CalPERS has a moral imperative to confront racism and economic inequality, according to its chair and president, Henry Jones, who spoke to Amanda White in a Sustainability in a time of crisis podcast.

Jones talked of his own experiences including growing up in the segregated south and in more recent years being inappropriately stopped by police in LA. And he discusses the role of the investment community in standing up and working together to shape a future which is just, equal, inclusive and deeply grounded in fundamental human and civil rights.
In the podcast Jones discusses how CalPERS, the largest pension fund in the United States, is tackling these issues internally and through its investment allocations, and also how the industry can collectively change the status quo processes and behaviours around systemic inequality.

“This is both a moral imperative and economic necessity and corporate accountability is vital. We welcome the attention brought to this issue in business, and tracking racism,” he said, adding that CalPERS is undertaking a new research project to identify where to focus attention to make progress.

“Mapping racism as a systemic risk means we should track this across the portfolio, but right now we don’t have the tools or the data. It is not unlike where we were on climate as a systemic risk, we didn’t have the information and had to build a data model and action plan with our partners. We need to do that with addressing racism and have commissioned research on this.”

Jones said that there is not currently enough information for investors to track issues of racism in their portfolios and has argued that the SEC needs to enforce a disclosure framework at company level. (The SEC held its own special meeting into diversity in the asset management industry last month.)

“We know that racism is not just an issue of employment practices in the companies we invest in. It shows up in lack of healthcare, affordable housing and decent education and leads to a vicious circle of depravation and inequality,” he said. “Intersectionality is critical in how to make progress. There is no silver bullet. We would like to see institutions and cultures taking steps to alleviate these profound impacts on our people and society.”

CalPERS commitment to diversity is reflected in investment beliefs and in its strategic plan with engagement with companies and advocacy with regulators among the implementation techniques.

“We are very clear on our focus in this area,” Jones said.

In August 2016 the CalPERS investment committee adopted the fund’s sustainable investment strategic plan which among other things identified corporate board diversity and inclusion as a strategic initiative.

Over the past few years CalPERS has engaged 733 companies on the lack of diversity on its boards and since 2017, 53 per cent of those companies have added a diverse director to their boards.

The interview is part of a podcast series Sustainability in a time of crisis by Top1000funds.com in collaboration with the Principles for Responsible Investment and with the support of Robeco.

Other episodes have looked at what a sustainable recovery looks like and the role of investors in making that happen.

Masja Zandbergen who is head of sustainability integration at Robeco said there are three important long-term trends that need to be addressed: climate change, loss of biodiversity and inequality.

“This crisis has very well laid bare the flaws in our current economic system. In the future we need to prioritise fixing these issues, building more inclusive and more green economies and this will lead to good economic outcomes. But that requires a vision and leadership. Consumers, companies, investors and governments need to adapt,” she said.

She highlighted three important areas for the finance industry to be focusing on to create change:

  • Building new models that are not only about maximising monetary profits but also transition theory, and the value of ecological and social capital.
  • Making sure finance students get education that is broader than only the neoclassical financial theories.
  • Truly integrating sustainability in all asset management embedded in a thorough research process. Not just outsourcing ESG opinion to a data provider. This requires a longer-term view.

In another episode Claudia Kruse, managing director global responsible investment and governance at APG, which with EUR 538 billion is the largest pension fund in Europe, described the fund’s long-term goal in line with a climate neutral economy by 2050 and the short-term steps to achieve that.

And Nigel Topping, who was appointed by the UK Government as the High Level Climate Action Champion for the United Nations talks, COP26 joins Fiona Reynolds chief executive of the PRI to discuss how amongst, and despite of the short-term focus of the COVID-19 crisis, government, business and investors can be mobilised around the important issue of climate change.

 

Advocating for diversity and inclusion is one of the campaigns of Top1000fundscom

Given the changing nature of the global economy we think it is a good time to question whether the status quo processes and behaviours that investment professionals undertake to tackle risks and opportunities, and meet their fiduciary obligations, will be sufficient in the future.

This crisis has prompted us to be more explicit in expressing what we stand for, what we have always stood for – which is to be a catalyst for reformed fiduciary thinking.

We have developed a set of campaigns that will be driving our conversations for change in the industry.

One of those campaigns is centred around the fact that we believe diversity and inclusion drives better investment outcomes

So Top1000funds.com will campaign to drive diversity in the investment industry – this includes driving gender diversity. But we will also campaign so that everyone in the industry regardless of race, gender or sexual orientation, feels safe to be fully expressed and has an equal opportunity to be part of the success that finance can create in wealth creation for millions of people.

 We’re committing to using our platform to bring these issues to light and we’ll be courageous in having these conversations in the industry so we can collectively figure out solutions to some of these huge systemic problems that shape the investment landscape, the economy and the societies in which we live.

The European Union has led the globe in sustainable finance reforms. But despite, this, capital markets remain unsustainable. The implications for European savers and citizens are profound. The revised sustainable finance strategy is a generational opportunity – to put in place guidance, tools and regulation; to remove barriers; to realign Europe’s capital markets with sustainability objectives; and to work urgently with governments and investors beyond Europe’s borders.

Read The EU Commission’s renewed sustainable finance strategy here.

This piece is part of Disability Demands Justice, a dynamic, ever-evolving hub by the Ford Foundation to deepen our understanding of how disability intersects with social justice.

Read No equality without everyone here.

Index providers question whether book-to-price provides a suitable definition of the value factor. They argue that intangible assets such as brand capital and technological know-how play an increasing role, but are not recognised in reported book values.

Many providers prefer to combine several accounting ratios to define value. They argue that a composite of valuation measures using earnings, sales or cash flows will be better able to capture the true value of a stock.

Such comments reflect the idea that value indices should mimic the traditional investment practice of active managers, who search for securities that are under-priced relative to their true value. But it would be naïve to think that a combination of accounting ratios could capture the true value of a stock. The value factor was never meant to provide a view on securities valuation. Instead, factor investing builds on insights from asset pricing that have identified patterns in the cross section of expected returns. Exposure to the value factor captures differences in expected returns across stocks that reflect compensation for risk.

In particular, value firms tend to be riskier than growth firms because their value is mainly made up of assets in place – rather than growth options. Firms with high capital stock will have difficulty downsizing to adapt to an economic shock. This leads value firms to suffer in bad economic times.

From this perspective, omitting intangible capital from the book value is problematic if it contributes to risk like physical capital does. If intangible capital is costly to reverse, holding a large stock of intangible capital may increase a firm’s risk and lead to compensation for stockholders. Empirical research has shown that investment in intangible capital is indeed costly to reverse and increases systematic risk.

Intangible capital also exposes firms to shocks in financing conditions in the economy. For example, firms which rely on specialised know-how are exposed to a risk of key talent leaving the firm. Such talent dependency increases the risk exposure of firms to financing constraints, as key talent will tend to leave financially-constrained firms when financing conditions deteriorate. Similarly, highly innovative firms may have to abandon R&D projects under financial stress, leading to additional losses in bad times. More generally, firms cannot use intangible assets as collateral, exposing them to a risk of tighter financing constraints in bad economic times.

There is a simple answer to the problem that reported book value excludes intangible assets: we can adjust book values to include unrecorded intangibles. The academic literature has established measures of intangible capital. Rather than dismissing book-to-price as outdated, we can update how it is measured by including intangible capital in the book value.

Economists recognised early on that intangible capital is a crucial part of firms’ capital stock. In addition to physical capital (property, plant and equipment), firms invest in knowledge capital and organisation capital.

Knowledge capital is created through research and development (R&D) that leads to know-how in the form of patents, improved processes, and better product quality. Consequently, it can be estimated using data on R&D expenses. Organisation capital is created through investment in training, advertising and organisational design and leads to a skilled workforce, brand recognition, and customer relationships. A part of selling, general and administrative expenses can thus be used to estimate organisation capital.

Recent research conducted by Scientific Beta assesses an intangible-adjusted book-to-price factor and compares it to other valuation ratios. (A version of the paper, Intangible capital and the value factor: has your value definition just expired?, has also appeared in the Journal of Portfolio Management).

We find that the intangible-adjusted book-to-price factor produces a strong value premium, which remains significant when accounting for exposures to other factors, at 2.09 per cent per year. The intangible adjustment thus improves investment outcomes for multi-factor investors. For an investor who held exposure to six factors, including intangibles in the book-to-price factor increased the Sharpe ratio by more than 10 per cent historically.

The intangible-adjusted book-to-price factor also aligns closely with the risks of the standard book-to-price factor. This alignment with a risk-based explanation is important for investors who are trying to capture a premium that will likely persist, even when it becomes widely known. The intangible-adjusted value factor leads to cyclical variation in market betas and earnings. Value stocks with high intangible-adjusted book-to-price also have higher operating leverage than growth stocks with low book-to-price. These observations suggest that value stocks are riskier than growth stocks.

Using alternative valuation ratios does increase returns compared to book-to-price. However, this improvement is explained by implicit exposures to other factors, such as quality and low risk. Due to this factor overlap, changing from book-to-price to other valuation ratios reduces the Sharpe ratio of multi-factor portfolios. For example, switching from book-to-price to earnings-to-price reduces the Sharpe ratio by 11 per cent for an investor who holds exposure to value and profitability. When using a composite value definition instead of book-to-price, the Sharpe ratio reduces by a similar amount. When adjusting for multiple exposures, the premium of a composite value factor is not distinguishable from zero, at -0.41 per cent per year.

In addition, we show that an intangible-adjusted value factor adds value for investors who are already exposed to a composite value factor. On the contrary, composite value factors do not add value for investors who are already exposed to the intangible-adjusted value factor. We conclude that composite value factors are fully subsumed by an intangible-adjusted value factor, which makes them useless for investors who have access to the intangible-adjusted book-to-price factor.

Combining various valuation metrics is an old recipe from the 1990s. Back then, investors did not have access to other factors, such as quality and low risk. But investment practices have changed. Many investors now hold portfolios that combine multiple factors. Therefore, picking up implicit exposure to other factors in a composite value definition does not improve investment outcomes.

Such composite value definitions may indeed be approaching their expiration date. Book-to-price on the other hand is still looking fresh, especially when unreported intangible capital is included.

Felix Goltz is research director and Ben Luyten is quantitative research analyst at Scientific Beta.

 

 

The CEOs of four of the world’s largest technology companies faced the United States House Judiciary Subcommittee on Antitrust, Commercial and Administrative Law last week about anti-trust behaviour. Their size, power and influence and whether this is bad for competition, is an important consideration for investors, says Denise Hearn, co-author of The Myth of Capitalism: Monopolies and the Death of Competition, and more effort by investors needs to be put into understanding their behaviour.

“I feel hopeful after watching the tech anti-trust hearings today that perhaps capitalism is not a failed experiment,” she said in a tweet.

But the hope only comes because the behaviours of these large companies are finally being scrutinised. The internet was designed to be a de-centralised platform and not have one central place where information is received or directed. And yet Google and Facebook have 70 per cent of all traffic on the internet as well as the lion’s share of advertising revenue and profits.

“This has become a scenario where the internet has become beholden to these choke points of who controls information. That’s deeply concerning,” she said in a Market Narratives podcast.

“Unfortunately these companies make up a huge amount of the S&P, and we need to put into perspective how much dominance they have in value capture and information capture and the infrastructure of commerce,” she said.

Most investors hold these companies in their equities’ portfolios and have made good returns doing so. The companies have acted in their own self interest and grown their business, revenues and profits to shareholders.

But Hearn warned that the ultimate impact of this profit maxim, and everyone acting in their own self interest, is a fragile macro-economic landscape.

“The monopolisation of industries leads to other concurrent problems, like economic inequality,” she said. “They have become giant behemoths with little incentives to spend on R&D or CAPX, or investment in workers. And that’s what we’ve seen.”

She argues that while ESG has been helpful in creating a more fulsome view of how different aspects of the economy need to be viewed in relation to each other, there is far too much marketing and not enough second-order thinking about what the impact might be of, for example, the behaviour of tech companies.

She said if investors have a narrow lens and want to maximise profits in the shortest amount of time possible, like some of her hedge fund clients, then it makes sense to invest in these companies. But it becomes more complex the further out the economic ecosystem that you look.

“When you think more in terms of systems and systems thinking whenever you get monopolised crops you degrade the soil to such a degree it becomes fallow and very difficult to grow anything else, it also becomes susceptible to disease and shock, and then you end up getting things like the potato famine,” she said. “It makes the entire ecosystem very fragile. If you want to find moated companies and invest in them because they get higher returns on capital that will work for a time. But over time there is enough latent risk built up into the system where that is no longer going to hold. This is a warning I would issue.”

Systems thinking

Systems thinking is gaining in popularity as lens for investors who understand that finance and economics is not linear, but complex and adaptive. It’s something the Willis Towers Watson Thinking Ahead Institute has been exploring for some years, as has MIT professor of finance, Andrew Lo.

Professor Cameron Hepburn, an environmental economist at Oxford University, says looking at sensitive intervention points and the idea that small changes in one area can trigger knock on effects to the whole system is an area of science gradually being brought into economics.

“This is the idea that if you have a complex adaptive system like the climate or the economic system then small deviations or changes in one part of the landscape can trigger knock on effects to the system as a whole, especially if it is at a state of criticality,” he said in a Fiduciary Investors Series podcast interview.

Hepburn, who is director of the Smith School of Enterprise and the Environment and leads a number of programs on sustainability at the Oxford Martin School, said investors need to get out of the old paradigms and look at a better way of understanding complex systems.

“Even the concept of the black swan doesn’t really help us to capture the fact these distributions are not bell shaped, or fat-tailed or non-normal distributions. The interactions between parts of the economy are shifting the distribution altogether. So these things that are supposed to be a 1 in 10,000 event become the mean because you’ve shifted the distribution,” he said.

“Put another way, if you’re walking towards the cliff edge, except you’re walking towards it backwards looking where you’ve been previously walking and saying there’s no evidence of a cliff edge, then you walk off the edge – you’re looking in the wrong direction. It’s pretty obvious that only using backward or historical looking data does not tell you what you need to do, especially where there are non-linear dynamics in the system. It’s uncomfortable because in order to turn around and look forward you end up having to be a bit more speculative, to understand the underlying connectivity and network of the system. If you don’t do that you’re pretending they don’t exist. It’s important we start doing more forward looking work in this area of finance risk modelling.”

Hearn, who is a graduate from Oxford’s Said business school, also says more transformational work needs to be done around systems thinking with regard to finance to change or even transcend paradigms. She believes there are fundamental paradigms that need to be questioned and narratives need to be reframed away from the mechanistic.

“It’s amazing we think markets can be calculable, but actually it’s so much more like a forest: complex, adaptive, non-linear. There are no such things as externalities, you only push them down into the future.”

She said the biggest example of the entrenched linear thinking is with central bankers.

“The reality is there is no way to grow ourselves out of this level of debt but we keep borrowing from the future to pay for the sins of today, at some point this will all come to a head. Some argue there will be a debt jubilee and all debt will be forgiven because there is no other way out.”

 

Beyond tech: banking’s concentration bad for the market

Even though Hearn said in her tweet that she feels “hopeful” watching the anti-trust hearings “that perhaps capitalism is not a failed experiment”, she also said “then I remember this”…. pointing to an article on CNBC which details “splashy tech deals”. As recently as May a lot of tech companies in the US have been buying competitive companies that have been distressed due to coronavirus-induced problems.

“That’s how they do R&D these days, they just acquire, and that doesn’t benefit the market,” she said in the podcast.

She pointed out that the large tech companies often don’t end up commercialising a lot of the innovations of the companies they acquire, or produce internally, and pointed to websites such as Google Cemetery that lists “dead” Google innovations.

By way of example, 45 per cent of the products on Amazon are Amazon-branded or owned and they can favour their own products in the way they sell to consumers.

“This is a concern because we are seeing one of the lowest rates of business dynamism. In free markets anyone should be able to have an idea and launch a product,” she said.

But it is not just in the tech sector that this market concentration is a problem.

The impact of onerous regulation such as Dodd Frank has meant that only the largest incumbents in the banking sector could afford to comply.

“We often don’t really recognise the effects of that,” Hearn said. “But we see it now with the coronavirus and so many of those small banks have disappeared, a whole infrastructure evaporated, and it has been difficult to get the money to where it is needed the most.”

And while chief executive of JP Morgan, Jamie Dimon, last month called this the golden age of banking from Hearn’s point of view this just further entrenches the dominance of the large players, which is not good for the market overall.

The path to a sustainable economy: social and economic consequences of the coronavirus.

  • Masja Zandbergen, head of sustainability integration, Robeco
  • Fiona Reynolds, chief executive, Principles for Responsible Investment (PRI)

 

This episode explores the key pillars of a sustainable recovery including the three important long term trends that need to be addressed climate change, loss of biodiversity and inequality.

It explores the key role for the finance industry which includes building new models that are not only about maximising monetary profits but also transition theory, and the value of ecological and social capital.

About Masja Zandbergen
She holds a Master’s in Econometrics from Erasmus University Rotterdam and is a CEFA charterholder. Her background is in equity portfolio management, in which capacity she has been responsible for a global financials fund and European portfolios. Zandbergen started her career at Robeco in 1997, where in 2003 she joined the sustainable investing team and helped set up the active ownership (voting and engagement) approach, with specific responsibility for social issues. She then moved on to start her own company, and later became head of equity at Syntrus Achmea. Zandbergen rejoined Robeco in 2015 and in her current role as head of sustainability integration, she works with the investment teams on integrating ESG. She is the company’s spokesperson on the topic of sustainability and works with clients to share knowledge and expertise on this field.

About Fiona Reynolds
Fiona Reynolds is responsible for global operations. She has more than 20 years’ experience in the pension sector, working in particular with the Australian Government, and has played a key role in advocating pension policy change on behalf of working Australians. She has a particular interest in retirement outcomes for women. Prior to joining PRI, she spent seven years as chief executive at the Australian Institute of Superannuation Trustees, an association for Australian asset owners. Reynolds has been a director of AUSfund, Industry Funds Credit Control, the United Nations High Commissioner for Refugees, and Women in Super. In September 2012, she was named one of Australia’s top 100 women of influence by the Australian Financial Review, for her work in public policy. Reynolds also serves on the International Integrated Reporting Council, the council for Tomorrow’s Company, the Global Advisory Council on Stranded Assets at Oxford University, and the Business for Peace steering committee.

For PRI’s whitepapers and resources for asset owners visit www.unpri.org

About Amanda White
Amanda White is responsible for the content across all Conexus Financial’s institutional media and events. In addition to being the editor of Top1000funds.com, she is responsible for directing the global bi-annual Fiduciary Investors Symposium which challenges global investors on investment best practice and aims to place the responsibilities of investors in wider societal, and political contexts. She holds a Bachelor of Economics and a Masters of Art in Journalism and has been an investment journalist for more than 25 years. She is currently a fellow in the Finance Leaders Fellowship at the Aspen Institute. The two-year program seeks to develop the next generation of responsible, community-spirited leaders in the global finance industry.

Sustainability in a time of crisis is a Top1000funds.com podcast collaboration with PRI, with support from Robeco

Sustainability issues have never been more important than they are right now. How can investors work together to use this unprecedented opportunity to put the promise of purpose-driven leadership and stakeholder capitalism into practice? This collaborative work with the PRI, with the support of Robeco, will showcase leadership in sustainability during a time of crisis.

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