes and ESG outcomes at the same time (2.0 optimize E+S+F)
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12
Q

Investing based on (..) is driving up prices of such stocks at the moment

A

Scores and themes

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13
Q

CSR is also considered (..), as it has an indirect effect on ESG (..)

Therefore, ESG scores can help to (..)

A

SI, through better financial performance

Identify social responsible companies

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14
Q

Conclusion CSR

Support SI 2.0: taking account of ESG factors primarily (..)

However the target is (..), not the ESG

A

In the fundamental analysis of firms

The financial returns

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15
Q

Evidence of ESG

  1. ESG performance
A
  • Scores/ratings

- Material vs immaterial

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16
Q

Evidence of ESG

  1. Value drivers
A
  • Sales growth
  • Margins
  • Cost of capital
17
Q

Evidence of ESG

  1. Stock performance
A

Type of companies

18
Q

Evidence of ESG

  1. Investor performance
A

Approach: ESG integrated vs ethical

19
Q

Blitz & Swinkels

Does excluding sin stocks cost performance?

Goal

A

The impact of excluding sin stocks on expected portfolio risk and return

20
Q

Blitz & Swinkels

Does excluding sin stocks cost performance?

Relationship

A

Investment choice directly on investment return

21
Q

Blitz & Swinkels

Does excluding sin stocks cost performance?

Financial arguments

A

Pro-exclusion: Sin sectors have no long term future, so they will underperform relative to other sectors

Against exclusion: Reduces diversification, which increases portfolio risk.

22
Q

Blitz & Swinkels

Does excluding sin stocks cost performance?

Background

A
  • Tracking error: return deviation of an investment portfolio from the return of the market portfolio
  • In CAPM, deviating from the market introduces risk and a rational investor seeks compensation
  • The exclusion portfolio does not give the required return because it does not sit on the tangency line
  • Sin sectors are expected to outperform the market according to Fama-French-5-Factor
  • Sin premium – they are cheap enough for the cash flow they generate
23
Q

Dimson

Does engagement work? Does it affect financial performance? Does it affect returns?

Stewardship

A

Pay a company to engage on your behalf according to your principles

24
Q

Dimson

Does engagement work? Does it affect financial performance? Does it affect returns?

Data

A

Engagements performed by an institutional investment firm on U.S. companies, concerning ESG factors

25
Q

Dimson

Does engagement work? Does it affect financial performance? Does it affect returns?

Engagement success

A
  • Apple Inc. announces eliminating toxics and more recycling
  • Yahoo Inc. commits to human rights and freedom of expression online
  • Illinois Tool Works Inc. publishes a Sustainability Report
26
Q

Dimson

Does engagement work? Does it affect financial performance? Does it affect returns?

Problems

A

Not explained deeply about engagement results

Only one investor data is used

27
Q

Dimson

Does engagement work? Does it affect financial performance? Does it affect returns?

Conclusion

A

A company is more likely to be engaged if it is:

  • Large
  • Old
  • Performs poorly
  • Sensitive to reputation
  • Weak governance
  • Investor shareholding is large

Successful (unsuccessful) engagements are followed by positive (zero) abnormal returns

Sustainable Investing (7 decks)

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