I want a yacht
December 14, 2018

Blain's Morning Porridge  - 14th December  2018

"I want a yacht, and really that's not a lot, been an angel all year..." 

I shall be wearing shades all day today. It was our Christmas Party last night.. Ouch. I am not going to write about Brexit. I am not going to write about Brexit.. x 100 times.

As for markets? Gratifying to see the Great GE panic is over – stock up, and JP Morgan admitting it's a neutral hold rather than a screaming sell. We called the selective buy a couple of weeks ago!

But I still think one of next year's big panics will be corporate leverage and indebtedness - sure, there isn't a corporate repayment hump in 2019…it starts from 2020. Meanwhile, China slowdown, lack of direction in stocks, what will the US Federal Reserve do next week (hike), digesting European slowdown, and all the other one-hundred-and-one-other things that are going to go wrong all contribute to the miserable market mood. So much for Christmas..

And since I am in truly grumpy mood, and Friday is my traditional rant day…what shall I take a pop at today?

Let me pick a random line from a report I read: "Underwriters note that they are able to print in bigger size when they have social or environmental themed issues, as a younger demographic emerges to complement their traditional buyer base." Yes, it was a report bigging up funds that invest with "environmental, social and governance" (ESG) mandates. 

I'm all in favour of changing corporate behaviours for the better by making them think good acts will be rewarded by the market. But I just don't believe that's the way it works. Instead, I'm afraid that ESG has become yet another compliance tick-box. (I'll probably have to do an FCA training video course for even suggesting that might be the case…) 

Green bonds are part of the story – lots of issuers swear by them. Investors lap them up – especially if they come with premium pricing. Some funds buy because they believe they are changing the world and making it a better place – and they will cite lots of evidence on how compliant firms do better.

More fund managers buy because they believe such a display of good investment behaviour will make it easier for their marketing departments to sell their funds to external investors. Some investors are brutally honest and admit buying labelled securities is the easy way to meet the firm's stated ESG objectives: "It's just easier to get a green bond on the buy list… if they look blank, I say ESG and they let me buy it..", one prominent London fund manager told me.

A few days ago another client was telling me he'd just had a couple of hours stolen by a Swiss bank pitching a whole series of exchange-traded funds (ETFs) under a "Gender Equality" umbrella – which invests in the Solactive Equileap Global Gender Equity 100 Leaders Index..

Que? I looked it up – Global Stocks are ranked by Equileap according to gender equality criteria including such positives as fair pay, equal opportunities, flexible work, human rights, freedom from violence and assault, diversity and empowerment. Very interesting meeting, but it barely touched on these indices performance or fundamentals – just their basis.

Let me make absolutely clear: I see absolutely nothing wrong with ethical investing and applaud investors who do it properly. (I've refused a number of deals because I consider them unethical in ways like predatory lending or hidden risks.)

I completely support the financial sector making the planet better, fairer, more honest and more rewarding for us all. I am also committed to gender equality – and want my wife, son and daughter, grandkids, and extended family treated with equal respect and honesty.  

But…the reality is I know how this market works, and we are not going to change the world by passive investing in labels that claim they will do it for us. If we want to change the world, we have to be shaking the tree at board level, not picking apples.

That means roiling boardrooms directly on income inequality, gender policies, sexism and polluting our planet. We should be swinging the axe across the executive floors and parliaments. Where is my yellow gilet? 

Slaking the market's conscience by buying ESG labels is something of a cop-out. Labelling a bond or stock green, ethical or gender-equal boils down to marketing. Whatever the best intentions and innocence of issuers keen to extol the greenness, fairness and social worth of their products and projects, the reality is such labels make them easier to sell. Says a lot that it's a "younger demographic" that's cited as driving demand.  

I'm guilty myself. When I was head of FIG DCM at a large bank, I was involved in the launch of bonds designed to appeal to investors with a religious prohibition against the charging of interest. So, we dressed them up with opinions from religious scholars that coupon payments were not actually interest, but permissible profit-sharing.

We told issuers it was a way to reach new investors and diversify their investor base into a very rich part of the world, for which they were prepared to pay a premium. (Actually, because we could sell bonds with a higher yield, and we simply sold them to the same old buyers..)

Then we discovered there were different kinds of religious opinion. Learned scholars from a properly fanatical country insisted on extremely tight ringfenced conditions designed to ensure "profit-sharing" was risk-sharing and would only approve deals pretty close to equity. Scholars from a laxer country half a globe away, would happily approve just about anything, labelling senior debt as compliant for the equivalent of a few shekels. 

Such labels can be a distraction – calling something green and gender-fair doesn't necessarily change the investment fundamentals: will it pay interest and principal? It might attract younger (and less cynical fund managers), but you immediately add a bias to funds that invest in such a manner. For the record, the Gender Equality index is down about 3.2 percent this year, compared to the S&P down 1.4 percent.

Why is that? The moment you label something good and a must invest, you change its intrinsic value by engaging other investors to also buy it on the basis of the label. If these labels are used too liberally, and young inexperienced investors buy the concept and join in, then the market becomes more distorted. You could argue the market distortion reflects a premium the issue should receive for being ethical. But…would that not happen anyway?

There is also the problem the world won't work if you only invest in good stuff. Like it or not, human nature is what it is. So we need defence industries, and we need oil, and our modern consumer society demands cheap clothes currently sewn by child labour – which we know needs to be fixed.. but won't be if firms can't afford to replace them with machines, while incidentally making the kid's family's poorer – the world does not work in straight lines. The big firms in the equality index are laudable and good, but generally are utilities, pharma or telecoms – firms that can easily be seen to tick boxes.

Making the bad issuers cheaper by making the good issuers expensive might be a reason counter ethical investment strategies tend to work. Yep, if you were to buy an index of oil, weapon, ciggies, booze and gambling…It will probably outperform. And yes, I have invested in medicinal Sweet Mary Jane. That is the stark reality of human nature.

Maybe it's because the market's invisible hand is about finding arbitrages and exploiting them. The more you distort the market – by limiting choices, defining behaviours, or setting rules, the more you are likely to see these distortions come back and bite.

This will be as true for ethical funds as it is for the distortions of quantitative easing, and as I believe it will ultimately be for Algo/AI-driven funds. Markets are about ever changing rules! As soon as you think you understand the rules…they change (it's a bit like trying to learn the Welsh language). 

If you want to put a premium on ethical and social cohesion investments, do it directly. Make the fundamental analysis and decide for yourself. Don't be led by labels. Please feel free to write and tell me how wrong am I am about ethical investments. I will be happy to publish rebuttals.

I guess I won't be getting an invite to The Green Bond Congress.

Have a great weekend…

Bill Blain

Strategist

Shard Capital





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Blain's Morning Porridge  - 14th December  2018

"I want a yacht, and really that's not a lot, been an angel all year..." 

I shall be wearing shades all day today. It was our Christmas Party last night.. Ouch. I am not going to write about Brexit. I am not going to write about Brexit.. x 100 times.

As for markets? Gratifying to see the Great GE panic is over – stock up, and JP Morgan admitting it's a neutral hold rather than a screaming sell. We called the selective buy a couple of weeks ago!

But I still think one of next year's big panics will be corporate leverage and indebtedness - sure, there isn't a corporate repayment hump in 2019…it starts from 2020. Meanwhile, China slowdown, lack of direction in stocks, what will the US Federal Reserve do next week (hike), digesting European slowdown, and all the other one-hundred-and-one-other things that are going to go wrong all contribute to the miserable market mood. So much for Christmas..

And since I am in truly grumpy mood, and Friday is my traditional rant day…what shall I take a pop at today?

Let me pick a random line from a report I read: "Underwriters note that they are able to print in bigger size when they have social or environmental themed issues, as a younger demographic emerges to complement their traditional buyer base." Yes, it was a report bigging up funds that invest with "environmental, social and governance" (ESG) mandates. 

I'm all in favour of changing corporate behaviours for the better by making them think good acts will be rewarded by the market. But I just don't believe that's the way it works. Instead, I'm afraid that ESG has become yet another compliance tick-box. (I'll probably have to do an FCA training video course for even suggesting that might be the case…) 

Green bonds are part of the story – lots of issuers swear by them. Investors lap them up – especially if they come with premium pricing. Some funds buy because they believe they are changing the world and making it a better place – and they will cite lots of evidence on how compliant firms do better.

More fund managers buy because they believe such a display of good investment behaviour will make it easier for their marketing departments to sell their funds to external investors. Some investors are brutally honest and admit buying labelled securities is the easy way to meet the firm's stated ESG objectives: "It's just easier to get a green bond on the buy list… if they look blank, I say ESG and they let me buy it..", one prominent London fund manager told me.

A few days ago another client was telling me he'd just had a couple of hours stolen by a Swiss bank pitching a whole series of exchange-traded funds (ETFs) under a "Gender Equality" umbrella – which invests in the Solactive Equileap Global Gender Equity 100 Leaders Index..

Que? I looked it up – Global Stocks are ranked by Equileap according to gender equality criteria including such positives as fair pay, equal opportunities, flexible work, human rights, freedom from violence and assault, diversity and empowerment. Very interesting meeting, but it barely touched on these indices performance or fundamentals – just their basis.

Let me make absolutely clear: I see absolutely nothing wrong with ethical investing and applaud investors who do it properly. (I've refused a number of deals because I consider them unethical in ways like predatory lending or hidden risks.)

I completely support the financial sector making the planet better, fairer, more honest and more rewarding for us all. I am also committed to gender equality – and want my wife, son and daughter, grandkids, and extended family treated with equal respect and honesty.  

But…the reality is I know how this market works, and we are not going to change the world by passive investing in labels that claim they will do it for us. If we want to change the world, we have to be shaking the tree at board level, not picking apples.

That means roiling boardrooms directly on income inequality, gender policies, sexism and polluting our planet. We should be swinging the axe across the executive floors and parliaments. Where is my yellow gilet? 

Slaking the market's conscience by buying ESG labels is something of a cop-out. Labelling a bond or stock green, ethical or gender-equal boils down to marketing. Whatever the best intentions and innocence of issuers keen to extol the greenness, fairness and social worth of their products and projects, the reality is such labels make them easier to sell. Says a lot that it's a "younger demographic" that's cited as driving demand.  

I'm guilty myself. When I was head of FIG DCM at a large bank, I was involved in the launch of bonds designed to appeal to investors with a religious prohibition against the charging of interest. So, we dressed them up with opinions from religious scholars that coupon payments were not actually interest, but permissible profit-sharing.

We told issuers it was a way to reach new investors and diversify their investor base into a very rich part of the world, for which they were prepared to pay a premium. (Actually, because we could sell bonds with a higher yield, and we simply sold them to the same old buyers..)

Then we discovered there were different kinds of religious opinion. Learned scholars from a properly fanatical country insisted on extremely tight ringfenced conditions designed to ensure "profit-sharing" was risk-sharing and would only approve deals pretty close to equity. Scholars from a laxer country half a globe away, would happily approve just about anything, labelling senior debt as compliant for the equivalent of a few shekels. 

Such labels can be a distraction – calling something green and gender-fair doesn't necessarily change the investment fundamentals: will it pay interest and principal? It might attract younger (and less cynical fund managers), but you immediately add a bias to funds that invest in such a manner. For the record, the Gender Equality index is down about 3.2 percent this year, compared to the S&P down 1.4 percent.

Why is that? The moment you label something good and a must invest, you change its intrinsic value by engaging other investors to also buy it on the basis of the label. If these labels are used too liberally, and young inexperienced investors buy the concept and join in, then the market becomes more distorted. You could argue the market distortion reflects a premium the issue should receive for being ethical. But…would that not happen anyway?

There is also the problem the world won't work if you only invest in good stuff. Like it or not, human nature is what it is. So we need defence industries, and we need oil, and our modern consumer society demands cheap clothes currently sewn by child labour – which we know needs to be fixed.. but won't be if firms can't afford to replace them with machines, while incidentally making the kid's family's poorer – the world does not work in straight lines. The big firms in the equality index are laudable and good, but generally are utilities, pharma or telecoms – firms that can easily be seen to tick boxes.

Making the bad issuers cheaper by making the good issuers expensive might be a reason counter ethical investment strategies tend to work. Yep, if you were to buy an index of oil, weapon, ciggies, booze and gambling…It will probably outperform. And yes, I have invested in medicinal Sweet Mary Jane. That is the stark reality of human nature.

Maybe it's because the market's invisible hand is about finding arbitrages and exploiting them. The more you distort the market – by limiting choices, defining behaviours, or setting rules, the more you are likely to see these distortions come back and bite.

This will be as true for ethical funds as it is for the distortions of quantitative easing, and as I believe it will ultimately be for Algo/AI-driven funds. Markets are about ever changing rules! As soon as you think you understand the rules…they change (it's a bit like trying to learn the Welsh language). 

If you want to put a premium on ethical and social cohesion investments, do it directly. Make the fundamental analysis and decide for yourself. Don't be led by labels. Please feel free to write and tell me how wrong am I am about ethical investments. I will be happy to publish rebuttals.

I guess I won't be getting an invite to The Green Bond Congress.

Have a great weekend…

Bill Blain

Strategist

Shard Capital



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