ESG CurrentsESG has come under fire in recent years as investors have struggled to understand the tradeoffs and benefits of including “values-based” factors in their investment process. On this episode of ESG Currents, Bloomberg Intelligence’s senior ESG analyst Andy Stevenson is joined by Lukasz Pomorski, Senior Vice President at Acadian Asset Management and author of “The Puzzle of Sustainable Investment,” to discuss how data related to governance, climate and wages may help investors build their portfolios. This episode was recorded on Sept. 3.
ESG has become established as a key business theme as companies and investors seek to navigate the climate crisis, energy transition, social mega trends, mounting regulatory attention and pressure from stakeholders. The rapidly evolving landscape has become inundated with acronyms, buzzwords and lingo, and we aim to break these down with industry experts. Welcome to ESG Currents, your guide to navigating the evolving ESG space, one topic at a time, Brought to you by Bloomberg Intelligence as part of Bloomberg's Research department. With five hundred analysts and strategists working across all major world markets. Our coverage includes over two thousand equities and credits, as well as outlooks on more than ninety industries and one hundred market indices, currencies and commodities. I am Andy Stevenson, senior ESG analyst, your host for today's episode, and I'm joined today by Lucas Pomorski. He's a professor at Columba University on sustainability as well as a senior vice president as Arcadian Asset Management and has a very deep experience with ESG through his time He spent at AQR Investment Management.
Welcome to the program.
Thank you very much, pleasure to be here.
Thank you.
So we've got an author in the house. Lucas has just written a book on ESG. I'm looking at the title right here, The Puzzle of Sustainable Investment What Smart Investors Should Know, and it's definitely a worthwhile read, and I think in particular for people that have a kind of a low exposure to the space, shall we say so, it's a very good introduction, and we're going to start with, you know, kind of questions that are really the first question I think most people get into space is if you are going to pursue any investment strategies that incorporate ESG, what are the trade offs? There's values that need to be considered, there's things you don't want to be involved in, but I'll let you speak. When you think about the ESG space and the trade offs that people are making, what are those trade offs and how may they affect your portfolios?
Thank you Andy, And just to start with, you know, one thing that I that I would very forcefully assert at the beginning is that there are trade offs in investing more broadly, and especially when it comes to ESG or sustable sustainble investment. In fact, you know, I wrote the whole book because I was more of a little bit irked by a lot of commentators who would lead you to believe that there are no trade offs. There is one group, probably the larger group, that would have you believe that it's all all just gravy. You know, if you invest with ESG in mind, then something beautiful happens, and your risk gets smaller, your returns gets larger, get larger, and in fact everybody should be investing with ESG in mind. That's one and of a spectrum. There's the other ends, which would tell you that ESG is horrible. And if you as much as think about ESG when building a portfolio, then suddenly your portfolio underperformance. You know you cannot do well. Maybe you do outright poorly in the first place. And this is why we should never talk and do ESG, and if we do, when something horrible happens. And obviously neither extreme is right. Obviously there is a truth somewhere in the middle, and nuances will matter a lot, to the extent that when you hear of the most frequently asked questions in ESG, does ESG help you or hurt you? I'm going to mimic the answer that one of my former colleagues loves to give. The answer is yes, because it really depends on.
What you mean, of course, of course, and you know, there's obviously if you are talking about values and you care about values in part of as part of your investment, that is maybe not unexpected. If there are trade offs and it maybe you may be fine with that, right, that is not necessarily you know, there are more reasons to invest than the very very short term. And you may think that if you're setting something for ten years or so or you know, very long periods of time, that having these kind of kind of guard rails on your portfolio are helpful, right, And you know, I mean it's it's a little bit of an unfair fight, I would argue historically, because you could basically if you think about some of the sinstocks, you know, like let's just say oil and gas, which some people, you know, we we do work do a lot of work on how some there's some real strong players in that space. But if you just took the sector out of your portfolio as an example, you know, compared to the S and P. You would have done better, you know, over the last ten years by a lot. You could have I think the I think the last time I looked at you could have taken a hundred dollars bill lit fifty dollars of it on fire, put the rest of it in the S and P, and you still would have outperformed the oil and gas sect. You know, there is there are some historical reasons that may may be may be helpful, but you know, this is I think what we get down to, and this really kind of begs the second question is we're talking about the data, right and there there is data that is alternative data, and there's sort of traditional data, and it is not unwise to think some alternative data can be helpful in shaping the performance of your portfolio. And I just wanted to get into one of the points in your book about you know, kind of ESG aware versus ESG unaware, just as a framework, you know, like let's forget it, but don't talk about performance, just like set the stage if you would, for us about what those two mean and why that. You know, there may be a bias in the way you think about.
It of course, So let me start with the ESG ounaware. As you will see, this is a bit of a Strauman, but it's a really useful straman just to be able to think through all the nuances. So the ESG aunaware investor, as the second investor I was talking about a second ago, this is the investor who doesn't want to look at ESG anything that might have anything to do with sustainability. That investor will just ignore, will not allow to that piece of information to enter into into his or her analysis. And it's a bit of a straw man because what I'm describing as the investor who is deliberately reducing the information that they might use in the an disease that they might leveraging that portfolio that just cannot be efficient. You know, I'm not making a stance that ESG is a good thing or a bad thing. No, I'm just making a very strong statement here that more information is really better than less information. And if you deliberately from the get go refuse to ever look at information that might have to do with ESG, and I would argue that you're not a very good investor, not a very good researcher or analyst.
Right.
I mean I also argue that more more data that other people are not following closely may be helpful. That is, you know, like it's it's the real focus. You know, fundamental data is everyone one owns it.
You know what I'm saying.
It's not hard to get to the core of fundamental data. There's no edge in that, right, So there if you see what in you know, AQR is obviously a hedge fund and and you know other people are. They have gone further and further afield into the alternative data sets to look for ways to gain an edge. And if you know only twenty percent of your competitors are looking at this, then that may be an edge, you know, Like it obviously depends on the quality of the data. It's not a univer more is not more as like you know in hot dog competitions. It works more as better, but it doesn't always work out it on data science not that you know.
Is a huge topic and I hope we can get into it.
Sure.
Let me tell you to your first question to values versus value, So why is that that thought that values maybe the tmental detrimental tool the alpha outcomes of your portfolio. Well, the reason is that if we believe that a given stock is worthholding for non financial reasons, maybe it's doing the right thing for the society of the world, then plausibly, investors who have that mindset will drive up the price, will drive up the price, so the stock can still be attractive, but it's not as attractive as it would have been at a cheaper price. And this is why people have an issue with this. Great let's talk about data. You can think about data, but tell you what is the overall let's say, eg, profile of a stock. And you know, assuming that it's truly sort of overpriced in the sense that I just gave you, then you know that data might actually potentially point you towards stocks, but you may not want to hold because we are a little bit too expensive. I don't think that happens much, at least not today, but in principle that is a possibility. But fantastic to your point, there's data and there's data. So from the point of view of investment manager, if you give me a piece of data and can predict changes in that score overall, I mean business because the logit here would be that if I can proactively identify those stocks, but will improve the East credentials, and then they will have inflow of interest of money trying to buy those stocks. Eventually those prices will be buid up. And if I can establish a position ahead of time, great, you know, I'm well positioned to capitalize to earn an additional return because of a future inflow of interest of money into us G yep.
And then sort of the counter to that, which I think is as important is if you think of some of these let's say saying stocks and not you know, like tobacco as an example. You know, like they are relying on a huge crutch in the marketplace, right, so they are relying on the fact that they are not paying the full price of the health insurance that is being required to take care of their client base. So it works both where you could you know, there's.
Two ways of looking at it.
There's something that's not discovered in price, which is what you're describing, uh, and that may help in the future. And there's also things that you know, they are really relying on basically a public subsidy in this case, right if you think about again, I'm just picking tobacco as a pretty easy answer. I don't think it's controversial to say if the US bill for tobacco smokers is three hundred million dollars from the government and they pay one hundred it's not enough, right, So they there's always the risk of additional of additional policies that would make.
Their share of the pie go up.
And of course that's not in the most in most people's thinking, that's not a risk factor, right, So you're in your you're you can add this risk factor to the modeling. But it's very much what you're describing, you know, which is, uh, there may be some unseen things there that are have certain tailwinds behind them and certain headwinds ahead of them based on kind of the shape of society going forward and cost sharing in that society.
So that's very interesting. And you know, so that that framework that I would use here is one of externalities which are describing as an externality that the tobacco industry have, meaning they impose a certain constal society and they're not built for that. And that idea actually translates easily into many other sustainable spaces, for example, climate where you may think about the idea of pollution COUTO equivalance for example, in the atmosphere, having a lot of impact on climate broadly, but also on how economic agents operate, and arguably that corn that cost may not be borne by the emitrors at least not yet which are describing. As you know, you could think about long term risks of changes in regulation, for example, but also more broadly changes in the way that people vote with their feet. You know. So if at sample consumers prefer to buy goods that are produced with low carbon for example, or in the tobacco example, they choose not to smoke, for example, that would there directly influenced the cash flows of the underlying companies, and well you pretty much quickly imbed just what maybe translate into the price. Yeah.
I mean.
Another example that's not even in the environmental space is labor. The cost of labor, right, so when you have inflation and you have things like you know, there's a federal minimum wage which is pretty meager, but there are statementimum wages that are kind of being hiked up, and for you know, McDonald's in places like that, a lot of the arb in that business is being able to control your labor costs, right, because you really can't control the cost of meat and you can't control, you know, like there's a lot of things you can't control in the in that space, and so the ability to h if something happens as an external shock to your business model, which is we expect to have low wages forever, you know, like an ever a never ending flow of young people or old people to fill those boots. That could also have an impact, right and in a very immediate and not this is not a five year impact or can you impact?
This is a six month impact.
I love it, and may I built on this and you know, again link it to values, value and data and maybe highlight a really nice overlap between many of his ideas. So when you think about labor and you know, human capital more broadly, this is one really nice example where values and value based investing might actually overlap. And what I'm talking about is, but there's a lot of research that will actually tie how individual companies think about labor, that they hire, human capital of labor workforce, how they do use a very sort of crude measure how happy VOS employees are. Clearly the sense, but this is a you know, I cant rel deeper into into the economics of it idea but you know, if we can measure this, we actually may have had instrument to identify companies but would score well on at least some dimensions of stadability of ESG. But arguably I would I would also characterize them as companies that potentially tend to outperform going forwards, tend to have higher returns than the risk od of the benchmarks. And there's a lot of research on this and beautifully illustrates something that you mentioned, the second ago versus evolution of data, where you know, if you go back to the first academic studies of a topic, you know, people used just very crude rankings. You know, which are the companies that are good companies to work for? And interestingly, those companies that made the list did really well going forward, not just in terms of stock price, but actually produce higher earning surprises. They outperform own fundamentals, which might not be but surprising when you think about what it is that labor does. Labor produces your output, your goods and services, and if you have happy employees, arguably they can be more productive. They can be more creative that I say, if I might, they might even agree to work for you at a lower wage when they would have demanded otherwise, and for work to today. There is so much more that a lot of managers, a lot of data providers do when it comes to human capital. You know, we may leverage employee surveys for example, some of them done almost in real time, you know, through web services. We might leverage instructured data around job openings and whatnot. You know, there is so much more. But we can break to actually better on the question and ideally capture those companies, but exhibit these characteristics before it becomes obvious to just about everybody in the market.
Yeah, absolutely, I mean a happy employee is definitely a more stable employee is a good way of looking at it, right, And you want, especially if there is change in your industry, that that's.
When it really comes to bear, right.
I mean it's obviously if things are going straight up in the line, you know, you can you can screw up and still do well. But but when you're seeing a lot of change in industry, which is often the case. Depends on the industry of course, but that is where that kind of as you mentioned the glassdoor and other data sources, where you have this sort of rich pretty getting pretty deep data data set, right, I mean you really have data from twenty fourteen, so you have probably good ten ten years of good data, millions of reviews. There is something to be said for again thinking about ESG data is really just an alternative data set that maybe pointing to things that other people are missing. Right, that's really the goal. I want to get to. Something that you discuss in the book as well, this idea of kind of an ESG efficient frontier, and I'll let you break that down for everybody, since that seems to be the fairest way to do it. But you know, the idea really is what is this balance that we're trying to accomplish when we are trying to make the portfolios more let's say, resilient or you know, aligned with value.
Sure, so do think about this, you know, put yourself in the position of an asset or of a pension fund for example, or a foundation, and suppose that you do have some needs that are values in your terms, you know, very non financial in nature, that you absolutely want to perform. Well, you want to generate a high risk returned tradeoff, fine, but you also, on top of this have some non financial preferences. Now, the way that I describe this at the very beginning of this podcast was there are tradeoffs. So if you're an endowment, you know, foundation, a passion fund that I'm talking about, then very naturally you will come back and say, well, if there are tradeoffs, then I want to be better of recent financial dimensions. But tell me how much better should I aim to be? Twice as good as sub benchmark, you know as twenty percent improvement enough, et cetera. And the idea of ESG efficial Frontier is basically the idea of trying to quantify the tradeoff that is for you know, think about for any given level of sustainability. And I'm being very vague here because the ad actually translates into pretty much all kinds of measures of ESG can be an esgrating, can be a carbon footprint of a portfolio, et cetera. But for any given level of that characteristic, you can actually try to build the best possible portfolio that delivers exactly that level of sustainability. And then we can actually see that there is one portfolio that actually maximizes your risk turn tradeoff. That's a portfolio. But somebody who's in my language ESGU R who allows that ESG might help you identify risk and return opportunities. That's the portfolio. But person that investor would choose regardless of us as on on ESG because they will use e ESG to but basically build a better portfolio in the risk return space.
Yeah, it makes makes sense. I mean we we Bloomberg do a lot of research on you know, looking at five year returns, three year returns, and you know alpha generation from these signals. But for or if you think about just to interject for a second, if you think about the pension funds and these you know twenty to thirty and an endowment is like one hundred year horizon.
Right, so I can tell you it's better for five years.
I could maybe tell you in many cases better for ten years, but the window is much longer than that for a lot of just in terms of satisfying the end of the answer to the question. Right, So there may be some bumps in the road, but you're really thinking about, especially if you're an endowment, you know, if you're Yale or Columbia one of these places that you know they're looking very far down the road. Having this awareness and this sort of what you're talking about this efficiency frontier is really managing to that, I think is fair to say. It's hard to say that you're managing it to somebod who's going to hold the stock for three months.
So those frontiers might look very different for different intests. And you're right, but the horizon will feature there. And you know, if you allow me, I'll put a pin in this, you know, for a moment I will come back, of course. Yeah, But just to finish the thought, you know that risk return maximizing portfolio may not be suitable for investors who have the first non national needs, for example, who want portfolios to have a greener characteristic that than the overall benchmark. And the what the ESG efficial frontier does. It basically tells you the exchange rate. You know, how much are you sacrificing in terms of your sharp ratio, let's say, or your alpha versus a benchmark if you build a portfolio but has increasingly better stainability characteristics. Now, the point that that we made in the paper where we where we where we proposed concept was that that that exchange rate can be quite a bit cheaper than you might think, or at least in some regions around that optimal risk return portfolio sustainability becomes extremely easy to achieve, meaning that you will only marginally reduce your risk return ratio sharp pracial, let's say, and still will be able to end up with a portfolio but meaningfully better on esg. On climate, you know, whatever your your your preference is, that exchange rate might be a little bit more costly if you push out, if you if your needs no financial needs become greater and greater. But I believe, but until we publish this paper, that concept was not really very well formalized, you know, bension fast let's say, didn't really have a tool with which to try to understand what are the implications of how much emphasis I should put on sustainability.
And just to be very clear for people listening, this is about historical This is what it would look like historically, and then you're obviously making the assumptions about how that's going to affect future performance. You're not you don't have a magic you know one going and blessing their portfolios with with a guaranteed risk return. This is a yeah, this is based on ten year history, fifteen history, twenty year history, or five year history, depends on what you're doing and understanding that Historically this has been the trade off, if there is any. In some cases there are positive trade offs obviously, and and and forecasting that forward. This is just just from I'm just trying this. We have all sorts of audiences, so I just you know't you don't you don't have a you don't have a crystal ball there. Otherwise you we'd have you doing other things with your life.
Certainly I don't, but maybe life is somewhat fair. I don't believe anybody else does either, And people might lead you. I I was suspicious, you know, one of my pet thiefs. You know, people people will accuse anybody looking at data or you're you're just backwards looking. You're trying to you know, fit to the past. You know, we cut about the.
Future, so do I.
If you make decisions about the future without any regard to what happened in the past, then I would question the quality of your decisions. And you know, yes, so so so. But that concept of the youtubt from Frontier is very much forward looking. But as you point out, it is informed by the past. It does it shouldn't take the past in the face value it might be sort of more and more informed, more more more sophisticated than that. But you know, ultimately the data that we have in the past, you know, are probably the only well the data and some sort of economic analysis, you know, economic theory are the only things that we have to actually build informed views about the future. And we're just one one more thought of this, you know. So because I really really love as vestas common that you just made, well, I'm talking about trade offs and I'm telling you about you know, well you might you might need to agree to a little bit of a reduction, to a haircut in your financial outcomes if you take on these these uh, non financial values. Well, that doesn't mean that the future is predetermined. It doesn't mean that a portfolio that is low carbon will necessarily underperform a portfolio that is very brown. Well, you know, we made we make a decision based on expectations about the future. But apps and a crystal ball, these expectations may not be true. So what what may happen is you make get lucky. And I just want to be quite clear, it's luck. You may get lucky in a sense, but you build a portfolio, but there's no carbons. As you mentioned, if you if you run a Baptist you know, simulation of a portfolio. So you look back in time and ask how would this portfolio have performed over the last ten years. You would conclude that this portfolio would do brilliantly. And unfortunately there's some people who will take this and say that, hey, I have I have built a better mouse trap. I can now promise you a higher return. Well, be careful with such promises, because you shouldn't assume that the future will be identical to the past. And in particular, you should assume with these trade offs, will only you know, work in the direction of luck. You know, they're kind of symmetric. You may get lucky and make it unlucky. I would argue that you know, on average it will be slight headwind, but not to the point unless your your your usings are very very acute, not to the point of actually building a portfolio, but outright underperformance.
Sure, I mean, and we find a bloomberg. You know, you look at the intensity of oil and gas production, intensity of midstream companies, the the intensity of production of steel and cement and aluminum. I mean, really across the board, the cleaner companies have been crushing it, you know, like it's just as And that's not to say they're going to continue to do so, but it's a much easier to understand why if you have a recycler, for example, in the steel industry, why their business may be simpler and and as a result, more steadier and less prone to these kind of crazy supply shocks. And you know that we've seen plague. You know, if you're steel, you have to get the met coal and you have to get the iron ore and these are all these kinds of things are I can be complicated in a world, but we are, I would argue deglobalizing in uh and so you need to be kind of uh, you know, stockpiling things and it changes the changes your business model, whereas if you're recycling company, it's just like one day after the next, you know, it comes in the door and thank you very much, and blah blah blah.
But even if you you know, even if you try right to make it a very sort of apples plus comparison. If you take two companies but have very similar production function, they use similar resources. They they you know, they rely on the same technology as such, you might make an argument and that that measures of carbon intensity, for example, are just a proxy for the underlying quality, underlying efficiency of the company. Let me explain, you know what is what is carbon efficients carbon intensity? Carbon intensity is a measure of how much carbon do you produce? How much do you emit para dollar of revenue para dollar of sales? Right?
You know?
So so if you, if you, if you think about two companies, if you and I are are are managing two companies that are very similar, but we produce the same widget. And to produce that one widget, you know, your company needs to emit one ton of co two equivalents you know has some measure of emassireons My company EM's twice as much to produce the same widget. Then that tells you probably not just about the standability profit of the company, but also how efficient I am versus how efficient you are in my example.
Your and how wheezy and old your equipment? You know, I mean that's usually the reason why is someone's got fifty year old equipment and how you know, and someone has twenty year old equipment.
And now go going forward, you know, which which of us is a better bet? If our companies are are worth the same, you know, according to the stock market today. Would you rather invest your retirement savings in your company or in mind may happen to a good example, you know, I would argue that going forward, you know, the better bet is probably your company because it's more efficient that it can produce what it produces, you know, easier cheaper than than than my company does. And again I'm saying probably is an expectation, because who knows. Things may happen. You know, we could you could, I could get lucky, maybe I find gold to my property and suddenly my values is kyrockets for instance. We have nothing to do with carbon.
Sure, yeah, you know, you just think about maintenance cost period You'd be like, well, I don't want to be involved in something that's fifty years old.
They're all the engineers.
Are dead from starting for a starting point, Okay, I'm going to kind of move on a little bit here to to a governance, which I think is an important area of you know esg that you know a lot of gets. A lot of the discussion is really focused around climate or around energy, and these are great because they're from a data perspective, because the data is there. You know, the data exists in a way that is, if you're very careful about it and you do a good job of cleaning it, you can actually arrive at a fairly sophisticated analysis of what each of these companies is doing.
Governance is it's all. You only want it.
You only think about it when you need it, you know, if you know what I'm saying, like it And these things are harder to measure, but obviously you're talking about the value effectively of the CEO, you know, like it is the CEO worth his current weight in gold. For everyone's CEO is worth quite a bit in gold anyway. But uh, understanding how they react to different situations, the choices that they make, these are all obviously fold under the governance umbrella. And you know, it's it's hard to think you wouldn't have some if you studied that as a as a standalone kind of input, that you wouldn't have a slightly more informed on trying to I'm kind of leading the witness here, but you would end up saying having a slightly more informed opinion about how that company will behave under stress. Maybe you can can you go into a little bit about how you think about governance, any kind of findings you may have had on it, and just you know, some your broad thoughts.
Sure, and I would actually maybe broad a sort of bigger, bigger sort of picture here. I would I would go beyond the CEO, you know, I think you know, governess is also how how other officers of the company behave, how how incentivice they are. It's about the role of the board. You know, a variety of structures that the company operates with it so you may have any impact on how the company elects directors for example, you know, et cetera, et cetera. It's it's a really broad and somewhat nebulous concept. I don't think there's a two sentence definition that exhausts what governance is. But I think broad people would agree that there is something to the idea that governance is important. And I think you know, all shareholders who vote anually in an annual meeting to elect new directors, for example, effectively give you evidence for that. You know, people people care about this. You have proxified you have you have sometimes very very very fierce fights between the dissident and incumbent management about who should oversee the company. These are important concepts that I would argue translate into into the price. Now, as you point out, you know, this is frequently, uh, something that you observe on average over the long term. This is this is, this may happen, but it's rarely something that happens overnight, and you know, people wake up and say, oh, the company is now meaningfully where's governed? You know, Hence the price would fall and low and behold the stock market reacts. But having said that, you know, if you think about comparing a portfolio composed of well governed companies and again I'm being vague here, but i'll i'll clarify the moment what I mean back, but what government could use compare that to a portfolio of companies but are very poorly governed. There's a lot of research that well predates much of ESG work. You know that certainly wasn't published and as an EUG type white paper that documents time and again that well governed companies perform better than poorly governed companies do. And frankly, there is there is a puzzle here. You know, this might seem intuitive, and I would argue maybe it's it shouldn't be all that intuitive. Think about what I'm what I'm what I'm saying. I'm saying, but companies fed you should feel better about. Companies that are better governed are generating higher returns going forward. But companies that are effie, that are perhaps involved in activities that are not always very easily defensible than such, well, that's a problem from the point of view of finest one of one one on one, but tells you that generally more risk should translate into a higher level of return. What I'm describing is that you're more boring companies, more more more stable companies, better government companies are generating a higher level of return than companies that people may have questions about companies where you may have a higher probability of something bad happening because top management the board are not not doing that duty basically overseeing the company or or or managing the company. That's That's that's a broader puzzle in finance. It goes beyond governors. It's also about overall. There is to mind all, there's no good risk story. White quality works. You know, think about profitability. Why is it that companies that generate higher profit by by by some much profitability, profit over assets. For example, these companies deliver higher returns when companies that generate very poor profitability same idea. I'm much more comfortable with highly profitable company. It's much more likely that that company will exist next year or in ten years when a company where's balancing on the brink of bankruptcy and yet it is a safe company that delivers higher return.
Yeah, I mean, it's a really about an execution. Is really what you're describing there, you know, like the confidence and execution. Obviously this is again historical data that is suggesting that this is the case. So what I'm saying, I'm just saying, I'm just saying, you know, like you what you're describing as again the historical results, which people seem to be you know, very into into if they're counter to what the ESG outcomes are. But in this case, it seems pretty camp, seems pretty solid that the data that you're having and what we've I found anyway, is that it's one of those fool me once you know, that's that's on me for me twice and the stock usually sees a pretty big battering, you know that it's really that that's Secondly, you think about Boeing or some of these companies where they you know, like there was a murmur of some of these things happening, and then then that was sort of like the first whiff of it, and then the second exposure to the same risk is like, well, we thought we figured this out, you know, like that or whatever. This so you know, this is uh And I'm not trying to pick on Bowing very but I'm just saying it does happen where there is a problem that for most people think it's just a one off, you know, weird circumstances. But then it happens again and people start to think of this as more of an actual risk, a risk that should have some impact on what you feel about the future earnings of the company.
And I do agree. I mean, history is all we have, you know, we do not have a crystal ball. How do we build it for the well by looking at history. And the argument that I'm making is that a that relationship between how well governed a company is and it subsequent returns, it's actually incredibly stable over time.
You know.
Let me give you one of many many examples. People thought about how aggressive companies are when they produce accounting statements as a very well established, well known concept that's different measures of earnings management basically predict subsequent performance. Companies that are more conservative, but I would argue are better governed. Conservatives is just one of many facets of governance. Well, these companies tend to do better over time, and if you look at just publicly available academic research, it goes back to mid nineties at least, and since then that research has been replicated countless amounts of time. You know, so I replicated this myself, you know, with a team back in AQR. You know that team that I'm part of right now at a Kadian. It's incredible how that simple investment idea that companies that are safer basically that are that are more conservative when it comes to to accounting statements, they are better positioned to perform well going forward. Again, it's not an idea that easily rhymes with the risk return trade off. You get more return by betting on more risk. But that's perfect because what is the downside here? But downside as you could be wrong, you know, you may not be able to outperform well. At least you build a portfolio of companies that are arguably safer, but give you less risk.
And it's one input out of many, you know that you're using to steer that decision right to let you think about scaling and sizing and things like that. All I think we're gonna we're running toward the end of our time here. I want to give you one last opportunity to raise something that anything.
That you would like to raise about your book or just.
In general you think people should be a little more aware of with respect to you know, obviously the investing case free issue.
So let me just name one of my other bad peeves. And this was very much as on point that with a discussion so far, data is incredibly important, you know. I you know, maybe I'm biased. I love looking at data. I love building different forecasts based on the data, building portfolios out of these forecasts. But I really think that we live in a wonderful sort of point in time where we increasingly appreciate the value of data. We have more and more data, and we have more and more tools to process the data with, and we can address many more interesting questions that we could just you know, ten or twenty years ago now without stress. However, is that data due diligence is in really short supply. And this is not a against you know, any one particular personal institution, but I think we do ourselves and the overall investment community at this service by not thinking more about some of the questions that spec you and I discussed on this on this podcast. How do you think about the data? How do you think about how the past might inform the future? And you know, spoiler alert, you know, assuming with the future is identical to the past is not a good not a good forecast. You need to be a little bit more and more sophisticated on this now. Taking the data, you know, if you if you know, Bloomberg is a really interesting uh stendable data solutions and I, you know, I I trust a trademark, I trust the team, you know, but I still want to take the data and actually not use it sight unseen. There's so much that investors that portfolio managers should do to actually analyze whatever the data actually captures, what it says, it does, you know, what is the what is the incremental value? But the data brings on top of what you already know. For example, my my point earlier that you know, some data will give you a sense offtware the company is today as as a very sustainable company or not. Well, other data might tell you more about where a company is going forward. You know, maybe you can give me a sense, for example, that some oil majors are actually incredibly important in decarbonization because they invest in the R and D around the idea, because they spend more and more resources to actually transition parts of the production, et cetera, et cetera. So and in my view, we very often underappreciate the value of such data and underappreciate how important both interactions are. I would argue personally if that's sometimes have a very brown portfolio by some measures, but let's say carbon reserves you know in the ground, or carbon carbon intensity then might be a portfolio but actually is really well positionedly in terms of the potential transition. But these underlying companies will will take.
Yeah, I would agree with that.
Now, you know, especially with respect to gas the United States, where there's a lot of methane coming out of the ground from that and you know, the companies that are shipping it overseas now, particularly those focused on Europe, are going to have to be accountable to how clean that fuel is, and so you know, there's a wide range of outcomes in the United States with respect to the cleanliness of their output. Some are even worse than coal, you know, like in the gas space, it's just you have very very leaky, some leak wells. You have a million wells the United States. It's not surprising that there is a condrey that's not living up to the expectations of the highest end.
But yeah, I totally agree with you.
If we, you know, associally Bloomberg, we try to in the US in the oil and gas sector. Globally we look out to twenty thirty. We use something called the moldl function, which looks lets us look at expectations of production into the future based on the investment banks. And we have companies intensities, and we're able to kind of see what they're doing, and some are really making an effort and some aren't, you know, like you know, is really what it comes down to. And it's good to understand that because, as you say, judging them by today's standard is a little unfair. Depending on where you're coming from. You think about an Excel Energy as a company is a very much a coal based company. Just two or three years ago, and they're really you know, dumping their coal assets pretty quickly here, So thank you so much again, just for everybody. Once again, the book is called The Puzzle of Sustainable Investment for those that are looking to dig deeper on this. We really appreciate your time, Lucas and look forward to hopefully seeing you again.
Wonderful and thank you so much both for the invitation and for a really great conversation.
You can find more information on climate data by going to the Climate Damages Tracker said in the BI Carbon section of the ESG dashboard. By entering b I ESG go on the Bloomberg terminal. If you have an ESG quandary or burning question you would like to ask bi's expert analysts, send us an email at ESG Currents at Bloomberg dot net. Thank you, and we look forward to the next episode.
