Active Ownership. Academic Study.

October 16, 2017 Ben Yeoh

From Active Ownership, by Dimson et al. (see end for notes)

“Active Ownership” by Elroy Dimson , Oğuzhan Karakaş and Xi Li - this paper, in my view, suggests that successful active engagement in a collaborative and constructive manner on material ESG concerns improves the fundamentals of a company and also increases stock returns.

I differentiate this type of engagement with what one typical sees from “hedge-fund activists” or where board proxy fights occur; and where media engagements and open letters are used (although that type of activism has also seen positive returns see Klein and Zur, 2009).

Starting with the conclusions: “How does the market react to ESG activism? We find that ESG engagements generate a cumulative size-adjusted abnormal return of +2.3% over the year following the initial engagement. Cumulative abnormal returns are much higher for successful engagements (+7.1%) and gradually flatten out after a year, when the objective is accomplished for the median firm in our sample. We do not find any market reaction to unsuccessful engagements. The abnormal return patterns and magnitudes are similar for the subsamples of CG and ES engagements.4 This suggests the existence of a threshold for success to be pursued and achieved for both types of engagements. We then examine the cross-section of abnormal returns (controlling for industry and year fixed effects) and find that the positive market reaction to successful engagements is most pronounced for the themes of corporate governance and climate change. For these themes, the cumulative abnormal return of an additional successful engagement over a year after the initial engagement averages +8.6% and +10.3%, respectively.”

Then:

“To investigate the sources of the positive market reaction to successful engagements, we take a difference-in-differences approach and examine the subsequent changes in target firms’ operating performance, profitability, efficiency, institutional ownership, stock volatility, and governance after successful engagements relative to after unsuccessful engagements. We observe significant improvements in all these measures (i.e., an increase in firm performance, investor base, and governance, and a decrease in stock return volatility) following successful engagements, as compared to the unsuccessful ones.

Particularly focusing on the ES and CG subsamples, we first find that the return on assets and the ratio of sales to the number of employees improve significantly one year after successful ES engagements, as compared to the unsuccessful ones; but such improvements are less pronounced for successful CG engagements. These findings support the view that successful ES initiatives enhance customer and employee loyalty. Second, we observe an increase in shareholdings by the asset manager, pension activists, and SRI funds one year after successful ES engagements; but such an increase is not apparent for successful CG engagements. These results support the view that ES initiatives generate a clientele effect among shareholders. Third, we find improvements in the corporate governance structure of targeted firms, as measured by the Bebchuk, Cohen, and Ferrell (2009) entrenchment index, two years after successful engagements on all ESG issues. This suggests that good ESG practices signal improving governance quality.

And to conclude:

“We conclude that environmental, social, and governance activism of the type that we study

improves social welfare to the extent that it increases stakeholder value when engagements are successful and does not destroy firm value even when engagements are unsuccessful. We note that, after successful engagements (particularly on ES issues), firms with inferior governance subsequently improve their governance and performance. Our interpretation is that active ownership attenuates managerial myopia and hence helps to minimize intertemporal losses of profits and negative externalities (see Benabou and Tirole 2010). This approach is differentiated from other styles of shareholder action, particularly hedge fund activism. Responsible investment initiatives are less confrontational, more collaborative, and more sensitive to public perceptions; yet they achieve success.”

The full methodology and discussion is in the link SSRN here (further bibliography in that paper to studies on the full range of stewardship to activism) .

An overview of several Active Ownership studies is given by Share Action here.

Summary slides given by Dimson on this paper are here.

If one puts this work together with the work on the outperformance of Global Equity managers described here, one can start to build a defense of Active Management; where John Kay would argue Active Managers should compete on style and philosophy in any case.

If you'd like to feel inspired by commencement addresses and life lessons try: Ursula K Le Guin on literature as an operating manual for life; 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.

The chart above figure plots the cumulative monthly abnormal returns (CARs) around the initial engagements from one month prior to the engagement month to 18 months afterward. The chart examines the entire sample Each CAR is decomposed into the CAR for successful engagements (i.e., those that achieved milestones) and the CAR for unsuccessful engagements. For each event month, authors calculate the average abnormal return from holding an equally weighted portfolio of all target firms that initiated engagements in month 0. The stock returns are adjusted for Fama-French decile size-matched returns. The stock returns are winsorized at the 1st and 99th percentile levels before calculating the average CARs.

Richard Thaler. Nobel Prize.

October 11, 2017 Ben Yeoh

Richard Thaler has won a Nobel prize. Perhaps most famous for his book Nudge and the behavioural policy units spawned in the UK and US. This has led to the default on option on UK pensions as being enrolled, with an opt-out option given. This has “nudged” participation in UK private-sector pension schemes from 42 per cent to 73 per cent between 2012 and 2016. That’s quite an impact from “libertarian paternalism”. Video of Thaler at Google Talk below.

His observations on the “irrational” behaviour of man can be neatly seen in this New York Times column.

“This illustrates an important problem with traditional economic theory. Economists discount any factors that would not influence the thinking of a rational person. These things are supposedly irrelevant. But unfortunately for the theory, many supposedly irrelevant factors do matter.

Economists create this problem with their insistence on studying mythical creatures often known as Homo economicus. I prefer to call them “Econs”— highly intelligent beings that are capable of making the most complex of calculations but are totally lacking in emotions. Think of Mr. Spock in “Star Trek.” In a world of Econs, many things would in fact be irrelevant.”

Later in the article he mentioned how cash is the perfect econ gift.

I once gave one of my best friends cash for his birthday. He was in debt, and I was much better paid. I had thought about it long and hard, and decided cash was the most optimal solution.

It wasn’t particularly well received. In fact, I recall he tried to return it almost immediately, something the most ugly jumper from a grand-aunt would not trigger.

I now tend to make a card and sometimes a drawing or poem. Perhaps, much more valuable a higher return on investment for sure.

Still, my friend is now out of debt. Perhaps not wanting to be embarrassed by his friend giving him money ever again.

(In my defence, it’s fairly traditional in Chinese culture to give money on various occasions perhaps that rooted me in this one rational strategy)

(Today, I’d suggest as a gift i. Some shared experience (there’s evidence that experiences → postivity/happiness over objects) ii. Hand made some thing and then iii. Cash only leaving a physical retail object as a distant iv. Sadly, this would likely lead to a global recession if people stopped buying things, so perhaps good that not everyone thinks like this.)

Cross fertilise. Read about the autistic mind here. On investing try a thought on stock valuations.

Principles. Ray Dalio.

October 10, 2017 Ben Yeoh

Ray Dalio - Principles:“...you, like me, probably don’t know everything you need to know and would be wise to embrace that fact. If you can think for yourself while being open-minded in a clearheaded way to find out what is best for you to do, and if you can summon up the courage to do it, you will make the most of your life. If you can’t do that, you should reflect on why that is, because that’s most likely your greatest impediment to getting more of what you want out of life. That brings me to my first principle:

• Think for yourself to decide

1) what you want,

2) what is true, and

3) what you should do to achieve #1 in light of #2 . . . . . .

and do that with humility and open-mindedness so that you consider the best thinking available to you.

The principles you choose can be anything you want them to be as long as they are authentic—i.e., as long as they reflect your true character and values.

Think for yourself!

1) What do you want?

2) What is true?

3) What are you going to do about it?

Ray Dalio (wiki) should be listened to, in my view, whether you agree with him or not. He is in the top 100 richest people in world. Dalio has pledged half that wealth to the Bill Gates foundation. He has a coherent and thought provoking personal philosophy that Dalio also applies to his hedge fund, Bridgewater, one of the largest and most successful in the world (which works under this culture: “an idea meritocracy that strives to achieve meaningful work and meaningful relationships through radical transparency.”) He uses these principles in life and in his business. Originally available in short form on the Bwater website, it is now out in longer book form. (part 2 on investing and economics out some time in the future).

Dalio himself advocates developing your own principles rather than absorbing another’s completely whole. Thus this provides a fascinating take in the mould of “investor-philosopher” (thus joining Warren Buffet, Charlie Munger, Howard Marks, Peter Lynch, perhaps Seth Klarman, perhaps Nassim Taleb in this mould).

I noticed Dalio on mistakes sounds like Neil Gaiman's view on mistakes, one written by a story teller (I take a look at Gaiman's commencement address extolling mistakes in an earlier post) and the other written by an "investor-philosopher"; and also chimes with JK Rowling on the benefits of failure.

It also offers interesting reflections on his “mistakes” and experiences.

I highlight a few that struck me:

On consensus thinking “...everybody thinks the same thing—such as what a sure bet the Nifty 50 is—it is almost certainly reflected in the price, and betting on it is probably going to be a mistake.”

On losing money on a pork belly trade “It was a very tactile experience . . . [and] it taught me the importance of risk controls, because I never wanted to experience that pain again. It enhanced my fear of being wrong and taught me to make sure that no single bet, or even multiple bets, could cause me to lose more than an acceptable amount. In trading you have to be defensive and aggressive at the same time. If you are not aggressive, you are not going to make money, and if you are not defensive, you are not going to keep money. I believe that anyone who has made money in trading has had to experience horrendous pain at some point. Trading is like working with electricity; you can get an electric shock. With that pork belly trade and other trades, I felt the electric shock and the fear that comes with it.”

On expectations “I lost money until I figured out what was going wrong and how to deal with it. I gradually learned that prices reflect people’s expectations, so they go up when actual results are better than expected and they go down when they are worse than expected. And most people tend to be biased by their recent experiences.”

On learning from history “I learned that everything that was going on—the currency breaking its link to gold and devaluing, the stock market soaring in response—had happened before, and that logical cause-effect relationships made those developments inevitable. My failure to anticipate this, I realized, was due to my being surprised by something that hadn’t happened in my lifetime, though it had happened many times before. The message that reality was conveying to me was “You better make sense of what happened to other people in other times and other places because if you don’t you won’t know if these things can happen to you and, if they do, you won’t know how to deal with them.” “

On learning that there is always risk and uncertainty: “I vividly remember one “can’t lose” bet that personally cost me about $ 100,000. That was most of my net worth at the time. More painful still, it hurt my clients too. The most painful lesson that was repeatedly hammered home is that you can never be sure of anything”

If you’d like a provocative read of an investment philosophy of our times check out his book - UK link to amazon kindle version here http://amzn.to/2wN4Oy4

A previous post on Dalio and risk and populism here. Video interview post book launch (Sep 2017) below.

Cross fertilise. Read about the autistic mind here and ideas on the arts here. On investing try a thought on stock valuations.

Kevin Warsh. Future Fed Chair?

October 3, 2017 Ben Yeoh

Kevin Warsh could be next Fed Chair. He’s currently favourite in betting markets. A recent meeting with Trump has been confirmed. So, who is he?

Albert Edwards is not known for his optimism (I've worked with him, I should know!) The macro strategist, currently at SocGen, has mostly been an Equity bear for the last decade or so, and has the Ice Age thesis (West would slowly replicate Japan’s experience of the 1990s by descending into outright deflation) on deflation.

But Edwards has written very positively about Warsh. Not something I’ve come to expect from Albert regarding policy makers. This from Edwards after hearing Warsh speak in a Oct 2016 meeting:

“[Warsh] explained that the Fed has been “captured” by a groupthink of academics led by the ‘Secular Stagnation’ ideas of his friend, Larry Summers. Rather than admitting they are wrong, this group, who failed to predict the current economic malaise,have constructed this theory to explain why ever more stimulus is required. In particular Warsh warned that the Fed had become the slave of the S&P.”

For Fed watchers it’s worth looking at these articles. Warsh in WSJ in August 2016. He writes:

“The conduct of monetary policy in recent years has been deeply flawed. U.S. economic growth lags prior recoveries, falling short of forecasts and deteriorating in the most recent quarters.”

“Two major obstacles must be overcome: groupthink within the academic economics guild, and the reluctance of central bankers to cede their new power...

First, the economics guild pushed ill-considered new dogmas into the mainstream of monetary policy….

The second obstacle to real reform is no less challenging. Real reform should reverse the trend that makes the Fed a general purpose agency of government…

Warsh as Chair would be shaping a different kinds of Fed it would seem.

And interview with Warsh on CNBC below:

Read a thought on valuations here. Cross fertilise. Read about the autistic mind here and ideas on the arts here. Ray Dalio on populism and also a thought on risk and valuations. Or Black Swan author, risk expert, on life lessons from his commencement address.

Fed policy running against capital investment: Kevin Warsh from CNBC.

Nassim Taleb. Climate Change Risk.

September 18, 2017 Ben Yeoh

On climate change… we should ask “what would the correct policy be if we had no reliable models”? writes Nassim Taleb and co-authors (see below).

We have only one planet. This fact radically constrains the kinds of risks that are appropriate to take at a large scale. Even a risk with very low probability becomes unacceptable when it affects all of us - there is no reversing mistakes of that magnitude.

Without any precise models, we can still reason that polluting or altering our environment significantly could put us in uncharted territory, with no statistical track-record and potentially large consequences...

While some amount of pollution is inevitable, high quantities of any pollutant put us at a rapidly increasing risk of destabilising the climate, a system integral to the biosphere. Ergo, we should build down CO2 emissions, even regardless of what climate-models tell us.

Push a complex system too far and it will not come back. The popular belief that uncertainty undermines the case for taking seriously the “climate crisis” that scientists tell us we face is the opposite of the truth.

Properly understood, as driving the case for precaution, uncertainty radically underscores that case and may even constitute it. [My emphasis]

I think this case could be pushed more strongly given 3/10 Americans disbelieve manmade climate change. Even with this disbelief, most believe the climate is likely changing and an understanding of the risk framed in Taleb’s view should underscore the need for climate policy.

Nassim Taleb is not known for liberal left leaning views (although his politics are more complex to easily fit in the left-right axis; his local-global or libertarian axises are - in my view - more important) still this puts Nassim Taleb as a core anti-mainstream-left-thinker and Gregory Mankiw as an economist associated with the Republicans, strongly suggesting (1) Climate change should be taken seriously (in Taleb’s case) and (2) Carbon taxes or some form of Pigovian tax on carbon (in Mankiw’s case) should be enacted.

A post thinking about the pros/cons of a carbon tax (and dividend).

A long thought about various sustainability ideas.

Bitcoin. Energy unsustainable.

September 17, 2017 Ben Yeoh

Source: https://digiconomist.net/bitcoin-energy-consumption

Bitcoin is unsustainable in light of its energy consumption. Several authors have examined Bitcoin’s energy consumption and concluded Bitcoin is using up as much energy as a medium sized country. Currently about 72 in the world if considered a country.

I can not find a peer review, but I see several independent sources (see end) making their own assumptions, which seem plausible (I am no expert).

I highlight the digiconomist work. They calculate bitcoin’s energy consumption to power approx 1.5m US households, They estimate the VISA network to be equivalent to 50,000 households.

As I have argued earlier, I do not believe Bitcoin is a good investment, but it might be thought of as a currency or a money. Many are excited by the possibilities of blockchain.

This work suggests more needs to be done to make blockchain energy efficient, if this will be a sustainable mechanism.

The author Deetman writes after his calculations: “I haven't given up on the idea of distributed network transactions, but a radical rethinking of how these may be secured would be beneficial, be it at least for the environment.” And if the calculations made by analysts below are true, I would concur. H/T to https://digiconomist.net/bitcoin-energy-consumption as source.

References: Bitcoin Consumes A Lot Bitcoin Is Still Unsustainable

Electricity consumption of Bitcoin: a market-based and technical analysis

Proof of Work Flaws: Ethereum Lays Out Proof of Stake Philosophy

An Unsustainable Protocol That Must Evolve

Bitcoin Could Consume as Much Electricity as Denmark by 2020

Bitcoins are a waste of electricity Bitcoin is Unsustainable

How Much Power Does the Bitcoin Network Use?

Cross fertilise. Read about the autistic mind here. On investing try a thought on stock valuations. Or Ray Dalio on populism and risk. You can also click on the Carbon tag below.

Climate Survey

September 14, 2017 Ben Yeoh

Source: Yale Climate Change Communication

3/10 Americans disbelieve manmade climate change. This percentage has been stable for 20 years (with a slight rise to almost 4/10 in some years).

The fine work of the Yale Climate Communication Center focuses on the positive. It heralds the 6/10 who believe in manmade climate change. This proportion has also been stable for 20 years.

This discomforts me as it shows virtually no change in opinion over 20 years.

Climate_Change_American_Mind_May_2017-1.1.png

1/10 to 1 in 8 Americans do not think climate change is happening. I find this still rather high. But perhaps I am out of touch. 1/4 Americans believe in clairvoyance (source Gallup).

Perhaps, most alarming only about one in eight Americans understand that almost all climate scientists (more than 90%) have concluded human-caused global warming is happening.

If that survey is correct then experts are having limited impact, and, or, peer reviewed robust information is not flowing down to the average American.

This lack of information or even disinformation (which seems to have plagued brexit) is a feature of today’s media that worries me.

The entrenched nature of people’s views also concerns me as it suggests to me there is a diminished ability to compromise and forge agreements from different viewpoints.

`'Public misunderstanding of the scientific consensus – which has been found in each of the Yale surveys since 2008 – has significant consequences. Other research has identified public understanding of the scientific consensus as an important “gateway belief” that influences other important beliefs (i.e., global warming is happening, human caused, a serious problem, and solvable) and support for action.

Updated in 2019: see here “… About seven in ten Americans (69%) think global warming is happening. Only about one in six Americans (16%) think global warming is not happening. Americans who think global warming is happening outnumber those who think it isn’t by more than a 4 to 1 ratio.
• Many Americans are certain that global warming is happening; 46% are “extremely” or “very” sure it is happening. By contrast, far fewer (8%) are “extremely” or “very sure” global warming is not happening.
• A majority of Americans (55%) understand that global warming is mostly human-caused. By contrast, only about one in three (32%) think it is due mostly to natural changes in the environment.
• More than half of Americans (53%) understand that most scientists think global warming is happening. However, only about one in six (17%) understand how strong the level of consensus among scientists is (i.e., that more than 90% of climate scientists think human-caused global warming is happening).
• About six in ten Americans (62%) say they are at least “somewhat worried” about global warming. More than one in ﬁve (23%) are “very worried” about it….”

For more information, see: van der Linden, S. L., Leiserowitz, A. A., Feinberg, G. D., & Maibach, E. W. (2015). The scientific consensus on climate change as a gateway belief: Experimental evidence. PLoS ONE, 10(2). doi: 10.1371/journal.pone.0118489

Cross fertilise. Read about the autistic mind here. On investing try a thought on stock valuations. Or Ray Dalio on populism and risk.

Bitcoin. Not an investment.

September 12, 2017 Ben Yeoh

Bitcoin is not an investment (as I define it). It is a money or a currency. You can speculate in it and trade in it. But I do not think it has a major place for most people as an investment, just like most people would not have South African Rand as an investment.

It does reveal facets of modern money, which we often ignore. Money relies on belief. Money relies on trust. Its value relies on a network of people who accept it as money. It helps that you can exchange if for goods, services and other currencies. It is not backed by gold, goods or tax.

Go back in time. Sea shells were used as money.

The traditional qualities of money: durability, handiness or convenience, recognizability and divisibility were mostly embedded in shells. (Large shells and small shells harder to divide but easier than camels). Cowry shells were still used as currency until the 20th century.

Fiduciary (or trust, fiat) currency was used in China over 2000 years ago, so in that respect bitcoin has a distinguished history to draw upon.

Howard Marks in his latest September memo (here are some thoughts on his July memo) partially adjusts his view on bitcoin, also concluding it is money, but sharing my view (or perhaps I should be sharing his view, Marks being much more distinguished than me!) that is it not a good investment. If you fancy a gamble, sure why not? But know it for what it is. A speculation. Perhaps like gold, it could have a place as geopolitical hedge, as money/gold has done over history, but I still don’t think that makes it an investment. It could make it a “safe asset” (see Andolffi below) but again I’m unsure that’s an investment.

Bitcoin could possibly be valued. There are some valiant attempts. The assumptions and data needed do seem to put it in the realm of speculation. But, if interested look at some of these writers below:

David Andolfatto (who works for fed reserve bank of st louis) is great on bitcoin - blog here . His view seems to be bitcoin is lousy money but a possible store of value. This slide deck here gives a thorough overview of Bitcoin that I recommend.

Tony Yates (former Bank of England) talks about the barriers to cryptocurrencies taking over at an FT guest post.

If you'd like to feel inspired by life lessons try: Ursula K Le Guin on literature as an operating manual for life; 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.

Eric Lonnergan on an overview of Bitcoin’s characteristics including “intelligence” in aspects of “self-regulation” (I’m personally unsure if that’s ‘true’ intelligence cf. Shells, gold) . Lonnergan writes: “Bitcoin’s ‘intelligence’ involves the application of a very simple rule: the quantity expands to 21 million and then it ‘grows’ at zero percent. I’m less interested in the merits of this rule, which are well-rehearsed, than the possibilities it suggests. The ‘intelligence’ of money could be extended in many interesting ways. From an economic standpoint, the obvious improvement in intelligence would be to design a currency which expands and contracts in line with demand for currency. Embedding this in the currency’s DNA would render central bank decision-making redundant – to everyone’s advantage. ‘Intelligence’ could also embed social goals – for example the currency could self-regulate the activities for which it is used, perhaps even rewarding or punishing activities contingent on their social impact.”

Howard Marks is always worth reading if you have any interest in markets and the world.

Marks caution joins the chimes of Ray Dalio (post here), John Hussman (post here) along with Albert Edwards (currently at SocGen (with Andrew Lapthorne, his recent chart here), and to some extent James Montier (who also worked alongside Albert at DK previously, but has a behavioural economist streak to his work; now at GMO) and Jeremy Grantham (at GMO) have tended to put quite some weight on these type of metrics and valuation discipline, at least for long cycle returns (around 7 years). It's interesting that most of this group are chiming quite loudly, with the possible exception of Grantham who is ringing in a slightly different key (suggesting much slower reversions to the mean than before).

The world of macro has so many cross currents.

There is another interesting chime with Nassim Taleb's thinking from his pop risk books. This idea that we do not handle "fat tails" or "Black Swan" events very well. That models do not account for these events well (real world is not "normal" or "gaussian"). This dovetails well with Hyman Minsky's observation/theory on why we have and will always have boom/bust cycles.