Week 9 - Responsible investing

Question 1

Responsible investing & Responsible stewardship

Answer 1

Responsible investing
1. a strategy to incorporate ESG issues into investment decisions
2. aka sustainable investing / ESG investing

Responsible stewardship
1. being ACTIVE OWNERS and incorporating ESG issues into ownership policies and practices

Question 2

3 goals of Responsible investing

Answer 2

1. Financial: increase returns and/or reduce risk
2. Social / Impact: change the externalities a company produces {by investing in them rather than starving from capital}
3. Values / Tastes {doing the right thing, ie. creating large impact, might be contradicting your tastes}

*values/tastes is not the same as social/impact

Question 3

Confirmation bias - a particular issue with Responsible investing

Answer 3

People accept “evidence” if it confirms what ppl would like to be true

{and therefore, unlikely to question it. whereas if the “evidence” goes against what people would like to be true, they will question}

Statement -> Fact -> Data -> Evidence -> Proof
- a statement is not fact
- a fact is not data
- data is not evidence

Question 4

“Well-governed firms beat poorly-governed firms by 8.5%/year over 1990-1998”

But why does Governance only matter in NON-COMPETITIVE INDUSTRIES?

Answer 4

In competitive industries, CEOs have to work hard to stay competitive when they have a lot of wealth tied to the company
eg. Elon Musk/Tesla, Mark Zuckerberg/Meta

Question 5

Social: Diversity, Equity, and Inclusion

Answer 5

1. DEI has very little relation with Demographic diversity
2. DEI is positively correlated with FUTURE PERFORMANCE, but demographic diversity is not

> > need to be asking Qs about whether employees feel recognised, can be themselves, treated fairly, promotions go to those who best deserve them, etc.

Question 6

Environmental: Carbon emissions

What explains higher returns from firms with higher carbon emissions?

Answer 6

High returns is usually a sign of OUTPERFORMANCE, not a sign of risk (the authors’ claims were purely confirmation bias)

• Climate risk is not investment risk!
• A low-carbon portfolio sacrifices risk-adjusted returns
• Potential trade-offs between net zero and fiduciary duty

Question 7

2 pros & 6 cons of Exclusion/Divestment

= excluding a stock if it doesn’t tick a particular box
= including a stock if it does tick a particular box

Therefore, best practice is actually ESG INTEGRATION, not exclusion based on box-ticking!
ie. include ESG factors alongside financial factors; simply broadening the set of information used in an investment decision, just like any other non-financial factor

Answer 7

Pros
1. Easy - cheap, scalable
» not resource intensive, don’t have to scrutinise specific criteria which is time-consuming
2. Transparent
- clients know what they’re buying
- can hold the fund accountable; prevent “rational lies”

Cons
1. -vely correlated with values: sin stocks earn higher returns
- Confuses valuation issues with values issues. FINANCIAL GOALS must take VALUATION into account, so can’t be blanket
2. SOCIAL GOALS
- divesting from a company does not deprive it of capital; it lowers stock price and hinders future issuance but other investors can buy underpriced stocks
» ALL GOALS
3. Not all ESG factors are MATERIAL
4. ESG metrics may miss QUALITATIVE dimensions of ESG
5. Considers only one (or a small subset) of factors: “halo effects”
- many industries aren’t black-and-white: defence, energy, alcohol, semiconductors
» ignores other dimensions that a company can contribute to society, eg. semiconductors produce PFCs but could be used in solar panels (for renewable energy)
6. Focuses on pie splitting / “do no harm” rather than pie growing / “actively do good”