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Sustainable investing, innovation, and the post-pandemic world

Jason Wang, CFA

CFA Institute’s 2022 annual Alpha Summit ran from May 17 to 19. The virtual event attracted thousands of delegates from 146 countries and regions. The sessions were thought-provoking and interactive, allowing audiences to engage in real-time discussions with the speakers and one another. Compared to the one-day 2021 Alpha Summit, this year’s Summit offered much richer content over three days. Keywords such as “sustainability,” “valuation,” and “crypto” were discussed throughout the event, reflecting the diversity of the Summit’s content and spanning several themes:

  • Opportunities and responsibilities with sustainable investing
  • The post-pandemic world and the future of capital markets
  • Harnessing the benefits of innovation and technology

This article recaps one feature session for each of these themes.

Climate Risk, Net Zero, and Sustainable Investing

CFA Institute and charterholders have had a leading voice in sustainable investing; therefore, economic, social, and governance (ESG) and climate-related topics were a big focus of this conference. In a panel session titled “Addressing the Net Zero Challenge: Turning Commitments into Action,” asset managers specializing in ESG and responsible investment shared their perspectives.

The session began with level-setting of various terms, most notably “carbon neutrality” and “net zero.” According to one panellist, Jason Mitchell, Co-Head of Responsible Investment Research at Man Group, carbon neutrality is “trying to not increase your emissions but [also] trying to achieve reductions through offsets, and those offsets could be … carbon avoidance or, ideally, carbon removal.” Carbon neutrality, Mitchell explained, is a term used mostly in the past 10 to 20 years that has seen an evolution toward net zero, which refers to actively working toward emission reductions, paired with the use of offsets to address any residual emissions.

Another panellist, Linda-Eling Lee, Managing Director and Global Head of ESG and Climate Research at MSCI, then discussed climate-related company disclosures. One current pain point is that many companies are better equipped to measure their carbon footprints from the past year than to project for the future. That is why the Task Force on Climate-related Financial Disclosures provides guidance for conducting scenario analysis and, to address the lack of agreement on forward-looking metrics, is also leading alignment efforts in the industry.

Panellists shared their experiences in turning climate-related commitments into outcome-driven actions in portfolio management. These includes practices that aim to drive greater transparency, link remuneration and climate-related targets, and harden commitments around transition plans.

Author’s Update: On May 26, 2022, the Office of the Superintendent of Financial Institutions issued a draft version of Guideline B-15: Climate Risk Management for consultation. Its press release quotes Peter Routledge, Superintendent: “Ensuring that the financial system remains resilient in the face of climate change demands that we address its threats with a greater sense of urgency, vigour, and effort. With the release of this draft Guideline, we are taking deliberate steps towards addressing climate-related risks in our broader regulatory and supervisory activities.” 1

The draft Guideline contains specific instructions for financial institutions to measure two types of climate risks. The first type is physical risk: the near-term impacts of increased frequency and severity of weather events. These impacts can manifest as credit loss, market loss, insurance loss, operational loss, etc. The second type of climate risk is transition risk: risks resulting from increased regulation of greenhouse gases (GHG). GHG-intensive industries could face higher costs of doing business and/or lower revenues, leading to potential credit losses. Stranded assets may lead to unexpected valuation change. An institution with a GHG-intensive portfolio may experience reduced demand for its funding instruments in the wholesale debt markets as its assets become more illiquid. And finally, financial institutions may face legal liabilities and reputational damage if they are not perceived as fulfilling their legal obligations and appropriately accounting for and managing climate risks. 

1 Office of the Superintendent of Financial Institutions. “OSFI Consults on Expectations to Advance Climate Risk Management.” Press release, May 26, 2022.

Dreams and Delusions: Valuation and Pricing of Young Companies

The post-pandemic capital markets are going through a significant correction. Many of the fast-rising tech stars of 2020 and 2021 are not immune to the age-old boom and bust cycle. After these companies witnessed sobering corrections of their stock prices, it takes a scholar to remind us of valuation principles. Aswath Damodaran, a professor at New York University’s business school who spoke at the 2020 CFA Global Conference, returned to the 2022 Alpha Summit to discuss some unique rules of valuing and pricing young companies.

Start with the narratives, or the “story.” If the story is good, then accept that early-stage innovation cannot be quantified. “You take last year’s numbers and project them out. You’re essentially going to get numbers that mean nothing,” said Damodaran on modelling a young company. He went on to argue that “less is more.” He said, “We are drowning in details. Let it go. … In fact, almost every company that I value, I can basically boil down the valuation to six inputs.” The first three inputs relate to the business model: revenue growth, operating margins, and growth and investment efficiency. The other three inputs relate to risks and costs: failure risk, cost of equity, and cost of debt. Converting these six inputs to numbers is essential for valuing young companies.

Damodaran concluded the session by advising, “don’t look for precision” and “you can live with mistakes, but bias will kill you.” He suggested checking valuation biases with people who think differently. He summarized the main points in his approach to valuation with young companies as “telling a story, connecting the story to numbers, and then learning to recognize when you got the story wrong and correcting that story.”

Decentralized Finance and Innovations in the Global Financial System

Another scholar, Campbell R. Harvey, a professor at Duke University, offered his thoughts in a session titled “Rethinking the Global Financial System.” Harvey advised to look beyond the price fluctuations of cryptocurrencies and the negative (but changing) views of many influential bankers and be open-minded about the potential benefit of decentralized finance, or DeFi.

He defined DeFi as “fundamentally a competitive marketplace of decentralized financial applications that function as various financial ‘primitives,’ such as exchange, save, lend, and tokenize. These applications benefit from the network effects of combining and recombining DeFi products.”

DeFi attempts to solve several problems in the current financial system, such as inefficiency, limited access, opacity, centralized control, lack of interoperability, etc. Most existing money transfer solutions are slow, ridden with frictions, and have a 3 percent fee that has not changed in 150 years. This is just one example of the many problems DeFi could potentially solve. “Decentralized finance seeks to build and combine open-source financial building blocks into sophisticated products with minimized friction and maximized value to users using blockchain technology,” said Harvey.

He went on with a bold prediction. “Given it costs no more to provide services to a customer with $100 or $100 million in assets, we believe that DeFi will replace all meaningful centralized financial infrastructure in the future. This is a technology of inclusion whereby anyone can pay the flat fee to use and benefit from the innovations of DeFi.” CFA_Toronto_RGB Milly

Jason Wang, CFA, MBA, is the Chief Risk and Compliance Officer at Synergy Credit Union. He also advises two fast-growing fintechs. Jason has extensive experience in risk management, analytics, and compliance in the investment and retail banking sectors.

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