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CISI - Portfolio Construction Theory in Wealth Management > Chapter 9 > Flashcards

Chapter 9 Flashcards

1
Q

What does externalisation of company costs mean? (2)

A
  • companies consume resources and create waste
  • include the costs above in price of goods
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2
Q

What does the externalisation of CO2 emissions and global warming mean?

A

Companies pay for harm caused to planet producing products and CO2

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3
Q

What are the three instruments of environmental governance?

A
  1. The UN Framework Convention on Climate Change (UNFCCC)6
  2. The Convention on Biological Diversity (CBD)7
  3. The non-legally binding Statement of Forest Principles8.
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4
Q

What are the first three principles of PRI?

A
  • incorporate ESG issues into investment analysis and decision-making processes
  • Be active owners and incorporate ESG issues into ownership policies and practices
  • Seek appropriate disclosure on ESG issues by the entities invested in
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5
Q

What the last three principles of PRI?

A
  • Promote acceptance
  • Work together to enhance effectiveness
  • Report on activities
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6
Q

How many UN Sustainable Development Goals are there?

A

17

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7
Q

What do the critics say about companies regarding UN Sustainable Development Goals?

A

the breadth and quality of data that companies provide are inconsistent or incomplete

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8
Q

Are there standardised models to assess investments against the SDGs?

A

No

Open to interpretation

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9
Q

What is the problem with SDGs being open to interpretation?

A
  • lead to oversights and a lack of consistency across the industry
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10
Q

Why do some critics say voluntary disclosures on environmental performance are ineffective?

A
  • not bound by regulation
  • not held accountable when they act irresponsibly
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11
Q

What is a motivation for ethical, responsible and sustainable investing?

A

individuals might feel they want to ‘give something back’ or have concerns for ethical or ESG issues

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12
Q

Give two reasons for ethical investing

A

Financial - ESG companies better returns

Faith - religious beliefs

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13
Q

What is included in the sextet of sin?

ATGPAN

A
  • alcohol
  • tobacco
  • gambling
  • pornography
  • armament manufacturing
  • nuclear power-related activities
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14
Q

What is negative screening for ESG investing?

A

exclude companies producing ‘undesirable’ products

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15
Q

What is a challenge of excluding a company for ESG?

A

What to do if only a part of business activity is bad

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16
Q

What is the de minimis level in ESG screening?

A

the level of exposure to the excluded activity deemed acceptable

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17
Q

How is the de minimis used in ESG negative screening? (2)

A

apply to the firm’s turnover or revenue

the lower the level, the stronger the exclusion

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18
Q

What is positive screening in ESG investing?

A

invest in firms providing positive solutions to challenges

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19
Q

What is an advantage of positive screening? (2)

A

exclude companies deemed unacceptable

include less than perfect companies that try to improve their practices

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20
Q

Give an example of a less-than-perfect company that would be included in a positive screening ESG strategy (2)

A

company that sells fur (bad)

trying to improve the practices (preserving the environment)

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21
Q

What is a negative in investing ESG style? What are the tilts in ESG?

A

restricts diversification

might tilt to certain
- size
- growth
- sectoral
- industrial production
- market

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22
Q

What is the difficulty with ethical/responsible/sustainable investing?

A

it can mean different things to different people

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23
Q

What is ethical investing?

A

the practice of selecting investments based on ethical or moral principles

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24
Q

‘responsible and sustainable investing’ represents three key investment strategies, which are…

A

ESG

SRI

Impact investing

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25
Q

What do responsible investors hope for?

A

better manage risk and generate sustainable, long-term returns

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26
Q

What do sustainable investors hope for?

A

progressive practices and recognise that companies solving the world’s biggest challenges can be best positioned to grow over the long term.

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27
Q

What does ESG stand for?

A

Environmental

Social Justice

(Corporate) Governance

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28
Q

What does the Environment part of ESG concern about?

A

concerns about the environemnt

i.e. CO2 emissions, deforestation and pollution

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29
Q

What does the social justice part of ESG concern about?

A

human rights

30
Q

What does the (Corporate) governance part of ESG concern about?

A

companies with weak internal controls

31
Q

What is SRI?

A

SRI is broadly similar to ESG, except that SRI is driven first by investors’ individual values rather than investment potential.

32
Q

What is impact investing?

A

investment into companies to generate a positive environmental or social impact alongside a financial return

33
Q

Two types of impact investment

A

loans at below-market rates

positive screen - companies with positive or beneficial impact

34
Q

What is the size tilt on sustainable investing?

A

smaller and medium-sized companies

35
Q

Why are more smaller companies included in sustainable investing?

A

typically smaller, and therefore more nimble, growth companies operating in niche areas of the market that are providing solutions to the world’s challenges

36
Q

How does best in class help

i.e. in mining sector

A

invest in the best (or least harmful) mining company, on the basis that such investment should encourage less responsible mining companies to do better

37
Q

How can managers of funds influence management of companies? (2)

A
  • encourage improvement in policies
  • make company less harmful
38
Q

What are the concerns regarding managers of funds influencing management of companies?

A
  • commitment is weak
39
Q

How does exclusion approach reduce diversification?

A
  • many industry sectors not permitted in ethical funds
40
Q

What is the proposed benefit of being ethical?

A

companies enjoy a premium to valuation

41
Q

Why do ethical companies get an ‘uplift’ in valuation?

A

unethical and irresponsible behaviours as markets of corporate risk

42
Q

What are the corporate risks of being unethical? (3)

A
  • reputation
  • litigation
  • environmental clean up costs
43
Q

What are the intended results of influencing management of companies?

A
  • act in a responsible way
  • changing nature of business
  • consider external factors i.e. climate change and pollution
  • reduce potential financial liabilities
44
Q

What is greenwashing?

A

misleading environmental claims for marketing purposes with the aim of improving reputation and profits

45
Q

What are the other types of washing? (8)

A
  • impact washing
  • social washing
  • governance washing
  • rainbow washing
  • pink washing
  • blue washing
  • purple washing
  • diversity washing
46
Q

In the corporate social repsonsibility (CSR), what is a measure of labour equality within an organisation?

A

a simple test that may be available might be to compare the ratio of the salary of the highest-paid member of staff to the lowest-paid

47
Q

What are green bonds?

A

debt instruments for projects with positive environment or climate benefits

48
Q

What kind of projects are included in green bonds? (3)

A

energy efficiency
pollution prevention
sustainable agriculture

49
Q

Who typically issues green bonds?

A

governments and supernational organisations, as well as companies

50
Q

What are the four components of the green bond principles?

A
  • use of proceeds
  • process for project evaluation and selection
  • management of proceeds, and
  • reporting
51
Q

What is the intended use of the green bond principles?

A

provide guidance on the key components involved in launching a credible green bond

52
Q

What are labelled green bonds?

A

proceeds are earmarked for environmental projects

been labelled as ‘green’ by the issuer

53
Q

How do issuers label their green bonds if they are concerned about lack of standardisation?

A

They keep it unlabelled

54
Q

Who typically issues unlabelled green bonds

A

pure-play companies (ie, those focusing on a single type of product or service), such as solar energy or recycling companies

55
Q

What are ‘use of proceeds’ bonds?

A

Proceeds are earmarked for green projects, either by holding them in sub-portfolios or otherwise tracked by issuers and are backed by issuers’ entire balance sheets.

56
Q

What are ‘use of proceeds’ revenue bonds?

A

credit exposure in the bonds is to pledged cash flows of the revenue streams, such as fees and taxes

57
Q

What are ‘green project’ bonds?

A

issuers use proceeds to provide loans to a separate company or special purpose vehicle (SPV), which then deposits funds into those dedicated projects

58
Q

What are ‘green securitised’ bonds?

A

these are bonds collateralised by one or more specific green projects, with bond repayments generally coming from the cash flows generated by the assets

59
Q

What is one of the main concerns with green bonds?

A

lack of standardisation of what constitutes a green bond

60
Q

What are social impact bonds (SIBs)?

A

finance-raising instruments designed to raise funds to achieve social objectives

61
Q

What’s the difference between impact bonds and conventional bonds?

A

focusing on the social benefit (ie, social impact) rather than the investment potential

62
Q

How does repayment work for SIBs?

A

focus on social outcomes being met instead of a fixed return

63
Q

What are environmental swaps?

A

debt swaps that allow the debtor country (usually a less developed country) to have the amount of its debt reduced by the amount that it spends on key environmental projects.

64
Q

What is the primary purpose of environmental swaps?

A

reduce the debt problems of poorer countries while promoting conservation/environmental issues

65
Q

What makes it difficult to construct an ethical/responsible/sustainable portfolio? (3)

A
  • a lot of options to choose from
  • companies do not report relevant information
    -ESG ratings agencies do not have language skills to interpret ESG reports
66
Q

What does the research say about companies with good environmental and social ratings? 4

A

historically demonstrated lower levels of

systematic risk,
less volatile earnings,
less systematic volatility
lower costs of capital

compared with their lower-rated counterparts

67
Q

How does ESG investing affect geographic diversification?

A

limits diversification

excluding countries with poor human rights records

68
Q

What are the competitive advantages of ethical, sustainable and responsible companies?

A

build a good reputation contributing to society and avoiding coercive, exploitative, or illegal practices while bringing financial reward

69
Q

How does a good reputation help a company?

A

attracts customers and business partners, creating economic opportunities

70
Q

How does strong moral principles help a company?

A

help limit abuses by employees tempted to circumvent regulation

71
Q

Advantage of companies with stronger ethical/ESG reputations (2)

A

higher P/Eratios for their stock and borrow at lower rates in bond markets

72
Q

What are other competitive advantages for companies with good ESG? (3) AAI

A
  • attracting talent
  • anticipating changes in regulatory and business environments ahead of competitors
  • increasing customer and investor loyalty

CISI - Portfolio Construction Theory in Wealth Management (15 decks)

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