Sunday Brunch: investment characteristics
Or how we describe things drives how we think about them
“what we call things matters, the words we use and how we perceive those words, reflect how we value, or devalue, people, places and things” - Anna Quindlen
or for those of my generation …
“Letting the days go by (same as it ever was, same as it ever was)” Once in a Lifetime - Brian Eno, David Byrne, Tina Weymouth, Jerry Harrison, Christopher Frantz (this quote will make sense when you get to the end).
A big challenge in sustainability finance is language. The finance industry has a tendency to use words in different ways from ‘normal’ people. Sometimes it’s with the aim of confusing (have you ever read the document document that describes a funds investment strategy?). But more often it’s about precision. All professionals do it. As an industry we call 1/100 of a percent a basis point. It makes little sense to those from outside, but to insiders it’s really clear exactly what we mean.
One word that gets used a lot is factors. It used to be mostly used in asset allocation and quant funds, but with the rise of ESG and Sustainability, it’s now used much more widely. My colleague Sandy, who has a background in quant (among other things) tackled this in yesterday’s Sunday brunch. You can read the full blog here., or by clicking on the image below.
Why does this matter?
Asset managers have always had investment strategies which described the type of companies that they invested in. This helped (or at least it was supposed to help) investors (asset owners) decide if this was the type of investment fund they wanted to put their capital into. And organisations such as Morningstar used to help by grouping all of the funds that they ‘rated’ into broad groups.
Our industry calls these characteristics ‘factors’.
With the emergence of ESG and Sustainability, new factors have emerged. This recognises the need to change our view point. The investing future will look very different from the past, so we need to develop a new language to describe it. Otherwise what you mean when you say ‘diversity’, will be very different from what the person you are talking to understands.
Which brings us to an important point. We understand what factors are - just ways of grouping potential investments into collections. But, at least for now, the new ESG and Sustainability factors do not have the same clarity of meaning.
To take an example - Diversity. Or in the language of ESG Diversity, Equality and Inclusion or DEI. You might think you are clear about what diversity means. But is the same definition being used by the asset manager when they talk about investment funds that consider or include diversity?
Regular readers will know that we are somewhat critical of how the word diversity is used in investing. We think it’s often more about things that can be easily measured, than the things that actually make a difference. We previously discussed the work of Edmans, Flammer and Glossner on DEI. You can read our thoughts here….
There could be a problem in identifying diversity just using traditional demographic methods. From that starting point, it could be that corporates and organisations are then approaching DEI in the wrong way.
Rather than focus on those traditional classifications, Edmans, Flammer and Glossner looked for the outcomes. What the words mean is important - otherwise factors we use in investing lack clarity. And if that happens investors don’t get what they were expecting.
Another example is energy. Traditionally, the focus has been on the source of energy or power generation. The starting point is the 'oil and gas industry' or the 'nuclear industry' or the 'wind industry' etc. And that made sense when these industries had common characteristics.
But, carrying this industry based approach (factors again), into the future energy world makes a lot less sense. Consider the use of the term “the hydrogen economy”. It sounds similar to say the Oil & Gas industry. But, this can problematic as it leads us to the starting point that we have this commodity hydrogen, and we need to find something to do with it.
As Professor Maslow (1966, “The Psychology of Science: A Reconnaissance”) put it “If the only tool you have is a hammer, it is tempting to treat everything as if it were a nail.”
Investment factors might sound benign. But, as we transition to a more sustainable way of living, our way of characterising and grouping must also change. We need to change our viewpoint - and the words we use to describe our investment factors need to become clearer and more precise.
It can't be 'same as it ever was'.
You can read the full version of this blog, and many others on topics relate to the transitions, on our website.
