Environmental and Social factors not reflected in financial valuations
ENV
- Carbon emissions
- Resource depletion
SOCIAL
- Labour exploitation - poor working conditions
- Community displacement - infrastructure projects displace communities
5 FORCES OF INTERNALISATION
- Government
- Civil Society
- Financials
- Consumers
- Corporates
Efficient Frontier of Risky Assets - explain how to do one
What are estimated?
Set of optimal portfolios that offer the highest return for a given level of risk.
Portfolios on the EF are well-diversified and efficient as they maximise returns while minimising risk
- IDENTIFY SET OF RISKY ASSETS
- CALCULATE - expected return, risk, correlation/covariance
- OPTIMISE PORTFOLIO WEIGHTS
- PLOT FRONTIER
ESTIMATES
- Expected return, historical data, CAPM
- Standard deviation, historical data
- Correlation/covariance matrix, historical data
STRUCTURAL + BEHAVIOURAL FACTORS OF EMH AND IMPACTS ON EFFICIENT / NON-EFFICIENT MARKETS
Structural
- Info asymmetry, insider trading
- Market frictions, taxes, regulations
- Illiquidity
Behavioural
- Overconfidence/overoptimism
- Regency Bias
- Confirmation Bias - NAIEV ACCEPTANCE, BLINKERED SCEPTICISM
IMPACTS EFFICIENT
- market stability
- fair pricing
- invest strategies, passive index
IMPACTS NON EFFICIENT
- Risk of crash
- unequal playing field
- exploitation
EFFICIENT MARKET HYPOTHESIS VERSUS ADAPTIVE MARKET HYPOTHESIS
EMH
- Investor assumes rationality and full info
- Static market efficiency
- Anomalies are exceptions
- Passive investing optimal
AMH
- Learning and bounded rationality
- Dynamic market efficiency
- Anomalies expected as part of changing
- Active strategies effective during inefficiencies
Functions of the financial system and their sustainable impacts.
- Risk management, green investments & climate risk mitigation
- Monitors investments, ESGs and acountability
- Payment mechanisms, Digital payments
MARKOWITZ MODEL
Optimal portfolio
INPUTS
- expected return
- risk
- correlation between returns
- Portfolio variance
WHY NOT ALWAYS USED?
- data sensitive
- estimation errors
- Practical limitations
VALUE AT RISK (VaR)
HOW TO CALCULATE
WHY USED TO MEASURE RISK
WHY IS EXPECTED SHORTFALL SOMETIMES USED INSTEAD (CVaR)
potential loss in value of an asset over defined period for given confidence interval
HOW TO CALCULATE
- Historical simulation
Historical data to predict future losses
- Varience covarience
VaR = U - za X SD
WHY USED TO MEASURE RISK
- simplicity
- risk quantification
- regulatory use
WHY IS EXPECTED SHORTFALL SOMETIMES USED INSTEAD (CVaR)
- Av loss goes beyond VaR
More info
SUSTAINABLE INVESTING
CHALLANGES IN MEASURING SUSTAINABILITY ?
RECENT DEVELOPMENTS
Negative screening
- excluding sectors that have negatve sustainable goods
Positive screening
-Actively selecting companies with strong ESG
ESG integration
- incorporates ESG factors into traditional financial analysis
CHALLANGES IN MEASURING SUSTAINABILITY ?
- greenwashing
- data gaps
- subjectivity
RECENT DEVELOPMENTS
- SFDR EU sustainable finance disclosure reg
- CSRD corperate sustainable reporting directive
HOW ARE INDICES USED
CONSTRUCTING AN INDEX
- Benchmark performance indicators
- Index funds and ETFs
- Asset allocations
- Selection of index universe
- Transparecy
- Liquidity
TRADITIONAL VS LONG TERM VALUE CREATION
TRADITIONAL
- Short term financial
- Maximise shareholder returns
- Take financial and market risks
SHORT TERM PROFITS
LONG TERM VALUE CREATION
- Long term sustainability
- Considers all stakeholders
- Social, env, financial risks
LASTING VALUE THAT BENEFITS SOCIETY
Why invest in bonds with a negative yield?
- Gov bonds - have negative yields - a safe haven for investors
- Deflation - can go back up - real value positive
- institutionals often required to hold low risk assets - hard to avoid low yieldse
FUTURE OR FORWARDS
- ENHANCE PORTFOLIO, derivative
- Hedge risk , against price movement
- Leverage , leverage large position with small capital outlay
- Enhance yield , taking positions that benefit from price movement
MARKOWITZ VS. SINGLE INDEX MODEL
MARKOWITZ
- correlations minimize portfolio risk for return
- expected return, cov matrix, portfolio variance
- highly diversified
- complex
SIM
- Returns driven by single factor - systematic
- expected return, asset beta, asset specific risks
- over simplifies
- simple
POSITIVES AND NEGATIVES OF SHORT-SELLING
POSITIVE
- Price discovery
- liquidity
- hedging
NEGATIVE
-unlimited loss
-market manipulation
-negative impact on company
ESG RISKS
ENV - costs from liabilities
SOCIAL - poor labour practicies
REP - scandals
CAPM CAPITAL ASSET PRICING MODEL
LIMITATIONS
Sharpe 1960s
assumption financial markets are efficent
calculate expected return by considering risk free rate
LIMITATIONS
- assumptions
- estimations
- only focuses on systemic risk
INVESTMENT POLICY STATEMENT (IPS)
FACTORS
Outlines investor’s goals, constraints and strategies
- INVESTMENT OBJECTIVES
return goals, impact on portfolio
higher return higher risk - RISK TOLERANCE
how much risk willing to take
LIQUIDITY NEEDS
how easy it is to convert investment into cash
PROS AND CONS OF DERIVATIVES
PROS
hedges risk
diversification
CONS
high risk
complicated
BOND PRICES IN SECONDARY MARKETS
- interest rates
- market liquidity
- economic conditions
