In ESG world, I did a webinar! For those who want to know a slice of what I do during the day – you can see the archive of it here. (free to register) I mention the work of Stian Westlake on intangibles which I’ve blogged about before.
MSCI: On ESG in higher ROIC companies
MSCI: “Among a universe of companies that have generated substantial value for their shareholders over the last decade (Jan. 2007 – Dec. 2017), we found that companies with strong management of industry-specific ESG risks and opportunities outperformed peers with poorer management of those same ESG risks and opportunities over the five year period from Jan. 2013 to Dec. 2017.”
“In this paper we apply an ESG filter to a highly selective universe of 100 companies that have already been screened for value creation as measured by ROIC, economic spread, margins and asset turnover ratio. We found that, over the last five years, companies with higher ESG Ratings exhibited higher average return on invested capital, compared to companies with lower ESG ratings. They were also valued at a premium over their other top performing peers with lower ESG Ratings. …. the main additional value of our ESG ratings did not come from our governance assessment in this case, but rather from how well these firms managed their industry-specific environmental and social risks, which varied considerably across different business models.”
You can download the paper through MSCI here. You can find the co-author Panos Seretis on Linkedin.
Caveats: Not peer reviewed, time frame limited and it has the ROIC-cost of capital framework as the economic value add but still an interesting and useful addition to the body of ESG research.
ESG plus fundamentals equals alpha
Source: BofAML March 2018
Savita Subramanian (BofAML, Quant team) finds further evidence that investors need to pay attention to ESG. In her 5th note on ESG, she finds ESG is largely uncorrelated with other fundamental factors.
She argues "(see top chart)
2) The proof is in the performance. Adding ESG to a…
· Value strategy (Low forward PE) would have increased returns by 200bps per year (pretty remarkable in a year where Value funds are struggling to maintain a 70bp lead vs. the benchmark).
· Dividend Yield strategy would have added an extra 300bps per year.
· Growth strategy (Earnings Estimate Revision) strategy would have improved returns by 150bps or more per annum."
She further suggests adding ESG to traditional factors would have lowered investors probability of losing money almost across the board (see chart above)
She notes in one of her recent surveys that only a minority of quant funds are using ESG as a signal, even though they are using around 20 signals on average.
This gives me some comfort as a bottom-up fundamental active manager. However, the data is looking increasingly powerful on the quant side as well. There have been positive findings across other ESG data sets (with Sustainalytics and MSCI being the two other most used data sets; this one is the Thomson Reuters data set), although the correlation between these data sets remains relatively poor at between 0.3 to 0.5 in the studies and work I have seen.
The other factor this work and similar raises is the power of passively managed funds. They now make up over 40% of US-dom equity funds up from 20% in 2009, and I do not see this trend changing any time soon. In fact various forces may if anything accelerate this trend.
Vanguard now owns more than 5% of over 494/500 S&P 500 companies. Vanguard is now the steward of many people's capital. That man in the street through Vanguard now owns 1/20th of the largest companies in the US. It will be interesting to see how stewardship evolves in this situation.
More thoughts: My Financial Times opinion article on the importance of long-term questions to management teams and Environment, Social and Governance capital.
One of the best Munger speeches on how to think about a mental model of inversion can be found here.
March 2018 thoughts on greed, fear and risk.
Top selling Drugs
Source: EP Vantage
What’s the length of a patent? 20 years. What’s the social contract behind patents ? Society gives you a time-limited monopoly to incentivise you to invest in R&D and intangibles and enable you to profit at higher levels due to lack of competition.
Drug development takes 8 to 12 years on average, so the average commercial life of a drug based on its first composition of matter patent should run approx 10 years.
Noticeable how many best selling drugs have 20+ years protection. Oft involving long litigation.
One way the pharma industry erodes the social contract is by NOT meaningful innovation and by extending monopolies beyond expectations.
One way it can strengthen trust is by developing life saving medicines and ensuring access.
It’s an active debate what creates more long-term value for shareholders and society.
I’ve written about the history of patents and patent philosophy here.
Original EP Vantage article here
One of the best Munger speeches on how to think about a mental model of inversion can be found here.
If you'd like to feel inspired by commencement addresses and life lessons try: Neil Gaiman on making wonderful, fabulous, brilliant mistakes; or Nassim Taleb's commencement address; or JK Rowling on the benefits of failure. Or Charlie Munger on always inverting; Sheryl Sandberg on grief, resilience and gratitude or investor Ray Dalio on Principles.
Cross fertilise. Read about the autistic mind here.
More thoughts: My Financial Times opinion article on the importance of long-term questions to management teams and Environment, Social and Governance capital.
How to live a life, well lived. Thoughts from a dying man.
CEO pay quiz
Top paid US CEOs. How many can you name? Which were the best S&P500 stocks since 2010? What’s the overlap? Which companies made most profit?
Note, Larry Page = $1 salary, Alphabet CEO, but Sundar Pichai, GOOG CEO is at $200m so almost double Hock Tan.
Of course, there are several problems with this simplistic look (length of CEO tenure) and there are several academics who warn of the danger of pay ratios (eg Alex Edmans).
Still it is noticeable that so few CEOs presided over the best stock returns.
And out of the best paid, not that many CEOs preside over the largest profit.
Source: Bloomberg. I doubt anyone is silly enough to think there is any implied recommendation or analysis here. But in our increasingly disclaimered world, there is not plus see disclaimer link on site. These are total stock returns since Jan 2010 until Feb 2018. No particular reason for date range, only a relatively log length of time of approx a business cycle.
Top 20 paid MSCI World CEOs by total $ comp.
A very similar result to above with just 4 new entries if you look at ex_US companies.
WPP Plc (WPP): Martin Sorrell ($65.3m).
Valeant Pharma (VRX): Joe Papa ($62.7m).
Liberty Global (LBTYA): Mike Fries ($40.1m).
BankGuam Holding (BKG): Tony Pidgley ($36.0m)
H/T Ross Yarrow at Baird. I source further data from Bloomberg.
If you'd like to feel inspired by commencement addresses and life lessons try: Neil Gaiman on making wonderful, fabulous, brilliant mistakes; or Nassim Taleb's commencement address; or JK Rowling on the benefits of failure. Or Charlie Munger onalways inverting; Sheryl Sandberg ongrief, resilience and gratitude or investor Ray Dalio on Principles.
Cross fertilise. Read about the autistic mind here.
More thoughts: My Financial Times opinion article on the importance of long-term questions to management teams and Environment, Social and Governance capital.
2bn loan tied to ESG metrics
ESG Innovation: rate on Danone’s EUR2bn 5 year syndicated credit directly tied to ESG metrics. 2 components: i) B-Corps certified sales ii) Ratings based on a) Sustainalytics, b) Vigeo Eiris
Implications: single demonstration that ESG directly impacts cost of debt and —> weighted cost of capital and thus impacting firm value via discount rate.
12 bank* syndicate shows serious financial institutional backing (although risk to banks likely considered low)
Lends weight to notion of ESG ratings. Lends credibility to B-corps certification process.
Concentrates power in ratings and certification providers.
Critique: following the criticisms of Cary Krosinsky on fund ratings** this potentially emphasises backward looking tick box scores too strongly. ESG ratings providers show low (but positive correlation) approx 0.3 in this study***
Counter: use of both B-corps impact methodology and two forms of ESG ratings, all independent (although question of who pays fees cf. standard bond credit ratings) reduces reliance of single interpretation. Single company ratings different from portfolio scores.
Further implications: ESG and B-Corp supporters can argue ESG direct meaningful financial and cost of capital implications. Critics can still invoke virtue signalling concerns.
Models for sustainable finance are still developing (cf. green bonds) but if genuine incentives exist and those incentives credibly encourage long-term sustainable strategies then long-termism supporters should be enthused.
Of note: MSCI is not used as one of the ESG rating providers. Some observers might suggest this shows the French/Euroland strength of Vigeo Eiris over MSCI
*Bank syndicate (Best of my belief): BNP Paribas, Societe Generale, Credit Agricole, Natixis, HSBC, Citibank, JPMorgan, Barclays, ING, NatWest, MUFG and Santander.
Link to Danone Statement:
**Cary Krosinsky: Failure of Fund Sustainability ratings.
*** Chatteji et al. (2014). Do [ESG/CSR] Ratings Converge ?
Goldman Sachs on ESG
Goldman Sachs: “top-quartile returns companies with stronger ESG performance have seen meaningfully less returns erosion over time than high-returns peers with lower ESG scores. This underlines our point that ESG integration, when done well, is complementary and accretive to fundamental analysis rather than a distraction to it.”
“We believe that ESG can offer valuable insights on a company’s culture and risk profile, but only if done properly — i.e., with a narrowed focus on the most material factors in each industry, emphasizing measurable performance over vague policies, etc. What are the rewards for investors? We think there are potentially many, in terms of linkages with superior growth, profitability and lower cost of capital. One that we particularly care about in our process is the durability of returns on capital.”
Comment: This adds to the debate on materiality of various ESG factors. Read in conjunction with theacademic Prof. George Serafeim, Mozaafar Khan, Aaron Yoon paper : "Corporate.Sustainability: First Evidence onMateriality it points to the importance of a materiality assessment in this area.
View: This is similar to traditional finance metrics eg RoE (return on equity) today for biotech is usually not material or useful measure for investors or management. So no surprise that materiality for extra-financial metrics also need to be assessed.
Open question is how skilled an investor needs to be, to use this information effectively.
H/T Derek Bingham and GS Sustain Team Source: Goldman Sachs
More thoughts: My Financial Times opinion article on the importance of long-term questions to management teams and Environment, Social and Governance capital.
If you'd like to feel inspired by commencement addresses and life lessons try: Neil Gaiman on makingwonderful, fabulous, brilliant mistakes; orNassim Taleb's commencement address; or JK Rowling on thebenefits of failure. Or Charlie Munger onalways inverting; Sheryl Sandberg ongrief, resilience and gratitude or investor Ray Dalio on on Principles.
Cross fertilise. Read about theautistic mind here.
More on ESG, Stewardship and Fund management – here.
When a board can't detect fraud...
I’m still utterly amazed at large company fraud. Christo Wiese owns 23% of Steinhoff and was Chair, and didn’t know anything about it at Steinhoff. Highlights to me that choosing the CEO is still one of the most important if not the most important job of a board.
“Normally when you’re in a business, and you’re responsible, you can see the problems coming, you’re aware of them,” Mr Wiese said. “This came like a bolt out of the blue.” “I can only say that cleverer people than this board have been duped before by people committing fraud,” he added. “To detect fraud in a company is an extremely difficult if not impossible task and it becomes more difficult when, as is alleged in this case, the CEO is directly involved.”
Jan 31, FT article here and Dec 2017, Bloomberg article here
Also, highlights the problems the board has if it can't assess what management are showing them. In the light of the UK's Carillion failure, its board have been given a hard time too.