I have written to the effect that bond yields would fall (so fixed income stocks would go up in value) and equities would start to revalue upwards only when markets thought that central banks had done with putting up interest rates. It would not require rates to begin falling, only that the end of the cycle of increases had probably ended.
Midweek musings – How Morninstar upsets the US energy lobby
As I got positive feedback from my offer to supply summaries of interesting investment webinars that come my way, I am going to try and precis a 50 minute presentation from Morningstar (MS) from a mini-series called “Investing in times of climate change”. There is a full written report with this title that I can access if anyone wants all the details.
As context, I need to point out that the presenation was from MS European and Asian staff, for reasons that will become obvious and the work underlying the report was done by the MS subsidiary Sustainalytics, itself now a ‘bete-noire’ of the US organisations that are influenced by the fossil fuel businesses and anti-sustainablilty lobby – a surprisingly powerful group of people.
There was a lot in the presentation and even writing notes for a precis, I had over 20 points, so this is a VERY condensed version.
Main points
In the database covered by Sustainalytics to which they applied their assessment methods (more of which later) not a single business was aligned with the +1.5C climate temperature rise target that is generally linked to the 2015 Paris Agreement.
MS have defined 5 types of portfolio strategy, or labels to attach to a company: Low carbon, Climate Transitions, Green Bonds, Climate Solutions and Clean Energy/Tech. Whilst Green Bonds is obviously a discrete category, the demarcation lines and classification rules for the others were not imediately clear to me from the presentation, but likely would be after reading the report.
Growth in climate focused funds has ballooned over the last 5 years, but this is nearly all in Europe. China now has more money in climate focused funds than the USA!
2021 saw record inflows into climate focused funds and in line with markets overall, they have since declined, but less rapidly than the whole market.
China has a growing but volatile (because heavily influenced by retail investor speculation) market for climate funds partly because of the Chinese government’s, often misreported, strong commitment to zero carbon goals.
Outside of Europe, the USA and China there are only a tiny number of climate focused funds with Australia, Canada, South Korea and Taiwan currently having a handful each. However, this market is growing fast from this low base.
Investors at the moment most prefer the Climate Transitions segment of the 5 categories defined by MS.
Tests by Sustainalytics against carbon emissions deliver better results for the Low Carbon (no surprise there) and Climate Transitions groupings and worse results for Clean Energy/Tech. The latter sector has been the least popular with investors recently but I did not spot any comments about correlation with emissions assessments. More was explained about the mehodology of scoring the companies and groupings later on.
An interesting aside observation supplied was that companies producing clean energy will in many cases still have fossil fuel operations, so as businesses will score badly on emissions measures.
The keystone measure used by Sustanalytics is Implied Temperature Rise (ITR). This is made up of a 2 part measurement/assessment: actual data in the public domain or made available to MS about the firm’s climate policy and actions, and in addition a governance or management quality factor. I would imagine that the latter is likely to be controversial and potentially highly annoying to some firms!
Some stock examples where firms that on the face of it might look good for ESG investors scored very badly using this methodology. L’Oreal was one, apparently because its supplier chain, being of course mostly chemical companies, have very poor scores for emissions. I had never thought that there should be a limitation on the use of make up by eco-warriors, but it seems very appropriate!
When the whole universe of ITR rated stocks was averaged out, the result was +2.5 degrees, so way out of line with the ambitions of the Paris accord. However, understanding the way this data has been derived is not so easy.
The presenter (English) from Sustainalytics showed an example fact sheet that is available to MS subscribers to the appropriate service level (All MS webinars have a sales objective that surfaces towards the end) and explained that their users want a ready made independent assessment of companies’ ambitions on climate related objectives so Sustainalytics has created more than 80 data collection points that are weighted to give a score against a target company’s own published plans and expectations, with the results seeming to show quite wide discrepancies. An element of AI processing is used to generate the resulting graphical outputs.
Observations
I found much of the data about investors’ attitudes to cimate change and carbon emmissions reduction generally encouraging. However, I found that I was thinking along the lines that it is not safe to accept carte blanche an assessment of a company’s suitability for investment based on rather arbitrary classification into one of 5 possibly overlapping groups and an ‘AI’ influenced score based on data that may not even be reliable. I am especially sceptical of over-classification using labels, which is in truth MS’ bread and butter modus operandi. I also am skeptical of MS use of the fashionable ‘AI’ label – I guess they have been using algorithms for years and there is no such thing as an intelligent algorithm!
I think it is maybe fair criticism of Sustainalytics by some senior people in US companies and institutions to suggest that they at least appear to be taking a political stance. Of course, the majority of governments, who by definition are taking a political stance, support the Paris accord climate obectives and later ones too, so MS are not on the face of doing work that does not have public consent. What is maybe worrying is that their methodology is proprietary, to a degree a commercial secret and could, in my opinion, generate misleading and unhelpful results in at least some cases.
I personally, as a very politically sensitive person, am all in favour of investors knowing about the real (as opposed to stated for PR purposes) influence on the environment of companies in the funds they own. But I would not be happy if I found the manager was picking stocks with over reliance on computer generated score sheets or databases.
As with many aspects of making sustainable investment choices, we find ourselves being given tools that are along the lines of what we want, but are probably rather less sophisticated than we would like. I feel at times like I would if I was asked to identify a small bird in the tree tops using Lord Nelson’s telescope!
PS Since publishing this piece, I see a headline in the FT – “UK set to unveil plans to regulate ESG rating agencies”. Your scribe is on point!
Watching Brief – November 2023
Pottering About
I wrote this last month: ‘The better news is that October averages out as amongst the best across the whole US stock market’.
As of October 30th, the main US market is down 4% over the month and European and UK markets are also in the red. Even the Japanese and Indian markets, which had been doing rather better are down a similar amount.
Thus is the nature of averages!
Midweek Musings – economic warfare, somewhat unobserved
Over a period that was maybe a couple of years back – I can’t exactly recall – one of the propositions I regularly put forward in discussions about the relative economic strengths of the USA and China was the idea that the Chinese could seriously impact US financial policy by dumping their then huge holdings of US Treasury stock.
An oddity and an explanation?
With US bond yields hitting levels that don’t seem fully justified by the market expectations of medium term interest rates, I have been struggling in discussions to explain to subscribers why, with recessions ever more threatening in developed economies, no-one was buying bonds. Stocking up on longer duration bonds would be the logical thing to do when the market cycle is where it is now.
Midweek Musings – China goes all Thatchery?
It was nearly 40 years ago…
Remember Sid? That was name of the mythical person who was going to be told by the whole newspaper reading/ ITV watching population of the UK to buy British Gas shares. This was the second big privatisation (after BT) in an era of mass privatisation by Mrs Thatcher’s Conservative government. The general idea was to get the public at large into share ownership as a way of making money over the long term (a sound idea, with qualifications, of course) and maybe feel a little bit fonder of capitalism.
It would surprise no-one that a Conservative government in a free market economy would encourage wider share ownership amongst the public.
China wants more micro capitalists
What astonished me was a quotation I heard yesterday from a senior official in the financial system in the world’s largest Communist state with a wholly state controlled economy saying, in essence, that the goverment needed to set up a fund to buy shares in the Chinese stock market, so that valautions were propped up and citizen share holders would feel better off and go back to the desired level of consumption!
Actually, I have learned that this is not the first time that the communist government of China has supported its equity market and on both previous occasions, it all ended in tears. The same could well be likely this time as the government running a fund that owns significant holdings in important companies, even if it not actually nationalisation by the back door, would turn other investors into co-investors with a large, ethics free and powerful shareholder capable of all sorts of undesireable behaviour. Pump and dump immediately comes to mind, even if it might be an accidental process.
Why?
The answer is that if consumption is the cocaine of capitalism, as I frequently say, then it appears it is the crystal meth of state led economic growth. or even Communism. Stalin many have failed to pick up on that.
The Chinese economy has not returned to rapid growth after coming out of the zero Covid lockdown period and that is thought to be partly because the Chinese consumer is nervous. In emerging economies (like where I live) the first asset class people fall in love with is real estate. It is tangible, you maybe want to live in it, and when economies are growing, it goes up in value most of the time. If Marx thought property was theft, then post Marx, let’s all be on the winning side!
However, the Chinese real estate market is currently something of a car crash. A good proportion of bonds (fixed income assets) are linked via the financial sector to the property market, so they look risky too. So it is perhaps logical that the state wants people to move on to owning that harder to understand and more volatile asset class, equity shares. But those pesky overseas institutions are having a big downer on China , because the economic good times have not returned as hoped for! What to do?
Options
Basic economic theory tells us that growth in GDP comes from 3 main sources: consumption, investment and government spending. The last is one to argue about, because if government spending was ‘honest’ it would be funded by taxation and that would be a depressor of growth. Generally, it is funded mainly by borrowing.
Exports and international trade are other factors but I won’t go into that here.
Consumer spending has an obvious sustainability impact. We all over consume because since the 1920’s there has been in place a massive machinery designed to make us feel happy doing just that.
Investment can have varying impacts.
Building a new fast railway line to Manchester has some environmental negatives in the building stage, but likely has considerable positives in reduced car journeys etc. I am no expert on the HS2 project but no doubt a lot of work was done on the sustainability implications of the project.
Investing in low cost housing, green energy, research and innovation facilities and so on adds to economic growth with probable social benefits too, but these are poorly accounted for in the rather crude calculations of economists.
Government spending can be both investment and/or consumption. Unfortunately much of it is poorly managed inefficient consumption and indeed, even in supposedly well regulated developed economies, a percentage of government spending is filtered off by corruption. You could argue that crime is economic activity, but few would encourage a rapid expansion of that sector!
And in China
It is well known that in China they certainly do the goverment spending, both nationally and at regional level, even if it may be disguised through intermediate financial structures. They have massive international debts to prove it!
Investment has been strong too and best of all, it was until recently coming into the country from overseas. That is the ‘gold standard’ primer of growth. But political decisions have scared off some international investors. As I write, Tim Cook of Apple is reported to be in China, so maybe all is not lost, but it needs to be born in mind that Hauwei have taken a serious swipe at Apple’s local market share, so maybe he is more interested in sales than production.
Maybe boosting consumption is the only policy lever left to pull and maybe a sort of reverse Thatchersim is worth trying – the government buying shares, not selling them, to boost the wealth of citizens and make them want to spend freely.
Increased Chinese spending would be good for investors like us, especially if we own funds invested in global brands and luxury goods, or firms that make money from global travel. However, my quick take on the reported proposal is that it is far from well thought out!
Midweek Musing – Morningstar on Europe
Having heard what Morningstar’s (MS) US experts think about US markets and reported that to you, I have since watched the equivalent webinar for Europe. Note that when we talk about European stocks we usually mean ex UK, whereas MS will be referring to their EMEA regional definition which includes the UK. It was notable how much less bullish the tone was overall!