RESEARCH & INNOVATION in RESPONSIBLE … Hoepner_DD… · The authors analysed the performance of a long-short investment strategy ... matuarity than 3M-, ... The 3 drivers of Portfolio

RESEARCH & INNOVATION in

RESPONSIBLE INVESTMENT

ANDREAS G. F. HOEPNER

https://www.facebook.com/pages/Principles-for-Responsible-Investment/434366556638201

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A personal introduction


Associate Professor of Finance, ICMA Centre, Henley Business School

Senior Academic Fellow, PRI

Managing Director, Sociovestix Labs Social Enterprise

President, ReFine Research Charity

Full list of affiliations on LinkedIn

ESG ~ Environmental, Social and/or Governance information

Presentation:

Part A:

ESG integration into Equities

Part B:

ESG integration into Fixed Income

Appendix:

Part C:

ESG within Financial Data Science

Part D:

DynamicESG: Responsible, especially when it matters

Agenda

ESG integration

into Equities ANDREAS G. F. HOEPNER




• ESG integration strategies can lead to sizable abnormal returns (Alphas):

• Corporate Governance (Bebchuk et al., 2009, Gompers et al., 2003, 2011)

• ESG Engagement (Becht et al. 2009)

• Eco-efficiency (Derwall et al., 2005)

• Employee Relations (Statman and Glushkov, 2009; Edmans, 2011)

• Community Relations (Kempf and Osthoff, 2007, Statman and Glushkov, 2009; Borgers et al. 2013)

• Green Real Estate (Eichholtz, Kok and Quigley, 2010)

• Best in class strategies (Kempf and Osthoff, 2007; Statman and Glushkov, 2009; Borgers et al. 2013)

• Successful ESG investment requires specific skills (Gil-Bazo et al., 2009)

• Financial institutions with more ESG appeal are found to • realise better competitive outcome in mortgage and deposit markets

(Callado-Muñoz & Utrero-Gonzalez, 2011)

• have more loyal clients (Bollen, 2007).

Some ESG Alpha findings

Integration across ESG criteria

Kempf and Osthoff, 2007

Light and dark blue indicate the 1%, 5% and 10% significance level, respectively. Grey bars represent statistically insignifiicant

estimations

6.22%

4.29% 4.09%

2.54%

0.46%

-1.13%

8.70%

7.59%

-2.50%

0.00%

2.50%

5.00%

7.50%

10.00%

Community Best-In-Class

(BIC)

Diversity BIC Employee Relations BIC

Environment BIC

Human Right BIC

Product BIC All criteria BIC All criteria BIC with Negative

Screening

The authors analysed the performance of a long-short investment strategy backing the

top 5% and shorting the bottom 5% stocks in an ESG criteria over the period 1991 to

2003 for the US market.

ESG integration in 10 GICS industries

Light and dark blue indicate the 1%, 5% and 10% significance level, respectively. Grey bars represent statistically insignifiicant

estimations

We analysed the performance of investing in the Global 100 most (likely) sustainable companies in

the year before (left bar) and after (right bar) the companies from each Global Industry

Classification Standard (GICS) industry received the annual award at the World Economic Forum

from 2005-2008.

7.20%

4.92%

3.48% 3.48%

7.20% 6.96%

-0.72%

-2.04%

9.00%

6.72%

4.08%

-0.84%

1.80% 0.96%

10.80%

6.48%

3.12% 3.84%

-3.84%

-0.72%

-6.00%

-3.00%

0.00%

3.00%

6.00%

9.00%

12.00%

Consumer Discretionary

Consumer Staples

Energy Financials Health Care Industrials IT Materials Telecom. Services

Utilities

[Based on a research project with P.S. Yu]

Analysing the materiality of ESG factors …

Synthetic Portfolio Construction

[Based on a research project with M. Rezec]

ESG:

Barely related to volatility (standard deviation)

Sample: FTSE All World 2005-2010 (Hoepner, Rezec & Siegl, 2013)

[Based on a research project with M. Rezec and S. Siegl]

ESG:

Reducing Downside Risk



ESG:

Strongly Reducing Extreme Downside Risk



ESG:

Very Strongly Reducing Worst Case Risk


Portfolios rated most responsible (shown in blue) have over 100 basis points lower worst case risk than less responsible portfolios (shown in red).


ESG integration

into Fixed Income ANDREAS G. F. HOEPNER




ESG, Risk Reduction, and fixed income

“ Companies with high

ESG scores are found to

have less company

specific risk ”

(Bouslah et al., 2012; Boutin-Dufresne and Savaria, 2004; Lee and Faff, 2009; Bauer, Derwall and Hann, 2009; Oikonomou et al., 2012)

“ Corporations with

better ESG ratings are

found to have lower cost

of debt and cost of

capital and higher credit

ratings ”

(Bauer et al., 2009; Bauer and Hann, 2011; Chava, 2013; Oikonomou et al. 2011)

“ ESG criteria are found to provide an insurance

like protection for firms in legitimacy crisis ”

(Godfrey, Merrill and Hansen, 2009)

Fixed Income Funds & ESG Engagement

• Study of 122 ESG integrating Fixed Income funds from 17 countries • Statistical model explains up to 98.3% of funds’ return variation • ESG engagement related characteristics of asset management firm

explain up to 450 basis points performance differential

-1.07% ***

-1.19% ***

-1.19% ***

-0.84% ***

-2.02% *

-0.96% **

1.33% ***

1.45% *** 1.21%

***

0.96% ***

2.55% ***

1.09% ***

-3.00%

-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

Engagement Policy Shareholder Activism Voting Policy Voting Policy: ESG issues Approach: Good Signed PRI

Performance influencing characterisitcs

Yes No Difference

[Based on a research project with M. Nilsson]

ESG & Sovereigns: Seeing Greece coming

[Based on a research project with K.B.H. Bouslah, J.M. Linares-Zegarra and A.L. Neher]

2

4

6

8

10

12

14

16

20

00

20

02

20

04

20

06

20

08

20

10

Moodys

Fitch

S&P

Oekom’s environmental, social and governance (ESG) sovereign rating sensed deterioration in Greece as sovereign much earlier than the Big 3

ESG: Protection against Portugal


ESG sovereign ratings also much earlier warning signals than Moodys and Fitch re Portugal

Similar results for Ireland, Italy and Spain

ESG & Sovereigns:

statistical results for short term sovereign debt

CONTROL

VARIABLES

(4)

3M, WITH

COUNTRY & YEAR

DUMMIES

(5)

6M, WITH

COUNTRY & YEAR

DUMMIES

(6)

12M, WITH

COUNTRY & YEAR

DUMMIES

oekom

totalrating -0.0203* -0.0132* -0.6935*

GDP p.c. (%) -0.0009** -0.0009* -0.0048

Inflation rate (%) -0.00001 0 -0.0028

Current Account

Balance Rate

(%)

-0.0006 -0005 -0.0169*

External Debt

(%) 0.0001 0 -0.0231

Trade Rate (%) -0.0002 -0.0001 -0.0051

S&P long term,

orthogonalised

(%)

-0.0043* -0.0030** -0.1496*

Constant 0.1112** 0.0836*** 3.1819*

No. observations 267 267 267

R-squared 0.808 0.778 0.564


Significant relationship between short-, and medium-term government bond rates and ESG-rating

Stronger relationship in case of 12M-matuarity than 3M-, and 6M-matuarity

ESG & Sovereigns:

statistical results for longer term sovereign debt


Highly significant relationship between long-term government bond rates and ESG-rating

Strongest relationship in case of long-term government bond yields

CONTROL

VARIABLES

(7)

3YR, WITH

COUNTRY & YEAR

DUMMIES

(8)

5YR, WITH

COUNTRY & YEAR

DUMMIES

(9)

10YR, WITH

COUNTRY & YEAR

DUMMIES

oekom

totalrating -0.1951** -0.0934*** -0.0788***

GDP p.c. (%) -0.0015 -0.0013 -0.0015***

Inflation rate (%) -0.0002 0.0004 -0.0002

Current Account

Balance Rate

(%)

-0.0038 -0.0020** -0.0012

External Debt

(%) -0.0038 -0.002 -0.0026

Trade Rate (%) -0.0011 -0.0003 -0.0004*

S&P long term,

orthogonalised

(%)

-0.0416** -0.0196*** -0.0165***

Constant 0.9236** 0.4515*** 0.3889***

No. observations 267 216 266

R-squared 0.691 0.852 0.804

Thank you for your attention


Sustainability Advisory Board, Bank J. Safra Sarasin

Senior Academic Fellow, PRI

Associate Professor of Finance, ICMA Centre, Henley Business School

Director, Sociovestix Labs Social Enterprise

President, ReFine Research Charity

Full list of affiliations on LinkedIn

APPENDIX to STATE of

ACADEMIC RESEARCH

Equities & Fixed Income ANDREAS G. F. HOEPNER




ESG within Financial

Data Science ANDREAS G. F. HOEPNER




Current “tools” (i.e. DCF) to find abnormal return opportunities originate from Corporate Finance not Asset Management

Returns are often confused with Price:

Is there a correct, true firm value, if thousands of market participants are arguing about the market valuation every minute?

What is more relevant for the investor? The expected price or the expected change in price?

Many ESG factors are hard to monetarise and hence difficult to integrate into ‘Price’ estimates. They can, however, easily be identified as driver of differential return, as long as firms can be separated on their ESG practices.

Price vs. Return

Current “tools” (i.e. DCF) to find abnormal return opportunities originate from Corporate Finance not Asset Management

Risk is commonly understood as ‘probability of negative events’, however:

current finance practice defines it commonly as ‘probability of deviation from expectation, downwards and upwards’ (i.e. standard deviation, tracking error)

Firms with more ESG conscious business practices have a lower probability of ESG related negative events but are not necessarily harmed in any positive events

Hence: measuring risk accurately as ‘probability of negative events’ is essential to highlight ESG’s competitive advantage in terms of risk adjusted materiality (i.e. semi-standard deviation instead of standard deviation)

Uncertainty vs. Risk

Is standard deviation always ‘risky’?

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00% 30 day rolling standard deviation

How about ‘pure downside deviation’?

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00% 30 day rolling standard deviation / Lower Partial Moment (Benchmark: 0)

Return/Risk ratios in Bull vs. Bear markets

Low Risk Asset High Risk Asset

Bull market

Bear market

Bull market

Bear market

Return 3% -3% 3% -3%

Risk 1% 1% 10% 10%

Sharpe Ratio

+3 -3 +0.3 -0.3

Detailed background

on diversification ANDREAS G. F. HOEPNER




• Variance term diversified away with number of stocks (1st driver)

• Covariance matrix crucial (Covariancea,b= Correlationa,b * Standard Deviationa * Standard Deviationb)

• Weighted average correlation between assets (2nd driver)

• Weighted average specific risk of assets (3rd driver)

• Tradeoff between 2nd & 3rd driver: In a single covariance term, a reduction of the correlation by 10% has the same effect on portfolio risk than reducing the average standard deviation by 5.13%

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The 3 drivers of Portfolio Diversification

Environmental,

Social or

Governance

(ESG) Criteria

Portfolio

Diversification

Weighted Average

Correlation of

Portfolio’s Asset

Returns

Number of Assets

in Portfolio

Weighted Average

Specific Risk of

Portfolio’s Assets

(-) (-)

(-)

(+) (-)

(+)

Portfolio Diversification and ESG Criteria: A simple theoretical model

DynamicESG:

Responsible, especially when it matters ANDREAS G. F. HOEPNER




The ‘Corporate Monologue’ Paradigm:

ESG information currently focuses on the behaviour of (listed) corporations

It is adjusted to country or industry of the corporations

It is updated when corporate behaviour changes though this is challenging to observe at a high frequency

It often suffers from self-reporting biases.

But isn’t there some dialogue between corporations and society?

What about societal responsiveness to ESG issues?

Challenge to Status Quo

Can

societal perceptions

change

without a change in company

behaviour?

Challenge to the Status Quo

Trust in major German savings banks

Overall Brand Index (10 days moving average)

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00

20.00

25.00

Jan

-08

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v-1

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-12

Commerzbank

Sparkasse

[Based on a research project with M. Barnett, C. Palstring and Yougov]

Trust in major German savings &

commercial banks

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00

20.00

25.00

Jan

-08

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v-1

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Commerzbank

Deutsche Bank

Volks- und Raiffeisenbank

Sparkasse

Overall Brand Index (10 days moving average)

[Based on a research project with M. Barnett, C. Palstring and Yougov]

Do societal perceptions vary across cultures?

Challenge to the Status Quo

Trust in industries by country

United States

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

2007 2008 2009 2010 2011

Automotive

Banks

Insurance

Mainstream Media

[Based on a research project with M. Barnett, I. Timofeeva and Edelmann]


United States United Kingdom

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

2007 2008 2009 2010 2011

Automotive

Banks

Insurance

Mainstream Media 0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

2007 2008 2009 2010 2011

Automotive

Banks

Insurance

Mainstream Media




Germany

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

2007 2008 2009 2010 2011

Automotive

Banks

Insurance


20.00%

40.00%

60.00%

80.00%

100.00%

2007 2008 2009 2010 2011

Automotive

Banks

Insurance

Mainstream Media

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

2007 2008 2009 2010 2011

Automotive

Banks

Insurance

Mainstream Media




Germany China

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

2007 2008 2009 2010 2011

Automotive

Banks

Insurance


20.00%

40.00%

60.00%

80.00%

100.00%

2007 2008 2009 2010 2011

Automotive

Banks

Insurance

Mainstream Media

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

2007 2008 2009 2010 2011

Automotive

Banks

Insurance

Mainstream Media

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

2007 2008 2009 2010 2011

Automotive

Banks

Insurance

Mainstream Media


Climate Change Conference

[Based on a research project of Sociovestix Labs]

Dynamic ESG recognises the continuous dialogue between corporations and society

Therefore, it conditions individual ESG criteria on the relevance which these criteria have within a society (or country) at a certain point in time

In other words, Dynamic ESG allows to integrate individual ESG criteria into investment processes especially when and where it really matters

Societal relevance can be measured via mainstream media, social media or government preferences

Challenger to Status Quo: Dynamic ESG

Dynamic ESG

The case of Chinese A-shares:

Over 1,600 firms

RepRisk negative news data from thousands of sources

Text-mining of about 80,000 Chinese government statements to measure societal relevance

Statistical Model explains up to 93.4% of the variation in the return data

Societal Relevance of Corporate

Governance

[Based on a research project with Q. Li]

Please note, the Beijing Olympics took place between August 8th and 24th 2014

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Government Interests Dynamic ESG

Corporate Governance Index

performance & societal relevance



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Government Interests Anti-ESG ESG

Corporate Governance



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Government Interests Dynamic Anti-ESG Anti-ESG ESG Dynamic ESG

Corporate Environmental

Responsibility


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Government Interests Dynamic Anti-ESG Anti-ESG ESG Dynamic ESG

Corporate Social Responsibility


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Government Interests Dynamic 2-Sigma Anti-ESG Dynamic Anti-ESG Anti-ESG

ESG Dynamic ESG Dynamic 2-Sigma ESG

Corporate Legal Responsibility


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Government Interests Dynamic 2-Sigma Anti-ESG Dynamic Anti-ESG Anti-ESG

ESG Dynamic ESG Dynamic 2-Sigma ESG

Documents

RESEARCH & INNOVATION in RESPONSIBLE … Hoepner_DD… · The authors analysed the performance of a long-short investment strategy ... matuarity than 3M-, ... The 3 drivers of Portfolio