The Big Green Short - Pensions For Purpose
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Man Institute
Analysis
The Big Green Short
June 2020
When it comes to responsible investing, very few investors and hedge funds wish to
discuss shorting. However, in our view, it makes no sense not to short stocks whose
poor ESG practices leave them with a higher cost of capital, less productive employees
or facing more onerous regulatory burdens due to their environmental practices. Going
short marks the evolution of responsible investment from a more passive approach, that
just excludes stocks based on a categorical restriction list, to a more active approach
that uses all available information to fully reflect their views in their positioning.
For institutional investor, qualified investor and investment professional use only. Not for retail public distribution.
Authors
Robert Furdak Valerie Xiang Diana Zheng
CIO for ESG, Man Group Portfolio Analyst, Associate Quantitative
Man Numeric Researcher, Man Numeric
www.man.com/maninstitute
‘‘
Short everything that man has touched. ”
— Mark Baum, The Big Short
Introduction
To some, responsible investment is a goody-goody exercise. You buy some stocks
that you think are ‘responsible’ – exclude tobacco, include renewables, try not to buy
anything that makes nuclear weapons and voila! A responsible investment portfolio,
spotless and morally unimpeachable.
But is that enough?
We would argue that there is more that can be done to improve the quality of RI
portfolios. It’s not just about identifying those companies that are making the world
a better place. To take a leaf out of Mark Baum’s book, it’s also about shorting
those companies that are harming the environment, not treating their employees and
customers fairly or their shareholders well.
In this article, we will explore the dark side of responsible investing, focusing on the
companies who perform poorly on environmental, social and governance (‘ESG’)
metrics. Part I evaluates the effect of exclusion lists, currently the most popular way to
exploit a negative view of the ESG performance of a stock. We examine the historical
performance of exclusion lists and delve into the specific drivers of performance, in
particular the impact on some of the most excluded industries. We also attempt to
estimate the cost to a portfolio of divesting from some of the popular restricted names.
Part II takes things one step further and looks at the impact of expressing those
negative opinions in a more direct way: shorting the worst offenders in ESG. We cover
how shorting increases portfolio exposure to ESG themes, impacts on returns and
affects drawdowns compared with a long-only implementation.
Part I: Negative Screening – the Earliest and the Largest
Implementation of ESG
Negative or exclusionary screening was the largest sustainable investment strategy
globally in 2018, with a combined AUM of USD19.8 trillion (Figure 1). This is larger than
ESG integration and other strategies, including corporate engagement and shareholder
action, which have also seen rapid growth in recent years.
Figure 1. Sustainable Investing Assets by Strategy and Region (2018)
Europe
Impact/community Investing
United States
Sustainability themed investing
Canada
Positive/best-in-class screening Australia / NZ
Norms-based screening Japan
Corporate engagement and
shareholder action
ESG Integr tion
Negative/exclusionar y screening
$0 $5,000 $10,000 $15,000 $20,000
Source: Global Sustainable Investment Review; as of 31 December 2018.
Note: Asset values are expressed in billions of US dollars.
The Big Green Short |2
Breaking down the AUM of exclusions by region, negative screening was the most
popular strategy in Europe as of the end of 2018 (EUR9.5 trillion in AUM). The region
with the fastest growth was Canada, where negative screening AUM grew 64% from
2016 to 2018. In the US, Australia and New Zealand, where ESG integration dominates,
negative screening is often leveraged to complement ESG Integration.
The popularity of exclusionary screening strategies is driven, to a large extent, by
clients’ demand to restrict their portfolios from holding stocks that do not meet certain
ESG criteria. Globally, as of the end of 2019, more than USD9 trillion in assets have
restrictions with respect to common ESG concerns involving controversial munitions,
nuclear weapons, tobacco and coal production (Figure 2). The assets and categories
detailed in Figure 2 are based on data collected from multiple sources including public
websites, company filings, press releases, etc. The data was then carefully aggregated
by client origin and restriction type. Man Group maintains a version of these common
restrictions, referred to as the Man Universal List. Separately, assets worth USD4.5
trillion are restricted from holding stocks with conduct-related issues such as
environmental damage and financial crime, and USD2.3 trillion with regional/faith-
related (idiosyncratic) restrictions. European and Nordic clients make up the largest
portion in terms of AUM across all types of restrictions, which explains why negative
screening is the dominant strategy in these regions.
Figure 2. AUM with ESG Restrictions, by Client Origin
10,000
‘‘
9,000
8,000
Faith-Based and Foundations
7,000
USD Bi l l ions
North American
Since 2000, portfolios 6,000
5,000
Asia Pacific
made up of restricted Europe
4,000
stocks, with the 3,000 Scandinavian / Nordic
exception of coal, 2,000
1,000
have delivered better
0
Universal Conduct-Related Idiosyncratic
performance than
the benchmark, Source: Man Group; as of 31 December 2019.
Based on data aggregated from public websites, public filings, press releases and other private sources. This information is
suggesting based on an internal analysis of the data sources listed and may not be complete. Further information available upon request.
that applying
the restriction
has probably Impacts of Common Restrictions
hurt investment What percentage of the stock market is associated with these exclusionary themes?
The number doesn’t look huge at first glance. Taking the Man Universal List as an
performance.
example, historically, these traditional exclusion list stocks have made up roughly
However, it’s worth 2.8% of the MSCI World market capitalisation. However, the impact is not negligible
considering the volume of assets with restrictions on these names. Also, restrictions
noting that the
will result in an underweight versus the benchmark and are an implicit short if excluded
return gap has been from long-only portfolios.
narrowing in recent From an investment return perspective, what is the impact of applying popular ESG
years.” exclusionary themes on the portfolio? Figure 3 compares the long-term historical
performance of Man Group’s universal restriction list and three popular exclusionary
themes versus the MSCI World Index.
The Big Green Short |3
Since 2000, portfolios made up of restricted stocks, with the exception of coal,
have delivered better performance than the benchmark, suggesting that applying the
restriction has probably hurt investment performance. However, it’s worth noting that
the return gap has been narrowing in recent years. A look at the individual themes
shows a mixed performance. Tobacco stocks, in particular, have seen a dramatic
regime shift. Those stocks posted massive outperformance in the first dozen years
of the series, and after treading water in the middle of the decade, have significantly
lagged the index over the last three years. Nuclear stocks continue to deliver strong
relative performance versus the benchmark, while coal and associated stocks continue
to underperform.
Figure 3. Cumulative Alpha of Exclusionary Themes Versus MSCI World
350%
300%
250%
Cummul a ti ve Al pha
200%
150%
100%
50%
0%
-50%
-100%
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19
n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n- n-
Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja Ja
Tobacco Nuclear Coal Man Univ
Source: Man Restriction List, MSCI World Index, GICS; as of 31 December 2019.
Past performance is not indicative of future results. Returns may increase or decrease as a result of currency fluctuations.
Note: Tobacco portfolio as defined by the tobacco GICS industry; Nuclear weapon portfolio as defined according to Man Group’s
restriction list excluding Boeing and Airbus; Coal miner and electric utilities portfolio as defined by the coal and consumable fuels
and the electric utilities GICS subindustry. Performance is gross of any fees or expenses and should be considered hypothetical.
Please see the end of this paper for additional important information on hypothetical results.
What Has Been Driving the Performance?
A very natural question for us to ask is whether the outperformance of restricted stocks
was driven by better fundamentals or other factors. To address this, we created a cap-
weighted portfolio of tobacco stocks that are constituents of the MSCI World Index
and looked at how its risk profile has evolved through time in comparison with that
benchmark. Figure 4 plots the portfolio’s exposure of four Barra risks factors relative
to the index. As you can see, historically, tobacco stocks tended to have lower beta
and higher yield than the benchmark. On average, they were also more profitable and
higher quality than the benchmark, although these measures have deteriorated recently
as tobacco companies have increased leverage.
Notably, these qualities happened to have been favoured by the market over the last
decade. Post the Global Financial Crisis, central banks around the globe have taken
the ‘lower for longer’ approach to keep interest rates at near-zero, or in some cases,
negative levels. Against this macro backdrop, high-yielding stocks, including tobacco
companies, were favoured by investors who coveted yield.
Meanwhile, the lengthened bull market has prompted investors to seek a more
defensive posture and low volatility strategies have been one of the biggest
beneficiaries. Figure 5 shows that low volatility ETFs have received significant inflows
as the market has risen in recent years. Tobacco stocks, with their persistent low beta
exposure, are ideal candidates for such strategies in our view.
The Big Green Short |4
Figure 4. Exposure to Barra Risk Factors (Tobacco Stocks Versus MSCI World)
Beta Dividend Yield
3 3
Barra Factor Exposure
Barra Factor Exposure
2 2
1 1
0 0
-1 -1
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
Tobacco Stocks MSCI World Tobacco Stocks MSCI World
Profitability Investment Quality
3 3
Barra Factor Exposure
Barra Factor Exposure
2 2
1 1
0 0
-1 -1
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
Tobacco Stocks MSCI World Tobacco Stocks MSCI World
Source: Barra risk model, MSCI World Index; as of 31 December 2019.
Portfolio results should be considered hypothetical. Please see the end of this paper for additional important information on
hypothetical results.
Figure 5. Low Volatility ETFs Saw Sustained Fund Flows
3,000 2500
2,500
2,000 2000
Fl ows (USD Millions)
1,500
I ndex Level
1,000 1500
500
0 1000
-500
-1,000 500
-1,500
-2,000 0
2012 2013 2014 2015 2016 2017 2018 2019 2020
Low Vo l ETF - SPLV, USMV MSCI World Ind ex (RHS)
Source: Bloomberg; as of 31 December 2019.
As a next step, we looked at the relative performance of restricted stocks after
adjusting for these qualities. In this analysis, we regressed stock return against size
beta, momentum, yield, profitability and investment quality, and then took the residual
from regression as the risk-adjusted return. Figure 6 shows that all the restriction
categories, with the exception of nuclear stocks (which have more balanced exposure
to the risk factors), have produced dramatically lower excess returns over the period
after adjusting for the ‘in-favour’ factors. This confirms our conjecture that the superior
performance of restricted stocks is in part due to their exposure to risk factors
favoured by the market.
The Big Green Short |5
Figure 6. Risk Adjusted Returns of Restricted Stocks Versus MSCI World
Cumulative Excess Return: Tobacco Cumulative Excess Return: Nuclear
350% 140%
Cummul a ti ve Exces s Return
Cummul a ti ve Exces s Return
300% 120%
250% 100%
200% 80%
150% 60%
100% 40%
50% 20%
0%
0%
-50%
-20%
Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
Jan-12
Jan-14
Jan-16
Jan-18
Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
Jan-12
Jan-14
Jan-16
Jan-18
Tobacco (un risk-adju sted ) Nuclear (un risk-ad ju sted )
Tobacco (risk-adjusted) Nuclear (risk-adjusted)
Cumulative Excess Return: Man Universal List Cumulative Excess Return: Coal Miners & Electric Utilities
140% 40%
Cummul a ti ve Exces s Return
Cummul a ti ve Exces s Return
120% 20%
100%
0%
80%
-20%
60%
-40%
40%
-60%
20%
0% -80%
-20% -100%
Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
Jan-12
Jan-14
Jan-16
Jan-18
Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
Jan-12
Jan-14
Jan-16
Jan-18
Nuclear (un risk-ad ju sted ) Co al (unrisk-adjusted)
Nuclear (risk-adjusted) Co al (risk-adju sted )
Source: MSCI World Index; GICS; as of 31 December 2019.
Performance is gross of any fees or expenses and should be considered hypothetical. Please see the end of this paper for
additional important information on hypothetical results.
This could mean that the performance of restricted stocks might be dubious in the
future if the risk factors to which these stocks are exposed, go out of favour as the
market environment shifts. In fact, the gap in returns between risk-adjusted restriction
categories and the benchmark has already widened. Tobacco stocks, for example,
have increased their exposure to Barra Value, suggesting that they are becoming
cheaper than before (Figure 7).
Figure 7. Tobacco Stock Exposure to Barra Value Factor
1.6
1.4
Barra Factor Exposure
1.2
1.0
0.8
0.6
0.4
0.2
0.0
-0.2
-0.4
-0.6
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
Tobacco Stocks MSCI World
Source: Barra risk model, MSCI World Index; as of 31 December 2019.
Portfolio results should be considered hypothetical. Please see the end of this paper for additional important information on
hypothetical results.
The Big Green Short |6
‘‘
Some may argue
that these cheap
Some may argue that these cheap valuations imply higher future returns and that
the popularity of ESG-oriented strategies is creating a profitable opportunity from
divestment activities. These views may be short-sighted. These stocks are subject to
idiosyncratic risk arising from backward-looking valuation. A telling example is Altria
Group, which in January 2020, took a USD4.5 billion write-down on its investment in
valuations imply e-cigarette company Juul after facing increased pressure from regulators. These write-
downs have also occurred in resource-oriented companies like coal and oil and are
higher future returns worth scrutinising. This is a reminder that valuations (and potential future opportunities)
and that the popularity of stranded assets may be overstated and stocks that appear to be cheap may just be
the market’s anticipation of the inevitable write-down.
of ESG-oriented
Overall, this analysis highlights the importance of evaluating the inherent biases of any
strategies is creating a strategy and adjusting for them in analysing returns. When it comes to implementing
profitable opportunity ESG strategies, it is particularly dangerous to myopically focus on solely the ESG
aspects of a company. A holistic view is needed to fully understand all the underlying
from divestment factors driving stock return.
activities. These
views may be short- Impact of Divesting Restricted Companies
sighted. ” As institutional investors divest from negative ESG companies, there are growing
concerns about the potential drag on portfolio performance caused by outflows. Here,
we use the divestment of tobacco stocks to measure the impact. We first aggregate
total assets managed by large global asset owners and their exclusion list. Man Group
estimates that USD7.34 trillion of AUM have tobacco-specific restrictions. This estimate
was based on the same sources used in Figure 2. Tobacco’s weight in the MSCI World
Index is roughly 1%. Assuming the aggregate holdings by large asset owners to be
similar to the benchmark, we then map the aggregate AUM to the MSCI Index to obtain
weights and holdings of relevant tobacco stocks. Lastly, we leverage on Man Group’s
proprietary transaction cost model to measure the trade cost associated with different
scenarios of divestment progression and time to divest. Our analysis shows that,
depending on the timing, divestment can cause a large drag on portfolio performance.
The lines in Figure 8 represent different levels of portfolio holdings in tobacco yet to be
divested (i.e. 75% means that the investor has already liquidated 25% of their tobacco
holdings and must divest the remaining 75% to be fully divested). The x-axis indicates
various durations of time to divest. These range from one to six months. The y-axis
shows the trade cost per dollar traded. If assets owners have already divested 50% of
their holding in tobacco, the cost for them to divest the remaining half in one month
would be 65 basis points (‘bp’) per dollar traded; it would cost 41 bp per dollar traded
if divesting was spread over 12 months.
Figure 8a. Flow Effect on Divesting
Trading Cost (in bp)
80
cos t (bp) per dol l a r tra ded
70
60
100%
50
75%
40 50%
25%
30
20
10
0
1m 3m 6m 9m 12m
Ti me to Ful l Di ves tment
The Big Green Short |7Trading Cost (in Dollar Terms)
25
Dol l a r Cos t (Mi l l ion dol la rs)
20
15
100% $68Bn
75% $ 51Bn
10
50% $ 34Bn
5 25% $ 17Bn
0
1m 3m 6m 9m 12m
Ti me to Ful l Di ves tment
Source: Man Exclusion List, MSCI World Index weight; as of 31 December 2019.
These figures are represent estimated trading costs, based on Man Group models. Other investors may realise different
outcomes.
Figure 8b: Trade Cost in Dollar Terms (Million Dollars)
Assets Needed to Be Divested
100% 75% 50% 25%
(USD68 Billion) (USD51 Billion) (USD34 Billion) (USD17 Billion)
Time to 1m 22.2 16.6 10.5 4.0
Divest
3m 6.0 4.0 2.2 0.8
6m 2.2 1.4 0.8 0.3
9m 1.2 0.8 0.4 0.1
12m 0.8 0.5 0.3 0.1
Furthermore, Figure 8b shows the total dollar cost to the portfolio resulting from the
impact of divestment by multiplying the trading cost by the total dollars traded. So,
if tobacco stocks account for 1% of the MSCI World benchmark weight, the total
divestment would be roughly USD68 billion. It would cost asset owners USD22.2
million to divest those stocks in one month and USD2.2 million dollars if they spread
the divestment over six months.
Both charts show outflows can have a sizeable drag on portfolio performance. As
tobacco stocks included in the MSCI Index have an industry market cap of USD383
billion dollars 1 , the USD68 billion full divestment in the above calculation only accounts
for 18% of the total market cap of the tobacco industry! If investors choose to divest
more aggressively, divestment of restricted stocks would result in much greater drag
on performance.
Where Else to Turn?
If divesting from these industries does happen, what are some substitute industries we
can leverage to replace restricted stocks while keeping their desired qualities?
In this section, we focus on tobacco stocks as they are positively exposed to a
few highly desired risk factors: earnings/dividend yield, investment quality and
profitability. To find other subindustries that are most similar to tobacco stocks
with respect to these qualities, we represent the risk profile of each subindustry
with a four-dimensional vector where each dimension corresponds to a risk factor.
Then we compute the Euclidean distance between tobacco stocks and all the other
subindustries based on their risk vectors.
1. As of 31 December, 2019.
The Big Green Short |8Figure 9. Subindustries With Closest Euclidean Distance to Tobacco
1.4
1.2
Euclidean Distance
1.0
0.8
0.6
0.4
0.2
0.0
n
le
a ls
ts
s
s
&
er
s
ts
ie
io
ie
ie
uc
uc
ab
m
o r es
ili t
t ic
at
il it
il it
i c ns u
od
um
od
u t ani
ic
Ut
Ut
Ut
eu
un
Pr
Pr
s
rib mp
ns
o
ac
es
c
as
er
Se d C
es
m
tri
Co
d
re
at
m
ic
G
Co
om
ol
ec
s
is u
W
ar
rv
ifie
el
eh
rv
&
El
Ph
le c
g
Se
Fu
Le
rs
us
as
in
st
ve
Te
ad
Di
Ho
G
Di
Tr
l,
Oi
Source: Bloomberg, Man Numeric; as of 31 December 2019.
Figure 9 displays subindustries that are closest to tobacco stocks by the four risk
dimensions. Among these, Diversified Telecommunications and Pharmaceuticals stand
out as subindustries that are more consistent with the values of an ESG investor than
some of the options like Oil, Gas & Consumable Fuels and Utilities (see Figure 10 for
detailed risk scores). From a portfolio construction perspective, substituting these
stocks for tobacco stocks can potentially preserve the portfolio’s high yield and low
volatility feature while enhancing its ESG exposure.
Figure 10. How Does Tobacco Compare With Other Subindustries by Multiple Risk Dimensions?
earnings_yield
1.2
‘‘
1.0
0.8
0.6
0.4
While shorting a 0.2
0.0
stock does not investment_qu ality -0.2 divid end_yield
provide capital to the
company, it does not
Tobacco
mean the investor Teleco mmunication Ser vices
Oil, Gas & Co nsumable Fu els
loses her influence pro fitability
Ph armaceuticals
with management.
Source: Barra risk model, Bloomberg, Man Numeric; as of 31 December 2019.
Indeed, investors with
large short positions
will often gain the
Part II: Exploring the Dark Side – Shorting ‘Bad’ ESG
attention of corporate
Companies
officers who try to So, common restrictions have underperformed after adjusting for common risk factors.
convince them where Why not go one step further and actually go short those companies?
their bearish bets are When you buy a stock you are indirectly providing capital to the company; if you amass
a large enough position, you can influence management behavior. While shorting a
misguided. ” stock does not provide capital to the company, it does not mean the investor loses her
influence with management. Indeed, investors with large short positions will often gain
the attention of corporate officers who try to convince them where their bearish bets
are misguided. Management clearly recognises that excessive shorting is bad for their
stock price – we as investors should recognise it too, and apply that principle to our
ESG investing.
The Big Green Short |9Relaxing the short constraint can potentially bring many benefits to the portfolio. Many
academic studies 2,3 have shown that relaxing the short constraint allows investors to
better express their views and improves Sharpe ratios. Moreover, it is acceptable to go
short on the basis of other signals such as overvaluation or low-quality earnings.
Why then don’t we short bad ESG companies? Part of the ESG story is one of risk
– poorly ranked ESG companies will be subject to data breaches, higher costs of
capital and fines and penalties, which will impair brand value and impact stock prices.
Investors should use all available information, even if it is negative, to make their
decisions – why not short those companies that are at the most risk? One answer
is that many asset owners don’t want these stocks even showing up on their asset
holdings lists, even on the short side. We believe there are two reasons for this. First,
there is concern that once they short the stock, investors will eventually have to buy
back these bad ESG stocks in order to cover the short position. Secondly, there
is a possibility of press coverage if they show up as having a position. Still, these
arguments are not strong enough to convince us.
In this section, we explore the implications of shorting bad ESG companies. We
compare the differences between the long-short ESG portfolio and the long-only
positive ESG portfolio, from the following three aspects: ESG exposure, return and
risk. Our analysis indicated that shorting poorly ranked ESG companies increased a
‘‘
portfolio’s overall exposure to ESG signals. More importantly, there was strong value
to be found on the short side across various ESG strategies. In addition, shorting bad
ESG firms added additional benefits by lowering portfolio’s overall risk.
By shorting bad ESG
Shorting Bad ESG Companies Increases Portfolios’ ESG
firms, one can almost
Exposure and Return
double a portfolio’s
As a first step, we constructed sector-neutral, decile long-short portfolios from
overall exposures to a universe of about 4,500 of the most liquid developed market stocks between 1
January, 2013 and 31 December, 2019. Portfolios are formed by longing (shorting) the
ESG factors across
best (worst) 10% of firms within each sector. Firms are selected based on various ESG
all board based ESG characteristics. We examined three broad-based strategies, including two commonly
strategies. ” used data vendors (MSCI and Sustainalytics ESG rankings) as well as Man Numeric’s
proprietary ESG model. Man Numeric’s proprietary ESG model is based on 15
fundamental ESG pillars, which is sector neutral and is neutral to common factors. We
also evaluate performance from the long (short), high (low) carbon efficiency level data
from Trucost and an event-driven strategy built by shorting firms associated negative
ESG news using natural language processing (‘NLP’) techniques.
By shorting bad ESG firms, one can almost double a portfolio’s overall exposures
to ESG factors across all board based ESG strategies, as shown in Figure 11. The
sector-neutral decile return (Figure 12) shows that firms that rank poorly based on ESG
criteria underperform in the market. Moreover, our analysis indicates that returns were
about equal from both the long side and short side of all broad-based ESG strategies,
including MSCI, Sustainalytics and Numeric models, as well as the carbon-efficient
strategy. NLP news-driven strategies have a stronger return form the short side than
the long side.
2. Richard C. Grinold and Ronald N. Kahn; 2000; “The Efficiency Gains of Long-Short Investing”; Financial Analysts Journal, vol. 56, no. 6 (November/December): 40-53.
3. Steven Thorley, Roger Clarke and Harindra de Silva; 2001; “Portfolio Constraints and the Fundamental Law of Active Management”; Financial Analysts Journal, 58.10.2139
The Big Green Short | 10Figure 11. Shorting Doubles Portfolio’s ESG Exposure
4
3.5
3
2 1.9
ESG Expos ure
1.8
1.5
1.1 MSCI
1 0.8 Sustainalytics
Man Numeric
0
-0.6 -0.7
-1
-1.6
Long Side Short Side Long-Short
Source: MSCI ESG score, Sustainalytics ESG score; as of 31 December 2019.
Figure 12. Bad ESG Companies Have Underperformed
4 3.8
3.4
3 2.9
2 1.9
Annua l i sed Return
1.4 1.6
1.0
1
0.4 0.5
0.1
0
-0.1
-1 -0.8
-1.4 -1.4 MSCI
-2 Sustainalytics
-2.2 Carb on Inten sity
-3 NLP ESG Event
Long Side Short Side Long-Short Man Numeric
Source: MSCI ESG score, Sustainalytics ESG score; as of 31 December 2019.
All model spread performance shown is gross-of-fees and does not represent the performance of any portfolio or product. To
‘‘
calculate long-only model spreads, we invest long in the top 10% ranked names within each sector and display the gross of fees
return. To calculate long-short model spreads, we invest long in the top 10% ranked names within each sector and are short
the bottom 10% ranked names within each sector and display the gross of fee return. These spread returns are instantaneously
rebalanced and do not reflect transactions costs. Rankings are based on Man Numeric’s internal Alpha model scores.
Analysis of the Barra
factor exposures of
Besides enhancing portfolio ESG exposure and boosting returns, shorting poor ESG
the long and short firms offers other added benefits. Analysis of the Barra factor exposures of the long
and short sides of the portfolios ranked on Man Numeric proprietary ESG scores
sides of the portfolios
illustrated that betting against bad companies greatly reduces portfolios’ risk and
ranked on Man lowers the drawdown. As shown in Figure 13, we found that though both groups have
lower residual volatility than the overall universe, the stocks with good ESG scores have
Numeric proprietary
much less residual volatility exposure. Moreover, poorly ranked ESG firms have much
ESG scores illustrated lower investment quality, lower earnings quality and lower profitability.
that betting against
bad companies greatly
reduces portfolios’
risk and lowers the
drawdown. ”
The Big Green Short | 11Figure 13. Portfolio Exposure to Barra Risk Factors, Bucketed by ESG Scores
0.00
-0.01 0
-0.02
-0.05
Ba rra GEMLT Fa ctor Expos ure
-0.07
-0.10 -0.08
-0.11
-0.15
-0.20
-0.25 -0.23
Good ESG
-0.30
Bad ESG
-0.31
-0.35
Residu al Vol Investment Quality Earnings Qu ality Pro fitablity
Source: Barra risk model, Man Numeric; as of 31 December 2019.
We further compared the drawdown patterns of long-short portfolio and long-only
portfolio. Figure 14 shows the cumulative returns from 2013 to 2019 for both portfolios.
First, we found that the long-short portfolio is able to realise more than double the
cumulative return compared with the long-only portfolio at the end of 2019. From
2015 to 2016, both portfolios experience drawdowns, with the maximum peak-to-
trough decline of about 4.3% for the long-short portfolio, while the long-only portfolio
has a 4.1% drawdown. Though the long-only portfolio has a slightly lower absolute
drawdown, it takes the long-only portfolio more than three years to exceed the prior
peak level, while it only takes a long-short portfolio only 12 months to recover the
loss and achieve a higher level of returns. In historical simulations, shorting poor ESG
companies has allowed portfolios to achieve a higher exposure to ESG signals and
realise higher returns, as well as lowering overall risk exposure and drawdown. Thus, it
is natural to ask: why not profit from both good and bad companies, especially if those
companies are not friendly to the environment, employees or shareholders?
Figure 14. Long-Short Portfolios Are More Resilient Than Long-Only Portfolios
35%
30%
Cumulative Alpha
25%
20%
15% 12 months
10%
38 months
5%
0%
Jan-2 013 Jan-2 014 Jan-2 015 Jan-2 016 Jan-2 017 Jan-2 018 Jan-2 019
Cu mu lative_retu rn (Long Sho rt) Rolling_max (Lon g Sh ort)
Cu mu lative_retu rn (Long Only) Rolling_max (Lon g Only)
Source: Bloomberg, Man Numeric; Between 1 January 2013 to 31 December 2019.
Performance is gross of any fees or expenses and should be considered hypothetical. Please see the end of this paper for
additional important information on hypothetical results.
The Big Green Short | 12‘‘
If higher returns with
lower drawdowns
Shorting Bad ESG Companies Helps Fiduciary Obligation
A clear case can be made that shorting bad ESG companies is consistent with the
fiduciary obligation of the asset advisor/manager. As discussed above, betting against
companies that rank poorly on ESG issues has enhanced risk-adjusted returns in both
allows retirees to live historical simulations and out-of-sample periods. A fiduciary is charged with acting
in the best interest of the party whose assets they are managing and must do so in
more comfortably,
good faith and trust. If higher returns with lower drawdowns allows retirees to live
universities to offer more comfortably, universities to offer more generous financial aid or foundations to
fund more charitable projects, then shorting starts to look like a requirement. In fact,
more generous
if the manager is prohibited from shorting bad companies, they might be shirking their
financial aid or obligation as a fiduciary and could make the beneficiaries less well off. Relaxing the
short constraint is even more important if the responsible investor has other limitations
foundations to fund
placed upon them like restriction lists or carbon budgets. Allowing shorts can help
more charitable recover some of the degrees of freedom lost from other ESG constraints.
projects, then shorting
starts to look like Conclusion
a requirement. In For some reason, when it comes to responsible investing, very few investors and hedge
funds wish to discuss shorting. It is as if we are shying away from dealing with the
fact, if the manager logical implications of responsible investing: that by only being long firms which meet
is prohibited from our ESG criteria and applying a restricted list, we implicitly take one of two views: 1)
that we are prepared to sacrifice performance for moral rectitude; or 2) we believe firms
shorting bad who have good ESG performance will (vastly) outperform peers, so there is no need to
companies, they focus on exploiting the poorly ranked companies.
might be shirking The truth is if we take the latter stance, it makes no sense, in our view, not to
short stocks whose poor ESG practices leave them with a higher cost of capital,
their obligation as a less productive employees, or facing more onerous regulatory burdens due to their
fiduciary and could environmental practices.
make the beneficiaries “But truth is like poetry,” as Mark Baum mentioned in The Big Short, “…and most
people f*****g hate poetry.”
”
less well off.
Still, as we have demonstrated, the concept of shorting stocks on an ESG basis makes
intuitive sense: it increases a portfolio’s exposure to ESG signals, the potential for
delivering alpha and the speed of recovery from drawdowns. Furthermore, it allows
portfolios to properly capture the value of a growing risk: the risk that companies fail
to deal with the transition to more responsible models of operating, overstating the
value of potentially stranded assets and failing to account correctly for the ESG risks to
which their businesses are exposed.
More importantly, however, going short marks the evolution of responsible investment
from a more passive approach (that just excludes stocks based on a categorical
restriction list) to a more active approach that uses all available information to fully
reflect their views in their positioning. No longer should ESG considerations be siloed.
We accept shorting as a key tool of investment management for every other asset class
and style; why not use it in responsible investing as well?
The Big Green Short | 13Authors
Robert Furdak
Chief Investment Officer for ESG and Chair of the Responsible Investment Committee,
Man Group
Robert (‘Rob’) Furdak is Chief Investment Officer for Environmental,
Social and Corporate Governance (‘ESG’) of Man Group. He is
responsible for overseeing all aspects of Responsible Investing
across Man Group’s five investment engines. Rob serves as the
chairman of the Man Group Responsible Investment Committee
and is a member of the Man Group Executive Committee. He also serves on the
United Nations supported Principles for responsible Investment (PRI) Macroeconomic
Risk Advisory Committee. Rob was previously the Co-Chief Investment Officer at Man
Numeric and Chairman of Man Numeric’s Investment Committee. In that position, Rob
led the ESG initiatives and oversaw all aspects of the investment process. Rob joined
Man Numeric in 1997 as Director of International Strategies and designed and launched
Numeric’s first non-US strategies. Before joining Man Numeric, Rob was a Principal in
the Active International Group at State Street Global Advisors. During his eight years
there, Rob performed global quantitative research and was the principal architect of
State Street’s active emerging markets investment process. Previously, Rob worked at
Harvard Management Company. Rob holds a Bachelor’s Degree in Finance from the
University of Michigan and an MBA in Finance from the University of Chicago. He is
also a CFA charterholder.
Valerie Xiang
Portfolio Analyst, Man Numeric
Valerie Xiang is a portfolio analyst at Man Numeric. Prior to joining
Man Numeric in 2019, Valerie worked at Panagora and Citigroup
Global Markets. Valerie received a bachelor’s degree in economics
from Fudan University and master’s degree in finance from
Massachusetts Institute of Technology.
Diana Zheng, PhD
Associate Quantitative Researcher, Man Numeric
Diana Zheng is an associate quantitative researcher at Man
Numeric. She joined Man Numeric in 2019. Diana received a
bachelor’s degree from University of California Los Angeles, with
a triple major in mathematics, statistics and business economics,
with a minor in accounting. She has also received a doctorate
degree in finance from Columbia Business School.
The Big Green Short | 14Important Information
Hypothetical Results are calculated in hindsight, invariably show positive rates of return, and are subject to various modeling assumptions, statistical
variances and interpretational differences. No representation is made as to the reasonableness or accuracy of the calculations or assumptions made or that
all assumptions used in achieving the results have been utilised equally or appropriately, or that other assumptions should not have been used or would have
been more accurate or representative. Changes in the assumptions would have a material impact on the Hypothetical Results and other statistical information
based on the Hypothetical Results.
The Hypothetical Results have other inherent limitations, some of which are described below. They do not involve financial risk or reflect actual trading by an
Investment Product, and therefore do not reflect the impact that economic and market factors, including concentration, lack of liquidity or market disruptions,
regulatory (including tax) and other conditions then in existence may have on investment decisions for an Investment Product. In addition, the ability to
withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading
results. Since trades have not actually been executed, Hypothetical Results may have under or over compensated for the impact, if any, of certain market
factors. There are frequently sharp differences between the Hypothetical Results and the actual results of an Investment Product. No assurance can be given
that market, economic or other factors may not cause the Investment Manager to make modifications to the strategies over time. There also may be a material
difference between the amount of an Investment Product’s assets at any time and the amount of the assets assumed in the Hypothetical Results, which
difference may have an impact on the management of an Investment Product. Hypothetical Results should not be relied on, and the results presented in no
way reflect skill of the investment manager. A decision to invest in an Investment Product should not be based on the Hypothetical Results.
No representation is made that an Investment Product’s performance would have been the same as the Hypothetical Results had an Investment Product
been in existence during such time or that such investment strategy will be maintained substantially the same in the future; the Investment Manager may
choose to implement changes to the strategies, make different investments or have an Investment Product invest in other investments not reflected in the
Hypothetical Results or vice versa. To the extent there are any material differences between the Investment Manager’s management of an Investment Product
and the investment strategy as reflected in the Hypothetical Results, the Hypothetical Results will no longer be as representative and their illustration value will
decrease substantially. No representation is made that an Investment Product will or is likely to achieve its objectives or results comparable to those shown,
including the Hypothetical Results, or will make any profit or will be able to avoid incurring substantial losses. Past performance is not indicative of future
results and simulated results in no way reflect upon the manger’s skill or ability.
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Opinions expressed are those of the author and may not be shared by all personnel of Man Group plc (‘Man’). These opinions are subject to change
without notice, are for information purposes only and do not constitute an offer or invitation to make an investment in any financial instrument or
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material is proprietary information of the Company and its affiliates and may not be reproduced or otherwise disseminated in whole or in part without
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