Rio sells coal, what about the planet?

Thesis answer requested: Rio Tinto has sold its coal mine to EMR Capital and PT Adaro Energy, an Indonesian listed coal Co. Rio is now ex-coal. Reasonable people can disagree about the stranded asset, business and financial risks of coal and this impact on Rio’s cost of capital. 

But, from the point of view of the Planet, its inhabitants and the climate this has made no meaningful difference. Ownership has changed. How the mine will be run in the future has potentially changed. Certain reasonable people could argue it has made the situation from that point of view, worse. Discuss. 100 marks available. CEO Jacques has said that Rio is not exiting coal because of environmental concerns, but because it had better investment opportunities in iron ore, copper, bauxite and aluminium. I read both the gofossilfree  movement on the arguments for divestment + Cary Krosinsky on the cons of divesting. (see links below) I advocate listening to the arguments, engaging in thoughtful disagreements, examining evidence and then making up your mind. Ray Dalio thinks we are losing the art of thoughtful disagreement. Meghan Phelps suggests there is hope.

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Cary Krosinsky on the Pros/Cons of Divestment https://www.linkedin.com/pulse/lets-honest-divestment-isnt-answer-cary-krosinsky/

Good data based research by Carbon Tracker: https://www.carbontracker.org/

And by Vaclav Smil can be seen here: http://vaclavsmil.com/publications/ Bill Gates review of Vaclav Smil’s book Energy and Civilization (good summary_ https://www.gatesnotes.com/Books/Energy-and-Civilization

Movement advocating fossil free https://gofossilfree.org/divestment/what-is-fossil-fuel-divestment/

Tom Sanzillo FT Op-Ed advocating for divestment. https://www.ft.com/content/b5346cac-1e45-11e8-a748-5da7d696ccab

Stephen Beer response to Tom Sanzillo https://www.ft.com/content/ce1899ce-25fb-11e8-b27e-cc62a39d57a0

FT Editorial on divestment question at Cambridge University https://www.ft.com/content/1d8f3438-acfb-11e7-aab9-abaa44b1e130

Clara Vondrich response to FT advocating divest https://www.ft.com/content/c711a590-ad19-11e7-beba-5521c713abf4

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 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.   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.

Investing and Responsibility

Part of the reason I’m passionate about this job is that I believe through my role I have some influence in making (good) companies even better and hence moving capital to good ideas and good companies and away from bad ideas and companies (self-delusional maybe).

(It’s part of why I write about stories that are not often told, when I write plays)

So, it’s both a privilege and a responsibility (yes, Spiderman with great power comes…) to have a two-way conversations with Chairs of companies, billionaires, CEOs and the like… about the long-term, business, sustainability… diversity, employees, operations… the list is long.

(Thoughtful) investors are uniquely placed to have influence at board and senior management level at the most influential companies in the world. (Unthoughtful investors too).

In many ways our influence is overstated. Why should a governance/[insert specialty here] analyst a few years out of university with some understanding about governance frameworks, but limited understanding of the business, have such a say at setting incentives over a committee or board of combined 100s year of relevant experience?  So, it is up to those like us, who are interested in the long term, and understand business to make the case both to companies and to pension fund and asset owners alike that we are thoughtful and (socially, financially, strategically) useful.

There are few, if any, easy answers to complex questions. In some ways, staying out of contentious issues (eg don’t invest in Rio Tinto, don’t in Shell) is an easy way of signalling virtuous intentions. As I mentioned on my post on Rio, the fact that selling coal mines doesn’t make them go away is awkward. (Although you can also make the point on new capacity….)

In any case, I’d like to make the case that investors and pension fund managers (some of them at least) are heavily involved in these debates.  You can see it across a range of matters – the heavy (live) debates over Shell (as seen through Share Action, Environmental Agency and others, vs Shell management position here), to where we have come to on incentive plans at Weir (FT article here) or Unilever.

I don’t claim to have answers to many of these problems (although in the case of carbon, a carbon tax might help) but we are trying to think about them….

One person to be thinking on these matters a long while (we met back in the early 2000s), is Raj Thamotheram. Raj has cancer and this is a piece in IPE where he reflects on sustainability learnings from the lens of his illness. 

Raj is also looking for a Chair for his sustainability think tank - see the role here (1 June deadline)

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 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.   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.

ESG incidents analysis

Which sector had the most ESG incidents (2014-16) ? Banks, according to Sustainalytics research.

-Banks account for 19% of all incidents, more than twice the amount of the next most exposed industry (Food Products).

-With an incident risk coefficient of 0.52, the Automobiles industry is the riskiest from a size-adjusted industry perspective.

-Other industries with a high probability of producing incidents include Aerospace & Defense, Precious Metals and Banks.

-Real Estate firms are least likely to get caught up in incidents. Only 26 out of 376 real estate companies (7%) were involved in an incident from 2014-2016.

-Market cap analysis demonstrates that large firms are the most prolific contributors of incidents. Mega-caps produce an average of 106 incidents per firm, compared to 15 incidents per large cap firm, four per mid cap firm and three per small and micro cap firm.  

Link to the Sustainalytics Research.  

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More thoughts:    My Financial Times opinion article on the importance of long-term questions to management teams and Environment, Social and Governance capital.

Here is some MSCI research looking at ESG in high return companies. 

Here is some quant research from BAML on ESG. 

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 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.

Ben Yeoh ESG Webinar

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.

What are Governance ratings missing?

What are #Governance ratings missing? “Company #culture, sub-board management, alignment with strategy, track record on target delivery and the positives from long-term ownership are all underappreciated when it comes to the criteria used to rate the “G” in “ESG”. Code compliance is a poor proxy for good or bad practice in these areas”

What does the gap between a group’s policy and practice say about its culture?

Is sub-board level management taken into account when scoring governance?

Are the minority risks often associated with family ownership offset by governance positives?

How is the governance of cyber risk assessed?

Culture – How quickly did the company release bad news? Was the impact estimated? Was the market kept updated? How soon was the impact quantified?

Timeliness – Governance is dynamic, and changes are not tied to the annual reporting schedule. How current is the governance view that informs your rating?

Tenure - Has leadership been there long enough to demonstrate performance across business cycles?

Strategy – Are board changes aligned with strategy or is Code compliance the driver?

Good questions and thinking from Paul Marsland (Kepler) in his latest #ESG report: What are #Governance ratings missing? Can link you up if interested. 

Inequality. Inevitable? How bad?

  

Inequality. Does it matter ? “our most fundamental challenge is not the fact that the incomes of Americans are widely unequal. It is, rather, the fact that too many of our people are poor .”  Princeton philosopher Harry Frankfurt disagrees with Obama.   Discuss.

In the Great Leveller, Walter Scheidel makes the case that in dev countries 1) inequality has risen over last 50 years despite policy, regs etc. Designed to produce equity of opportunity (2) it has only recently reached the levels of 100 years ago but, (3) only major wars, famine, plague have been “great levellers of equality”

“Even in the most progressive advanced economies, redistribution and education are already unable fully to absorb the pressure of widening income inequality before taxes and transfers. Lower-hanging fruits beckon in developing countries, but fiscal constraints remain strong. There does not seem to be an easy way to vote, regulate, or teach our way to significantly greater equality. From a global historical perspective, this should not come as a surprise. So far as we can tell, environments that were free from major violent shocks and their broader repercussions hardly ever witnessed major compressions of inequality. Will the future be different?”

Thus, partly Harry Frankfurt moral philosophical viewpoint is provoking. He distinguishes economic equality with other kinds of inequity and argues that economic inequity is not a moral problem although other kinds are:

“There has recently been quite a bit of discussion—stimulated in part by the publication of the French economist Thomas Piketty’s research—concerning the growth in our society of economic inequality. The size of the gap between the economic resources of those who have more money and those who have less has been increasing rapidly. This development is regarded by many people as deplorable. It is certainly true that those with greater wealth enjoy significant, and often objectionable, competitive advantages over those with less wealth. This is most conspicuous, of course, with regard to consumption. It is also conspicuous, far more importantly, with regard to social and political influence. The richer are in a position to throw around quite a bit more weight than are the poorer, in affecting the character of our social mores and conduct, and in determining the quality and the trajectory of our political life. Insofar as economic inequality is undesirable, however, this is not because it is as such morally objectionable. As such, it is not morally objectionable. To the extent that it truly is undesirable, it is on account of its almost irresistible tendency to generate unacceptable inequalities of other kinds. These unacceptable inequalities, which may sometimes go almost so far as to undermine the integrity of our commitment to democracy, must naturally be controlled or avoided in the light of appropriate legislative, regulatory, judicial, and executive monitoring. It is, I believe, of some considerable importance to get clear about these matters. Appreciating the inherent moral innocence of economic inequality leads to an understanding that it is misguided to endorse economic egalitarianism as an authentic moral ideal. Further, it facilitates recognition of why it may actually be harmful to regard economic equality as being, in itself, a morally important goal. The first part of this book is devoted to a critique of economic egalitarianism. Its conclusion is that, from a moral point of view, economic equality does not really matter very much, and our moral and political concepts may be better focused on ensuring that people have enough. In the second part of the book I will recover one way in which economic equality may indeed be of some moral significance.”

Here are the Amazon links to Schiedel’s Great Leveller and here to Frankfurt's Inequality. 

As an aside, it seems both a universal basic income or a job guarantee would meet Frankfurt’s requirements as policy ideas.

ESG plus fundamentals equals alpha

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.