The Texas Teachers Retirement System (TRS) continues to build innovative relationships with its managers, the latest of which has seen it take a $250-million equity stake in asset manager Bridgewater Associates LP. (more…)
EDHEC-Risk Institute has conducted research looking at an application of the improved estimators for higher order co-moment parameters as they apply to the optimisation of hedge fund portfolios. (more…)
Ireland’s sovereign wealth fund has to delicately balance the twin demands of being a long-term investor with providing capital to rebuild the shattered Irish economy. (more…)
Research on environmental, social and corporate governance (ESG) and investments has advanced in rigour, coverage and volume, but data quality, and the problems of reverse causality are still concerns for academics looking for a meaningful relationship between ESG factors and investment performance.
A fundamental question about responsible investment is whether using ESG information enhances investment performance. Georgios Serafeim, assistant professor of business administration at Harvard Business School, says there have been many attempts to connect ESG and investment performance, but for him the quality of data remains the main barrier to any really conclusive outcome.
“Compared to the integrity of financial accounting with its data, auditing, mechanisms and measuring systems, ESG data is noisy, which means the probability of finding a significant relationship is less – it’s econometrics 101,” he says.
Jane Ambachtsheer, partner and global head of responsible investment at Mercer, agrees.
“In the past few years this has been a growing area of academic study and it has expanded in coverage across different asset classes. There is evidence to show there is not a performance penalty, but it is harder to make clear-cut the case in support of the positive investment case. There are still a lot of issues around quality of information and data,” she says.
Quality research counts
Ambachtsheer and Serafeim were speakers at a United Nations-backed Principles for Responsible Investment (UNPRI) academic-run webinar, which brought together academics and practitioners to discuss the developments in ESG investment studies and integration since the United Nations Environment Program Finance Initiative (UNEPFI) released its seminal 2007 report Demystifying Responsible Investment Performance.
A paper by Sweden’s Seventh National Pension Fund (AP7), which reviewed an additional 21 academic studies published after UNEPFI’s report, was also presented at the webinar. It focuses only on environment and social and omits governance studies.
The results of this review, The Performance of Socially Responsible, reinforce that there is nothing to suggest that responsibility for environmental and ethical issues in asset management in general either raises or lowers returns.
Two thirds of the studies in this report state that there is no obvious connection. And in the last third, five studies suggest a positive correlation while three point to a negative correlation.
With regard to AP7’s study, Ambachtsheer says funds labelled as Socially Responsible Investment (SRI) are a legitimate area of study, but it is difficult to compare across ESG as a screen of decision-making and ESG as an investment screen.
“From a fiduciary perspective the study provides comfort that you’re not destroying value. But it doesn’t answer whether ESG factors hold the key to better risk/return outcomes,” she says.
For Serafeim, it also highlights the problem that even when a relationship is documented it might be statistically significant but not economically so.
“There may be a certain effect and when you scale it by a standard error, it is a relatively big effect, but economically it’s not that significant.”
Serafeim also believes that when it comes to the academic study of ESG and investment performance there is a possible case of ‘reverse causality’.
“It’s a difficult one to solve. There could be a case of reverse causality, where financial performance is causing ESG, not the other way. This affects what you can take from the results.”
Patience will pay for performance
Serafeim presented at the webinar with his colleague Bob Eccles, professor of management practice at Harvard Business School.
They believe there needs to be more patience in the field and that material results will take a long time to appear.
“People want the answer before the experiment,” Eccles says. “Longer time frames are needed to measure the impact of ESG and performance.”
“It is hard to believe there will be a relationship between a rating and earnings of next year’s stock returns. It is hard theoretically to understand why there should be a relationship between them. It is not a fixed time but certainly not over one year, maybe five, seven or 10 years. A long-term perspective is needed – it is about long-term performance – and this leads back to why studies don’t find anything.”
Time will help heal the problems of reliable data too, says Eccles, pointing to the evolution of accounting standards over a 75-year time period.
However, as Ambachtsheer points out, perhaps the information asymmetry is also a period of opportunity, as information is at a premium. Research is already underway to supply this demand.
Recent work by Frank Figge and colleagues helps to assess data quality and studies on how investors use sustainability information by Anna Young at the University of Sydney Business School, DanielBeunza at the London School of Economics and Fabrizio Ferraro at IESE Business School are worthy examples. This type of work will help us to unravel the performance question and establish links realbetween ESG and investment.
Emerging market equities in Asia and Latin America could be a bright spot in the lingering gloom hanging over global markets this year, according to BlackRock’s managing director of iShares Russ Koesterich.
While emerging markets suffered from the risk on/risk off uncertainty that mired returns in the second half of last year, Koesterich says that emerging markets are more than just a long-term thematic play for investors.
Citing the tailwinds of negative real interest rates settings in many of the world’s economies, as well as attractive valuations compared to a year ago, Koesterich says that emerging markets with less exposure to Europe could also provide attractive opportunities for investors in 2012. He predicates his advice with the proviso that Europe does not blow up, taking the world economy with it.
Resources, CASH, emerging and developing markets
Along with these emerging market equities, Koesterich sees so-called mega cap stocks in developed markets as also potentially good performers.
He advocates a focus on the resources sector (excluding natural gas), as well as companies that are leveraged to emerging market consumers.
BlackRock also sees opportunities in what it calls CASH countries, the smaller developed economies of Canada, Australia, Singapore and the Special Administrative Region of Hong Kong rather than Europe and the US.
While Koesterich is positive about emerging markets, he cautions that Europe, the Middle East and Africa (EMEA) – particularly Africa and Eastern Europe, which are more heavily exposed to European markets and banking – could pose a risk to investors.
“When you consider the valuations of the asset classes, what is reflected in prices – and while there is no shortage of risks in the world and there are plenty of things that can go wrong – right now equities represent the better opportunity,” Koesterich says.
“Obviously, there is still fixed income as a source of income and it dampens volatility in your portfolio but there is a growing view that whatever your benchmark you should be overweight equities relative to that benchmark.”
In the long run BlackRock sees that emerging markets economies and assets will “decouple” from the slower growing and debt-ridden developed world.
As this scenario plays out in the short-to-medium term, BlackRock predicts, Europe is likely to slip into recession followed by a grinding recovery in 2013, while the US and Japan muddle through.
But with many developed world economies facing the long and rocky road of fiscal and structural reforms, BlackRock also sees a long-term shift in the underlying risk profile of developed world assets changing relative to more robust emerging market assets.
“You look at the relative risk in emerging markets versus developed markets and you are seeing a convergence, where not only are emerging market stocks and bonds becoming less risky as their macro-economic picture improves, but because all of the problems in developed countries, such as excess debt, slow growth and de-leveraging, you are seeing increased risk in many developed market assets,” Koesterich says.
“So, irrespective of returns, if you have a world where, from a relative basis, the risk is dropping in emerging markets and rising in developed markets, as that risk converges it would suggest a slightly higher weight to emerging markets.”
Institutional highs
Thinking about the big macro issues that may shape investment decisions, not just in equities, but also across asset classes is a focus of Koesterich, who is one of the founders of BlackRock’s Investment Institute.
Established in late 2010, the institute provides a forum for BlackRock staff from around the world to share ideas, as well as a conduit for BlackRock to share its latest investment insights with investors.
Since launching, the institute has held forums discussing sovereign debt and the sustainability of corporate profit margins.
The next forum will be on China and the institute is also considering a looking at the question of how the investment landscape will look if some types of sovereign debt can no longer be seen as a risk-free asset.
When it comes to China, Koesterich is part of a growing consensus that believes China will engineer a soft landing in the lead up to leadership change later this year.
“These are broad themes that, whether you are running a fixed income, equity or an emerging market portfolio, in one form or another affect us all,” he says.
“It is really a clearing house for investors in the firm to get together, exchange ideas and try to wrestle with these topics. It is also a way of providing some investment views to our clients, not with the notion that this is the BlackRock view but more here is the dialogue.”
This paper investigates the extent to which market risk, residual risk, and tail risk explain the cross sectional dispersion in hedge fund returns. The paper introduces a comprehensive measure of systematic risk (SR) for individual hedge funds by breaking up total risk into systematic and fund specific or residual risk components.
Contrary to the popular understanding that hedge funds are ‘market neutral’ it finds that systematic risk is a highly significant factor explaining the dispersion of cross-sectional returns while at the same time measures of residual risk and tail risk seem to have little explanatory power.
Funds in the highest SR quintile generate 6 per cent more average annual returns compared to funds in the lowest SR quintile. After controlling for a large set of fund characteristics and risk factors, systematic risk remains positive and highly significant, whereas the relation between residual risk and future fund returns continues to be insignificant. Hence, systematic risk is a powerful determinant of the cross-sectional differences in hedge fund returns.