Asset allocation & Sustainable
Investing
Lecture 1
Sustainability concerns the effects on the environment and society of human behaviour, of economic
activity in particular. Economic activity – conduct of producers and consumers. Who can steer this
behaviour of producers and consumers? Governments (regulation and taxes/subsidies), charities
(rewarding and subsidizing), financiers (ownership rights and cost of capital / funding).
When considering sustainability, we need to distinguish between business and how it is financed.
Sustainable business: economic activity geared towards improving the environment and society at
large (CSR). Finance is more about providing the capital and cash to business that it needs to operate
(Sustainable finance/investing).
For traditional investing, the main goal is to achieve the best possible risk-return trade-off.
Sustainable investing accounts for the environment, social society and the governance of firms
(=ESG) when investing. ESG investing is defined as the consideration of environment, social and
governance factors alongside financial factors in the investment decision-making process. In this
definition, there’s no goal of investing (you just need to take into account ESG).
Environmental Social Governance
Pollution, waste and circular Human and labour rights Board effectiveness
economy (value chain) (composition and culture)
Natural resource stewardship Human capital management Executive remuneration (of
(try to reduce use of water) (employee) board members)
Climate change (greenhouse Conduct, culture and ethics Shareholder protection and
gasses) rights
Governance can also be seen as a mean to an end, instead of a goal itself.
What’s the goal sustainable investing? Look at this frame-work:
Finance-as-usual =Traditional investing. You want to optimize the financial value. Risk-return
tradeoff.
Sustainable Finance 1.0, you still look for maximizing F, but you also look at S and E, whereas it is
not as important as the Financial value. Exclusion (of investment that do poorly by ESG).
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, Sustainable Finance 2.0. Then you look at the stakeholder value. You want to optimize I (sum of
F,S,E). Problem, what is the currency of S and E? You cannot sum them. It’s called ESG integration..
But one accounts for ESG optimize F (2.1) OR Optimize over F,S and E (2.0).
Sustainable Finance 3.0. You look at common good value. S and E > F. You try to optimise S and E,
but it’s subject to F (as investors still want an interesting return): impact investing (mostly venture
capital).
You want to have additional impact on society by making an investment, that is intentional and
measurable.
The donut economy. There are social boundaries or
foundations, such as food security and access to health care.
You need to stay on the green doughnut.
Investors also have investment choices at their disposal that are not part of the S&S investment
categorization: voting at shareholders meetings & engagement. They are known as ‘voice’. It
emphasizes why investors value the Governance in ESG.
Investment choices lead (to financial performance, which leads) into ESG results and investment
returns. It’s the ESG plot.
ESG Investment choices, is not just picking one of the SI 1.0-3.0 strategies to put together the
investment portfolio. It also includes being an active holder of financial instruments. The ESG
instruments:
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,So Sustainable investing looks at:
• Financial Performance. Does it affect the firm’s financials?
• Investment results. Does it improve the investor’s portfolio returns?
• ESG results. Does it improve a firm’s ESG factors? ESG results are the measurable
performance of ESG indicators at firm or project level, summed to the portfolio level.
Environmental (carbon emissions or water usage) + Social (number of labour conflicts or
gender imbalance)+ governance (conservative accounting or board resolutions = hard to
quantify).
Lecture 2
Retail investors are individual investors (Riedl & Smeets, 2017). Why would they invest in ‘do good’
or ‘do no harm’ funds = SRI: socially responsible investing. Do they expect high returns or low risk? Or
are they genuinely altruistic? Or do they want to appear good? So, are those investors rational?
The researchers look at portfolio characteristics, experiments conducted on the individuals (risk
preferences and social preferences) and personal characteristics. The sample group thought that the
SRI funds would perform a little worse (and less risky) than expected. This is not especially irrational.
The expectations of this risk/return is quite the same for SRI investors and non-SRI investors.
Though, those are just expectations. Looking at realized return, SRI funds perform worse and are
riskier (more expensive). Though, it’s a quite small sample of investing.
Conclusions:
People that are more altruistic (socially minded), are more likely to invest in an SRI fund.
Thinking that it will have social impact, individuals invest in SRI funds (because that’s who
they are as a person).
Signalling (talking about your investments) has a positive impact on the probability that
they’ll invest in an SRI fund. This effect especially occurs if those people are not that socially
minded themselves.
If people are convinced that SRI has a social impact, they are more likely to invest in an SRI
fund.
But people do not own more than a single SRI fund, or put a larger amount in the SRI fund,
the more they are socially minded, or think it has impact or anything else.
Investors are less likely to own a single SRI fund if they think that SRI funds underperform.
Riskiness of SRI funds does not affect owning one. So financial considerations do not
determine SI. SRI investors knowingly sacrifice money!
Investors are more likely to own a single SRI fund if they are wealthier, more active, but long
term.
But the wealthier they are, the smaller the allocation percentage to SRI.
There are some statistical concerns: the results of the test are not very strong, for a survey the
number of participants is not that high (of which a fraction holds SRI funds), all participants are
Dutch.
Though, they took every aspect into account that might have an effect on holding a SRI.
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, Side note; people invested in SRI funds donate more to charities. This implies that charities are a
different thing in the minds of retail investors than SRI (they are no substitutes).
So, investors are not necessarily the rational agents!
So far, this was retail investors. Now, we’ll look at institutional investors and the importance of
Climate risks (Krueger, Sautner and Starks, 2020). We expect institutional investors to look more to
commercial reasons, and less at things like ‘being an altruistic person’. Investors can be catalysts
towards a low-carbon economy! In this article, there’s quite some sample bias (respondents are
drawn from ESG conference goers,etc.).
The sample thinks that the main risks of climate risk is financial risk. After that, it’s operating risk
(that something goes wrong while conducting business). Next, governance risk, then social risk, then
climate risk, then other environmental risk. The last 4 contain 35% of the risk importance. Because of
the sample bias, ESG risks may be overstated.
A survey on the meaning of sustainability results in the main focus on environment. After that, it’s
social. Lastly, it’s corporate governance. The focus in this paper is climate change.
The investing horizon has an impact on the climate risk estimated. Long horizon investors are more
concerned about climate risk than shorter horizon investors. It’s something that’s meaningful, but
statistically significant is not great. We compare between people that are already more ESG aware,
so sample bias is not a problem (as it’s all within the sample).
Those investors that have a larger part of their investment incorporating ESG issues, care more. But
note!
Why do investors incorporate climate risk in their investment process? The first reason is protecting
the reputation (appear good = commercial reasons), legal reasons, moral reasons, business reasons
(money wise).
What do investors do to manage climate risk (risk management)? They analyze a lot, they make
active investment choices, not much exclusion, some voting/engagement (later on).
Then, let’s look at Shareholder engagement. What exactly do investors do when engaging with firm?
Some investors go out to the general meeting of shareholders to vote in favour of sustainable
investments. Those firms often acknowledge your input but do not really do much. Some investors
follow-up if the firm does not do much with the input. 40% undertakes no action. There are some
investors that sell their shares or they do the next level of engagement. So, what’s climate risk
engagement? This could be discussing, conference calls, etc.. They can also undertake legal actions,
do proposals, etc.. They can also vote against re-election of any board directors due to climate risk
issues.
Lastly, asset pricing. If climate change is an identified risk, is it taken into account for asset pricing?
Investors do not think so: most carbon emitting industries are considered to be overvalued. This is
especially thought by ESG heavy investors. Again, investors who are convinced they know better
about ESG construct a portfolio with a high ESG share
Concluding, the group of institutional investors that takes climate risk seriously is large and growing.
They do so: for commercial reasons –for the planet –because of the law –for better investment
results.
Out of the investor characteristics only long holding periods of assets seem to matter for the degree
to which they worry about the climate. Among ESG aware investors, people put their money in funds
that they talk about/support.
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