Capital Budgeting Techniques

New paper, "Sustainable Investing: Evidence From the Field" (with Tom Gosling and Dirk Jenter). We survey 509 equity portfolio managers, of both traditional and sustainable funds, on whether, why, and how they incorporate firms’ environmental and social performance into investment decisions. 1. Both traditional and sustainable funds rank ES last out of six drivers of long-term value: below strategy, operational performance, governance, culture, and capital structure in that order. Clients interested in financial returns should not overweight a fund's ES credentials above its ability to assess these other factors. 2. This low relative ranking doesn't mean that ES is immaterial in absolute terms. Indeed, 73% of sustainable and even 45% of traditional investors expect ES leaders to deliver positive alpha. Unexpectedly, the most popular reason is that ES is a signal for other important value drivers rather than mattering directly. As I wrote in "The End of ESG", ES is "extremely important and nothing special". 3. ES performance influences stock selection, engagement, and voting for 77% of investors (66% traditional, 91% sustainable). Calls to "ban ES" make little sense as many traditional investors voluntarily incorporate it. 4. Only 24% of traditional and 30% of sustainable investors would sacrificing even 1bp of annual return for ES, citing fiduciary duty concerns. Policymakers and the public need to have realistic expectations of the asset management industry's likely ES impact. It will incorporate financially material ES factors, but it won't subsidize ES investments that offer below-market returns. That’s not because fund managers are greenwashing, but because they are fund managers. Their fiduciary duty is to their clients, whose goals are often financial. 5. But non-financial goals can be pursued through ES constraints such as fund mandates. 71% (61% traditional, 84% sustainable) report that ES constraints required them to make different investment decisions. These constraints sometimes reduced the very ES impact they aim to achieve, for example by preventing funds from investing in ES laggards whose performance they could have improved. 6. Overall, traditional and sustainable investors are more similar than commonly believed. Sustainable investors recognise fiduciary duty and are unwilling to sacrifice financial returns for ES. Traditional investors view ES as material and face ES constraints (firmwide policies, client wishes) preventing investment in "unsustainable" stocks. While some clients are attracted by sustainability labels, many traditional funds invest sustainably and many sustainable ones don't - and chasing a label can prevent true sustainable investing. Big thanks to the those who filled in the survey, beta-tested it, distributed it, and were interviewed. We hope that by directly involving practitioners, we can increase the relevance of academic research. https://lnkd.in/eGzRzE5t

Sustainable Investment Framework 🌎 The evolving nature of investment demands a shift from conventional financial metrics to a comprehensive approach that captures real-world impacts. The Sustainable Investment Framework presents a methodology to assess investments across six key themes: Resource Security, Basic Needs, Healthy Ecosystems, Wellbeing, Decent Work, and Climate Stability. Aligned with the UN Sustainable Development Goals (SDGs), it provides a roadmap to measure both financial returns and societal contributions. Resource Security focuses on preserving natural resources through efficient, circular practices. It reduces dependency on virgin materials, promotes recycling, and encourages sustainable resource management. As demand for finite resources rises, investments prioritizing resource efficiency will drive long-term resilience and competitiveness in the shift to a low-carbon economy. Basic Needs and Wellbeing are critical for fostering sustainable societies. Investments in sectors like food, water, healthcare, and housing contribute to poverty alleviation and community development. Wellbeing extends to health, education, and social justice. Metrics tied to these themes show how investments reduce inequality and enhance public services, fostering inclusive growth. Decent Work and Climate Stability ensure investments contribute to secure jobs and climate risk mitigation. Decent Work measures the quality and sustainability of employment, addressing fair wages and working conditions. Climate Stability focuses on aligning portfolios with efforts to limit global temperature rise under 2°C, highlighting the need to reduce emissions across industries. Launched by the University of Cambridge Institute for Sustainability Leadership (CISL) a couple of years ago, this framework remains highly relevant in 2025. Finance will play a defining role in tackling global challenges like climate change and inequality. The framework ensures capital not only generates returns but also contributes to progress toward a sustainable future. Embedding it in financial decision-making will be essential for achieving long-term prosperity for people and the planet. #sustainability #sustainable #business #esg #climatechange #investment

Many people ask me, 'What is the real impact of #sustainableinvesting?' I am pleased to share an insightful paper that addresses this important question: 'The Impact of Sustainable Investing: A Multidisciplinary Review,' authored by Emilio Marti, Martin Fuchs, Mark DesJardine, Rieneke Slager, and Jean-Pascal Gond, and published in the Journal of Management Studies. Key insights: 💡 Three #Impact Strategies: Sustainable investors utilize three primary strategies to influence corporate #sustainability: portfolio screening, shareholder engagement, and field building. Each strategy plays a distinct role, with portfolio screening and shareholder engagement creating direct impacts on companies, and field building driving change through broader systemic influence. 🏢 Direct Impact on Companies: Portfolio screening and shareholder engagement primarily result in direct impact on companies by reallocating capital to sustainable firms and engaging directly with corporate leadership. This can lead to changes in corporate practices, from reducing carbon emissions to improving supply chain ethics. 🔗 Indirect Impact through Other Shareholders: Sustainable investors also influence other shareholders by shifting their perceptions and encouraging them to adopt sustainable practices. This indirect impact is crucial as it amplifies the efforts of early movers, creating a ripple effect across the investment community. 🏛️ Indirect Impact via the Institutional Context: Field building goes beyond influencing individual companies or shareholders. It reshapes the very institutional contexts in which businesses operate, through activities such as establishing voluntary standards, supporting regulatory changes, or delegitimizing harmful business practices. This broader impact is essential for driving industry-wide change. 🔄 Shareholder Impact as a Distributed Process: Sustainable investing is not a one-time effort. Impact emerges gradually, as different types of shareholders—both mainstream and peripheral—build on each other's efforts. This collaborative and distributed process underscores the importance of diverse investor involvement in achieving meaningful, long-term change. 📈 Implications and Future Research: The authors argue that understanding sustainable investing's impact as a distributed process opens up new avenues for research. Future studies should focus on the interaction between direct and indirect impacts, why shareholders choose different strategies, and the limitations of specific strategies. These insights will help refine our understanding of sustainable investing and its ability to drive systemic change toward a more sustainable economy. In my view, this paper offers a profound and multifaceted understanding of how sustainable investing influences not just companies, but entire industries and the institutional frameworks that shape corporate behaviour. #ESG #ImpactInvesting #CorporateSustainability #FutureofFinance

𝗜𝗺𝗽𝗮𝗰𝘁 𝗜𝗻𝘃𝗲𝘀𝘁𝗶𝗻𝗴: 𝗜𝗻𝘃𝗲𝘀𝘁𝗶𝗻𝗴 𝗳𝗼𝗿 𝗦𝗼𝗰𝗶𝗮𝗹 𝗮𝗻𝗱 𝗘𝗻𝘃𝗶𝗿𝗼𝗻𝗺𝗲𝗻𝘁𝗮𝗹 𝗖𝗵𝗮𝗻𝗴𝗲 Ever wondered how your investments can drive meaningful change? Impact investing not only promises financial returns but also creates positive social and environmental impacts. 💵 Financial Returns One thing I’ve personally experienced is that impact investing doesn’t mean sacrificing returns. In fact, I’ve seen sustainable investments outperform traditional ones. The Morgan Stanley Institute for Sustainable Investing even reported that sustainable funds outpaced their peers in 2022, proving just how financially viable this approach can be. 💵 Supporting Innovation I’ve also noticed how impact investing is fueling innovation, particularly in startups addressing global challenges. For example, I’ve worked with Indian startups focused on clean energy and sustainable agriculture, and the funding they’ve attracted is truly shaping both economic growth and environmental progress. 💵 Global Impact On a global scale, the growth in impact investing is undeniable. The impact investing market expanded by 42% last year alone, according to GIIN, and I’ve witnessed how this surge is pushing more investors to rethink how they allocate their capital. 💵 Future Outlook Looking forward, I see this movement only growing stronger. The impact investing market is predicted to hit ₹82.1 lakh crore by 2030, with rising demand for responsible investments and more regulatory backing for sustainable practices. #ImpactInvesting #SustainableFinance #SocialChange

How Is Your Investment Strategy Embracing Sustainability? ➤ In today's world, where the call for sustainability is louder than ever, how are you weaving Environmental, Social, and Governance (ESG) factors into your investment strategy? ↳ Sustainable investing is more than a trend—it's a transformative approach reshaping the financial landscape. ↳ The United Nations' Principles for Responsible Investment (PRI) defines responsible investment as integrating ESG factors into investment decisions and active ownership. ↳ While terms like ESG, sustainable, socially responsible, and impact investing may seem interchangeable, they each carry unique nuances. 💡 For instance, Bridges Fund Management's 2015 study highlights a key difference: responsible investment focuses on mitigating risky ESG practices to protect value, while sustainable investment adopts progressive ESG practices to enhance value. ➤ Investment managers today are tasked with a delicate balance. They must consider the interests of shareholders, employees, customers, and communities while delivering both financial returns and social and environmental impact. ➤ There are five primary ESG investment approaches: 📌 Screening: This involves both negative and positive screening to select investments based on specific ESG criteria. 📌 ESG Integration: The most favored approach, as per the Schroeder's Institutional Investor Study 2021, involves incorporating ESG factors directly into the investment process. 📌 Thematic Investing: Focuses on themes such as renewable energy or social equity. 📌 Engagement (Active Ownership): Involves investors actively engaging with companies to influence their ESG practices. 📌 Impact Investing: Aims to generate measurable social and environmental impact alongside financial returns. → As we move toward a more sustainable future, investors are increasingly seeking strategies that balance risk management with the opportunity to generate strong long-term returns. → How is your investment strategy adapting to this evolving landscape? → Are you ready to embrace the potential of sustainable investing to make a meaningful impact?

Today I've published an article on Market-Expected Return on Investment (MEROI) - a powerful framework that's transforming how I analyze companies in our increasingly intangible economy. I wrote this piece because I've grown frustrated with how traditional metrics fail us in a world where intangible investments dominate corporate spending. When companies like #Microsoft invest heavily in R&D, software, and brand building, traditional accounting treats these as expenses rather than the investments they truly are. This creates a 𝐟𝐮𝐧𝐝𝐚𝐦𝐞𝐧𝐭𝐚𝐥 𝐝𝐢𝐬𝐜𝐨𝐧𝐧𝐞𝐜𝐭 𝐛𝐞𝐭𝐰𝐞𝐞𝐧 𝐫𝐞𝐩𝐨𝐫𝐭𝐞𝐝 𝐟𝐢𝐧𝐚𝐧𝐜𝐢𝐚𝐥𝐬 𝐚𝐧𝐝 𝐞𝐜𝐨𝐧𝐨𝐦𝐢𝐜 𝐫𝐞𝐚𝐥𝐢𝐭𝐲. MEROI solves this problem by revealing what return the market actually expects a company to generate on its investments. Unlike backward-looking metrics like ROIC, MEROI decodes the expectations embedded in current stock prices. 𝐓𝐡𝐞 𝐤𝐞𝐲 𝐭𝐚𝐤𝐞𝐚𝐰𝐚𝐲𝐬: - Traditional accounting significantly distorts our understanding of companies with high intangible investments, creating market inefficiencies savvy investors can exploit. - By properly reclassifying portions of SG&A as investments rather than expenses, we get a dramatically different picture of a company's steady-state value versus future growth opportunities. - My detailed case study shows how MEROI for a software company drops from 25% to 16% when properly accounting for intangibles - completely changing how we should view market expectations. I've included a comprehensive framework for implementing this approach in your own analysis, from industry selection to expectation analysis. 𝐖𝐡𝐚𝐭 𝐲𝐨𝐮'𝐥𝐥 𝐥𝐞𝐚𝐫𝐧: - How to distinguish between genuinely unprofitable businesses and those creating substantial value through intangible investments; - how to identify expectation mismatches that could signal investment opportunities; and - how to more accurately assess whether seemingly high valuations are actually justified. For anyone serious about understanding market expectations in today's economy, MEROI provides a systematic edge that traditional metrics simply can't match. #valuation

What happens when investors exclude a part of the universe to create sustainable portfolios? We explore this question in our new paper 𝗧𝗵𝗲 𝗜𝗻𝘃𝗲𝘀𝘁𝗺𝗲𝗻𝘁 𝗜𝗺𝗽𝗹𝗶𝗰𝗮𝘁𝗶𝗼𝗻𝘀 𝗼𝗳 𝗦𝘂𝘀𝘁𝗮𝗶𝗻𝗮𝗯𝗹𝗲 𝗜𝗻𝘃𝗲𝘀𝘁𝗶𝗻𝗴 - which was published in the 𝘑𝘰𝘶𝘳𝘯𝘢𝘭 𝘰𝘧 𝘐𝘯𝘵𝘦𝘳𝘯𝘢𝘵𝘪𝘰𝘯𝘢𝘭 𝘔𝘰𝘯𝘦𝘺 𝘢𝘯𝘥 𝘍𝘪𝘯𝘢𝘯𝘤𝘦. Specifically, we tested how three common sustainable investing approaches - SDG Alignment; ESG Integration; and Carbon Reduction - affect diversification, factor premiums, and factor exposures. What we found: 🌍 Diversification holds up. Efficient frontiers for restricted vs. unrestricted universes are virtually identical over the long run. 🚀 Factor strategies stay intact. Value, Momentum, Quality, and Low-Risk premiums are not meaningfully affected, while factor exposures remain unchanged. 🥬 Sustainability integration can avoid controversies. Yet this applies to SDG alignment, and to a smaller extent Carbon Reduction - ESG Integration doesn't reduce controversies. Why it matters: These results suggest that investors can pursue sustainability objectives without sacrificing diversification or long‑run factor premia. Read the paper here: https://lnkd.in/e6pcAuny or the open access version on SSRN: https://lnkd.in/eBFiFuS5 Thanks to my great co-authors Joop Huij, PhD and Dries Laurs, as well as to Kees Koedijk and XIANG (Sean) GAO, PhD, CFA, FRM, CAIA, FAIQ (CII) for their feedback, and Anni Schleicher for editorial support.

Your investments could be shaping more than just your portfolio. What if every dollar you deploy could create a ripple effect of positive change? The cost of overlooking impact is higher than you think. According to the Global Impact Investing Network (GIIN), over 3,907 organizations currently manage $1.571 trillion USD in impact investing assets under management (AUM) worldwide, representing a 21% compound annual growth rate (CAGR) since 2019. Yet, this still accounts for only about 1% of total global assets under management, indicating a vast potential for growth. By not integrating impact considerations, investors may miss out on opportunities for meaningful change and long-term value creation. 7 Strategies to Align Investments with Purpose: 1. Define Your Impact Objectives ↳ Identify core values: Determine the social or environmental issues that resonate most with your mission. ↳ Set clear goals: Establish specific, measurable outcomes you aim to achieve through your investments. 2. Conduct Thorough Due Diligence ↳ Assess impact potential: Evaluate how prospective investments contribute to your defined objectives. ↳ Analyze track records: Review the historical performance of organizations in delivering both financial returns and positive impact. 3. Diversify Across Asset Classes ↳ Explore various vehicles: Consider equities, bonds, and alternative investments that align with your impact goals. ↳ Balance risk and return: Diversification can help mitigate risks while enhancing potential for impact. 4. Engage with Investee Companies ↳ Active ownership: Use your shareholder influence to advocate for sustainable practices. ↳ Collaborate on initiatives: Work with companies to develop strategies that enhance their social and environmental contributions. 5. Measure and Report Impact ↳ Utilize standard metrics: Adopt frameworks like IRIS+ to track and compare impact performance. ↳ Transparent reporting: Regularly disclose impact outcomes to stakeholders to build trust and accountability. 6. Stay Informed and Adaptable ↳ Monitor industry trends: Keep abreast of developments in impact investing to identify new opportunities. ↳ Be flexible: Adjust your strategies as needed to respond to changing social and environmental landscapes. 7. Collaborate with Like-Minded Investors ↳ Join networks: Participate in groups like the GIIN to share knowledge and resources. ↳ Co-invest: Partner with others to amplify impact and share due diligence efforts. Every investment is an opportunity to shape a better future. What’s one step you can take today to align your portfolio with your purpose? ♻️ Share this story with your network - let's spread inspiration far and wide! 👉 Follow Ben Botes for more insights on Leadership, Entrepreneurship and Impact Investment.

Think you’ve built a high-alpha investment strategy? Here’s how to truly put it to the test. In quantitative investing, strong backtests can be exciting - but they can also be misleading. Many strategies that appear to generate alpha are simply repackaged exposures to well-known risk factors. That’s why one of the most important steps in validating any strategy is factor analysis, most commonly using the Fama–French family of factors. What are the Fama–French Factors? Eugene Fama and Kenneth French identified several systematic risk premia that explain most equity returns. The modern “FF5 + Momentum” set typically includes: Market (Mkt–RF) – broad equity market exposure Size (SMB) – small-cap tilt Value (HML) – cheap vs. expensive stocks Profitability (RMW) – high vs. low quality Investment (CMA) – conservative vs. aggressive investment Momentum – recent winners vs. losers If you think your strategy generates excess return, the first question is: Is it truly alpha, or just factor beta? What’s the purpose of factor analysis? Factor regression allows you to decompose your strategy’s returns into: Systematic returns explained by known factors Residual return (alpha) that cannot be explained by those factors A positive, statistically significant alpha means your strategy may be adding genuine value - not just loading up on small caps, value, or momentum. How do you run the test? The process is straightforward: Collect your strategy’s daily returns. Download the Fama–French factor data (daily) from the Kenneth French data library. Align the dates and run a regression of Strategy Excess Return = α + β₁(Mkt–RF) + β₂(SMB) + … + β₅(CMA) + ε Interpret the coefficients: Significant betas → factor exposures Significant intercept (α) → true unexplained alpha Why this matters Two strategies can have identical performance, even identical Sharpe ratios, but very different sources of return. A strategy with real alpha is far more robust and scalable than one that simply repackages known factor risks. Before declaring victory in your backtest: Run the factor analysis. Know how much of your “edge” is actually your edge. Follow me Damir Illich for more on systematic, evidence-based, and quantitative investing.

A lot of the internet seems to think that stocks should be expected to return 10% or more on average. This figure hinges on the exceptional recent performance of U.S. stocks. Assuming that exceptional returns are normal is likely a mistake. 1950 - 2023, U.S. stocks delivered a nominal - before inflation - annualized return of 11.32%. For the 20 years ending December 2023, they returned 9.81%. The relatively recent history of U.S. stock returns does support ~10% being the norm. Some context on real vs. nominal returns is important. Take the 15 years ending April 1985 as an example. U.S. stocks returned 10.58% annualized for 15 years, but inflation ran at 7.05%. The real return was tiny. Real returns, not nominal returns, put food on the table. The real return on U.S. stocks 1950 - 2023 was 7.63%, and 7.16% for the last 20 years. The equivalent of the ~10% nominal return in recent U.S. history is a ~7% real return. A 7% real return is still exceptional, both relative to earlier U.S. return history, and global returns. 1900 - 1950 U.S. stocks returned a real annualized 5.57%. Global ex-U.S. returns 1900 - 2023 were 4.35%, or 5.16% including the U.S. market. Block bootstrap drawing on 38 developed markets as far back as 1890 shows a median 5.28% for international and 4.78% for domestic stocks. The recent U.S. real return is around 2% higher than earlier U.S. returns and global returns. The reason matters. The U.S. is special, but that does not mean its return premium will persist. Disasters that could have happened, and have happened elsewhere, have not happened to the U.S. Investors have learned that the U.S. market is safe, driving its discount rate down, and valuations up. Luck and learning explain about 2% of the U.S. equity risk premium 1920-2020. On the premise that it is non-repeatable - or at least should not be counted on since it's reflected in current valuations - U.S. returns 1920-2020 net of the 2% from luck and learning are 5.28%. All roads point to a 7% real return being higher than a reasonable expected return. Assuming that the best historical period for one of the best performing markets will persist does not seem wise, especially with U.S. valuations at their 97th percentile relative to history. At PWL Capital Inc we use a real expected return of 4.62% for financial planning purposes: https://lnkd.in/esiXdNCS Image source: Research Affiliates Asset Allocation Interactive