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PPCmetrics AG
Investment & Actuarial Consulting,
Controlling and Research. www.ppcmetrics.ch
PPCmetrics AG
Investment Consulting
© PPCmetrics AG
Responsible Investing – General Considerations and
Implications for Fixed Income
EPFIF
Dr. Diego Liechti, Senior Investment Consultant
Bern, September 21, 2016
Introduction
Definition
According to Cambridge Dictionary:
• Sustainability
1. The ability to continue at a particular level for a period of
time.
2. Environment, natural resources:
The idea that goods and services should be produced in ways
that do not use resources that cannot be replaced and that do
not damage the environment.
• Socially responsible investment
1. An investment in a company whose business is not harmful
to society or the environment.
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Source: http://dictionary.cambridge.org/dictionary/english/
Introduction
Brief History of Socially Responsible Investing
• At the end of the 17th century, religious investors refused investing in
alcohol, gambling and tobacco companies.
– In 1928, a group of 24 funds (“pioneer group”) conducted a sin screening
of the investments, which led to the exclusion of the above mentioned
industries.
• In the 60s, student protests against the war in Vietnam led to a
continued exclusion of the arms industry (e.g., at the Pax World
Fund).
• In 1972, the Dreyfuss Corporation excluded companies that were
doing business in South Africa due to the Apartheid.
• In the 80s, socially responsible investing became “mainstream” (e.g.,
Calvert established 9 funds).
• Around 1990, the first sustainable index was introduced (Domini 400
Social Index).
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Source: Cory (2012)
Investment Case
Arguments for Socially Responsible Investments
• Avoiding reputation risks (also from employer’s perspective)
• Anticipating a possible regulation
• Act in the beneficiary's best interest
• Achieving an outperformance compared to the benchmark
(Does it pay to be good? Or to be bad?)
• Combine business with pleasure: earn money and make a
difference
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Investment Case
Critical Evaluation of Arguments (1)
• Avoiding reputation risks (also from employer’s side)
Avoiding negative news paper articles
? However: in what way is reputation relevant for the achievement of
the pension fund’s main purpose, i.e., securing rents?
? Possible goal: align the investment policy of the pension fund with
the strategy of the company and the values of the employees.
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Investment Case
Critical Evaluation of Arguments (2)
• Anticipating a possible regulation
Weak argument due to transition periods.
• Act in the beneficiary's best interest
According to open-ended surveys, monetary
and service-oriented aspects are important
for employees.
However, in closed-ended surveys, where
sustainability is explicitly a possibility,
the insured employees think it is important.
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Investment Case
Critical Evaluation of Arguments (3)
• Achieving an outperformance compared to the benchmark
(Does it pay to be good? Or to be bad?)
? There are arguments and studies which argue for an out- or and
underperformance ?!
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Source: Dimson, Marsh and Staunton (2015)
Investment Case
Critical Evaluation of Arguments (4)
• Expecting an outperformance compared to the benchmark
Sustainability reduces risks, e.g., litigation or reputation risks.1
Sustainable companies have a better governance. 2
These risks could be compensated by the financial markets.
The price of a “sin” stock is lower and as a consequence, the
expected return increases.
Investors require compensation to hold such “noxious and
nasty” stocks.
“Sin” companies have steady demand for their goods and services
and high entry barriers. high-margins business
Academic and empirical studies indicate a lower return for
sustainable stocks.3
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1, 3 Nofsinger and Varma (2014) 2 Renneboog, ter Horst and Zhang (2007) 3 e.g., Fabozzi, Ma, Oliphant (2008)
Investment Case
Critical Evaluation of Arguments (5)
• Empirically, “sin
stocks”, i.e., alcohol,
tobacco, and gambling
outperform.1
– The same with
weaponry.
• Tobacco made a
transition from neutral to
sinful between 1947 -
1965. During that time,
those stocks
underperformed.
– After 1965 it was known
that smoking is harmful,
they outperformed again.
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1 Hong and Kacperczyk (2009)
Investment Case
Critical Evaluation of Arguments (6)
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Diagrammtitel
Dow Jones Global
Dow Jones Sustainability World
Dow Jones Sustainability World ex Tobacco
Dow Jones Sustainability World ex Gambling
Total Returns of Sustainable DJ Indices
Source: Bloomberg, own calculations
Investment Case
Critical Evaluation of Arguments (7)
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• Stock returns are the highest in the most corrupt countries.
Source: Dimson, Marsh and Staunton (2015)
Investment Case
Critical Evaluation of Arguments (8)
• Combine business with pleasure: earn money and make a
difference.
In theory, the financing costs should increase. As a
consequence, the company could change its policy to lower its
financing costs.
There is no academic evidence that avoiding such “sin”
investments has a positive impact.
? Interestingly, evidence suggests that investing in a “noxious
and nasty” company and changing its behaviour through
shareholder activism leads to a higher risk-adjusted return.1
However, shareholder activism funds are expensive.
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1 Dimson, Karakas, and Li (2015)
Investment Case
Further Aspects: Higher Costs
• Ceteris paribus, socially responsible investments come with
additional costs (e.g., asset management fees, transaction
costs, etc.).
– A sustainable strategy excludes an indexed implementation for
smaller pension funds.1
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*Source: PPCmetrics Peer Group ** Source: Tender documents of selection with a broad universe
1 There are usually no passive collective investment schemes. A segregated mandate would be between 0.04% and 0.10% more expensive than standard indexed
mandates.
0.00% 0.05% 0.10% 0.15% 0.20% 0.25% 0.30% 0.35% 0.40%
Active Balanced Mandate**
Sustainable Balanced Mandate**
Passive Balanced Mandate*
Fee p.a.
Diagrammtitel Management Fees of Mandates with a Size of CHF 100 Million
Investment Case
Further Aspects: Definition Problems
• Disagreement on the definition
– Should car manufacturers be excluded or included (carbon
emissions vs. development of energy-efficient vehicles)?
– What about oil firms investing in “clean energy”?
• Definition problems
– What about suppliers or firms that buy products (or services) of
“sin” companies?
– What about banks financing such companies?
– What about countries using the death penalty? What about
countries financing nuclear plants?
– A lot of products can be used for several purposes: e.g., micro
chips are used both for mobile phones and missiles.
• Pilatus: Indian Air Force vs. Royal Flying Doctor Service of Australia
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Investment Case
Further Aspects: Can such Cases be Anticipated?
• Take a look at some cases:
– BP Deepwater horizon
– Union Carbide Bhopal
– Exxon Exxon Valdez
– Japan Fukushima
– Lockheed bribery
– Grünenthal children with malformation of the limbs
– Siemens corruption
– Enron false accounting
– Walmart child labor
– Mattel lead paint
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Implementation in Case of Bonds
Basic Questions
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Reporting (from the asset manager and to beneficiaries)
Mandate structure? Asset manager (selection)?
Active or passive?
Implementation strategy (Exclude industries? Exclude firms? Best in class? Thematic Funds)
Shall those criteria be applied to all bond segments (including treasuries)?
What is the sustainability target?
What criteria is important to us, i.e., what do the beneficiaries think is important?
Implementation in Case of Bonds
Sustainable Treasuries: Some Food for Thought (1)
• Implementation with corporates is not a problem, but …
why are there (at least at the moment) no sustainable
indices for treasuries?
• Because you might end up with an undiversified portfolio.
Example Citigroup WGBI:
– Exclude:
• USA (e.g., climate protection, death penalty, nuclear weapons)
• Japan (e.g., climate protection, death penalty, whaling)
• France (nuclear power, nuclear weapons)
• UK (nuclear weapons)
• ….
• Switzerland (euthanasia)
• So how does the portfolio look like?
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Implementation in Case of Bonds
Sustainable Treasuries: Some Food for Thought (2)
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Source: Citigroup Yieldbook, Indexdata per August 31, own calculations.
United States
JapanAustria
France
Germany
Ireland
Italy
Spain
DenmarkUnited Kingdom
Diagrammtitel
United States Canada Mexico Australia Japan Malaysia
Singapore Austria Belgium Finland France Germany
Ireland Italy Netherlands Spain Denmark Norway
Poland Sweden Switzerland United Kingdom South Africa
Citigroup WGBI vs. sustainable WGBICitigroup WGBI vs. Sustainable WGBI
Austria
Germany
Ireland
Spain
Denmark
Summary
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There are reasons to invest socially responsible.
However, you have to keep in mind the consequences.
And…. it is not always easy to distinguish good from
bad … there might be an ugly as well.
Appendix
References
• Cory, J, 2012. Business Ethics: The Ethical Revolution of Minority
Shareholders. Springer.
• Dimson, E., Karakas, O. and Li, X., 2015. Active Ownership. Review of
Financial Studies 28, 3225-3268.
• Fabozzi, F.J., MA, K.C., Oliphant, B.J., 2008. Sin Stock Returns.
Journal of Portfolio Management, Autumn
• Hong, H., Kacperczyk, M., 2009. The Price of Sin: The Effects of
Social Norms on Markets. Journal of Financial Economics 93,15–36.
• Renneboog, L., Horst, J., Zhang, Ch., Socially Responsible
Investments: Methodology, Risk Exposure and Performance. ECGI
Working Paper.
• Nofsinger, J., Varma, A., 2014. Socially Responsible Funds and
Market Crises. Journal of Banking & Finance 48, 180–193.
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Appendix
Survey Results (1)
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Source: gfs-zürich RobecoSAM «Pensionskasse & ESGIntegration» 2014
Appendix
Survey Results (2)
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Source: gfs-zürich RobecoSAM «Pensionskasse & ESGIntegration» 2014
Appendix
MSCI World vs. MSCI Tobacco
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Diagrammtitel
MSCI World TR
MSCI World Tobacco Index TR
Absolute Return in CHF
Source: Bloomberg, own calculations, since inception of MSCI industry indices
Appendix
MSCI World vs. MSCI ESG and SRI
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Source: Bloomberg, own calculations, since inception MSCI World SRI Index
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Diagrammtitel
MSCI World TR
MSCI World ESG
MSCI World SRI
MSCI World Tobacco Index TR
Absolute return of sustainable MSCI Indicies
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