Wednesday, December 31, 2014

Checking the Principles for Responsible Investment in 2014

I attended a confab of local investment pros at the Commonwealth Club in December 2014, appropriately enough just before Christmas.  The Principles for Responsible Investment (PRI) initiative released its progress report for 2014 back in October, so naturally it takes money managers almost two months to figure out what it means.  It made for the perfect segue into how asset managers implement ESG criteria.

Experts from Bernstein Global Wealth ManagementBlackRockNelson Capital, and TriLinc Global held forth on how they manage money.  I have no business relationship with any of those firms, although I have invested in BlackRock's iShares securities in past years.  I also have no relationship with the sponsors MSCI, Parnassus Investments, and Industry Capital.  I tried very hard to launch a career as a portfolio manager with large investment firms, and every firm I encountered said my military background was a disqualifier.  I must therefore be very skeptical of what professional money managers have to say about how they apply theory in reality.

The panelists admitted that the $45 trillion figure quoted in the event's title was just a guess.  Well, there goes their credibility right down the tubes.  Analysis comes from data, and leading practitioners who can't cite reliable statistics from PRI or elsewhere should stay off the platform until they can get their stories straight.

The "responsible investing" rubric covers ESG criteria and impact investing.  It started with negative screens that eliminated objectionable stocks from actively managed portfolios.  Money managers tried to address the concerns of some institutional clients' investment policy statements that prohibited owning stocks exposed to alcohol, gambling, and other controversial sectors.  The evolving thesis is that reducing a company's ethical and environmental risks will raise its valuation.  It is a compelling thesis addressing the supply side of providing attractive investment products.  I need to see matching demand data proving Millennials and others want to buy responsible investments.

I have known about the Sustainability Accounting Standards Board (SASB) since 2013.  It has not yet overtaken FASB in prestige.  Advocates could probably use a hearing in front of the SEC to make that happen.  Public companies will hesitate to adopt SASB standards without a regulatory push.  CFOs already have a full plate with Sarbox compliance and IASB rules for their multinational operations.

I suspect that the extra effort going into responsible investing causes a larger tracking error when portfolio managers measure their alpha against a benchmark.  Tweaking the benchmark is not a satisfactory solution.  Independent studies of the tracking error acceptable in risk budgets will inform responsible investing decisions.

A large body of evidence substantiates the weakness of divestiture as a response to unpalatable investments.  Someone else always comes along to buy what others throw away.  The current trend among overly sensitive portfolio managers to divest from carbon-heavy energy companies is a perfect case.  Oil and gas stocks still make money, and plenty of people will buy them even if fourth-generation Rockefellers turn up their noses.

Stock exchange listing requirements can play a leadership role in responsible investing.  Solid ESG regulations can deter companies from exploiting regulatory arbitrage by listing on a less restrictive exchange.  Exchanges in multiple countries will have to adopt ESG guidelines simultaneously.

Responsible investing has a future.  Alfidi Capital does not yet have an ESG policy.  That may change in 2015.