Sustainable Wealth Management

Table of Contents

1. Frontmatter

2. Chapter 1. Learn or Lose: Challenges and Perspectives in Sustainable Wealth Management

   Karen Wendt, Bernd Villhauer

   Abstract

   2022 has been a catastrophic year for wealth management. The ongoing Covid pandemic, war in Ukraine, and rising inflation rates have all made it very hard to grow or even protect wealth. At the end of the year, the Financial Times quoted Renaud de Planta, Senior Partner of the Pictet Group: “This year is one of the most significant years of wealth destruction in nearly 100 years,” he said, and added: “Looking at it rather simply, many private investors could have lost more than a quarter of their real inflation-adjusted wealth.”

3. Chapter 2. From ESG to Impact Investing, Taxonomies, and Sustainable Development Goals

   Karen Wendt

   Abstract

   Since the economic crisis triggered in 2008, the concept of impact investing emerged. Impact investing has initially been a term coined by the Rockefeller Foundation. Impact creation was necessary “because governments, charities, philanthropists alone were no longer capable of dealing with the twenty-first century’s social and environmental challenges. Focussing on the act of charitable giving rather than on achieving social outcomes and a dependence on unpredictable funding hindered many charitable organisations from realizing their full potential concerning innovations, effectiveness and scale” (Brandstetter & Lehner, 2015). The World Economic Forum recently acknowledged the role the investment and finance sector can play in creating solutions to social problems and stated: “Given the nature of how resources are distributed in the world, private investors may have a special role and responsibility in addressing social challenges” (World Economic Forum, 2013). Yet apart from a small number of specialized forms of impact investing like social impact bonds, green bonds, and mission-related philanthropic investments, little is known about the complex interplay between entrepreneurs or organizations, intermediaries, investor regulations, and the successful use of instruments in the field. Glänzel and Scheuerle (2016) use the term social impact investing to clearly distinguish from finance first approaches of impact investing that have a stronger commercial orientation. Hummels (2014) places impact investing in the wider category of responsible investing, considering it just one component. Hebb (2013), Pretorius and Giamporcaro (2012), Viviers and Firer (2013), and Viviers et al. (2011) view impact investing as “responsible investing.” Shulman and George (2012) consider impact investing as a form of Socially Responsible Investing (SRI). Geobey and Weber (2013) highlight a distinction: SRI screens out investments for social, environmental, or governance reasons, while impact investing assumes that investments can create financial returns and address social and environmental challenges simultaneously. Impact investing is also included by many authors in the social finance landscape (Suetin, 2011; Geobey & Weber, 2013; Geobey et al., 2012; Mendell & Barbosa, 2013; Weber, 2013, 2016).

4. Climate Change and Climate Risk

   1. Frontmatter

   2. Chapter 3. Can the Financial Sector Protect the Climate? The Potential of Sustainable Finance

      Kai Lessmann, Franziska Schütze, Angelika von Dulong, Daniel Engler, Gunnar Gutsche, Achim Hagen, Christian Klein, Andrew McConnell, Oliver Schenker, Marie Theres von Schickfus, Boyan Yanovski

      Abstract

      Climate policy aims to reduce emissions by redirecting investment from emission-intensive toward carbon-neutral assets. One key instrument, carbon pricing, guides investors and asset managers by lowering the return of fossil fuel-related assets. This chapter reviews three key mechanisms on how sustainable finance can support climate policy: first, providing investors with the necessary information to factor climate risk into their investment and portfolio decisions; second, building awareness for sustainable investing by differentiated means for institutional investors and retail investors; and, finally, addressing the cost of capital as an obstacle to low-carbon investments. For each, we critically review opportunities and shortcomings based on recent research and draw up recommendations for investors and policymakers.

   3. Chapter 4. Environmental Information Disclosure Quality, Institutional Pressure, and the Cost of Debt: Evidence from China’s Heavy Polluters

      Shidi Dong, Lei Xu, Ron McIver, Ning Huang

      Abstract

      We examine the impact of firm environmental information disclosure (EID) quality on firm cost of debt using a sample of heavy-polluting firms listed on the Shanghai and Shenzhen Stock Exchanges. Our findings suggest that better EID quality may effectively lower the cost of debt for heavy polluters. Institutional pressure, especially from the normative perspective, may moderate the impact. Policy implications from our findings suggest that regulators may need to tighten the rules on firm EID, focusing on more verifiable quantitative EID measures, to allow the loan market to efficiently price firm environmental risk.

5. Sustainability and Environmental Social Governance (ESG) in Asset Management

   1. Frontmatter

   2. Chapter 5. Values and Norms in the Sustainable Finance Debate: Similarities, Differences, and Perspectives for Sustainable Investment

      Helge Wulsdorf

      Abstract

      Alongside norms, it is values that shape sustainable investment. In the sustainable finance debate, however, the influence of value preferences on financial investment has so far not played a significant role. This is surprising, since value preferences have just as much influence on the materiality of investment objects as financial and sustainability aspects. On the basis of the three investment criteria—human rights violations, nuclear energy, and armaments and military—commonalities and differences between values- and norms-based argumentations are presented. Wealthy capital owners in particular increasingly want to know what financial influence moral values have on their assets on the one hand and what contributions capital investments make to their moral values on the other.

   3. Chapter 6. Sustainability as an Information Challenge in Asset Management

      Marcel Malmendier

      Abstract

      Sustainability is existential, for all of us as part of the natural world. To preserve this world, changes in our economy and our way of life are inevitable. This poses transformational challenges, that are different in every industry. In asset management, sustainability is first and foremost an information challenge. In the financial industry, where data and information are the key raw materials, we face particular challenges in this area. The aim of this paper is to show how asset managers can improve their management to meet these challenges. To this end, the paper analyses quantitative, qualitative, project-oriented and rule-based asset management practices. The specific conditions for developing sustainability perspectives and integrating them into the everyday asset management practice are outlined and compared.

   4. Chapter 7. Sustainability Across Different Asset Classes: Integration in a Multi-asset Portfolio

      Daniel Sailer, Martin Buchner

      Abstract

      Institutional investors are increasingly integrating ESG criteria into their decision-making processes; at the same time, regulatory requirements are rising. In the following, we explain how ESG criteria can be taken into account together with regulatory requirements in an asset–liability study and then implemented in the portfolio construction of a multi-asset portfolio.

   5. Chapter 8. Two Sides of the Same Coin: ESG Risk and Opportunity Management in the Investment and Lending Business

      B. Tobias Peylo, Christian Nuß

      Abstract

      Following the publication of the EU’s Sustainable Finance Action Plan, many central banks and institutions of banking supervision at both European and global levels have published guidelines on ESG risk management. These consider especially climate-related risks, comprising both physical climate risks and transition risks with their damaging potential on investment or loan portfolios, which financial institutions are expected to understand, assess, and manage.

      However, it is often overlooked in this context that the basis of ESG risks—namely ESG factors—can also have a very positive impact on the financial performance or solvency. While banking supervision is strictly focused on their negative impact, investors and banks need to always consider the positive aspects of ESG as well in order to avoid excluding business opportunities along with the risks.

      This is especially true for transition risks: The very same political, technical, and market-driven developments that can cause massive disruption for some companies constitute the core of the success of others—like the proverbial wave on which one surfer is carried along and another is crushed underneath depending on their skill and positioning.

      In this chapter, the dual nature of ESG and transition will be explored, analyzed, and structured. Providing an overview of both ESG risks and their management approaches and ESG opportunities combined with their potentials and perspectives, the result is a pragmatic approach to an inclusive, coherent, and structured manner of ESG risk and opportunity management.

   6. Chapter 9. ESG Investing and Firm Efficiency: The Costs and Benefits of SRI Efficiency Screening

      Karl Weinmayer

      Abstract

      This study investigates the effect of SRI efficiency-screening intensity on a portfolio’s performance under joint consideration of financial and ESG criteria in the analysis of the firms’ efficiencies derived from multi-directional efficiency analysis for US and European firms. Two efficiency estimation approaches relating to the choice of the set of firms are used and several usual asset allocation strategies are implemented reflecting common SRI fund and ESG index portfolios. The portfolio results indicate a significantly negative screening effect on financial performance for mean-variance strategies for the USA and no significant effect for the EU. A significantly positive relationship can be documented between SRI efficiency-screening intensity and financial as well as ESG performance for naive and value-weighted asset allocation strategies. Depending on the level of transaction cost and the chosen efficiency estimation approach, either medium or high screening intensity is preferred. The results suggest that SRI efficiency-screening based on ESG is a viable approach for SRI fund management, but also indicate a potential application for conventional investors as well.

   7. Chapter 10. SDG Portfolio Construction in Times of the EU Taxonomy

      Karen Wendt

      Abstract

      This paper discusses the merits of a positive selection methodology for liquid stocks based the Sustainable Development Goals (SDGs). In 2017, the UN formulated its 17 Sustainable Development Goals (UN SDGS, The 17 Goals. Available at https://sdgs.un.org/goals, 2017). Whereas most of the SDG approaches used today are based on the SDGs reporting derived from the sustainability reports, this paper argues that in addition to this valuable information, it is necessary to find the companies that already create at least 70% of their turnover with a theme that corresponds to the SDGs. In addition, the thematic approach can be further evaluated in understanding how the companies have implemented a Theory of Change. Even a positive selection methodology cannot be seen in isolation and has to be complemented by Environmental and Social Governance (ESG) approaches. The author uses a worldwide portfolio that has been screened according to positive SDG selection, theory of change, and ESG criteria. The results show that such a portfolio is able to outperform the market and to dissolve the dichotomy between SDG investing and ESG investing.

   8. Chapter 11. The Green Siblings: Exploring the Emerging Structure of Sustainable Finance

      B. Tobias Peylo

      Abstract

      Starting early in the scientific discussion of sustainable finance, the lack of an all-encompassing definition for this object of consideration was a fact often cited by critics and advocates alike. With the rise of interest in the topic generated by both the political agenda of a green transformation and the banking supervision activities to protect banks against climate and ESG risks, the call for a definition gets even louder—generating the unfortunate side effect that some practitioners simply postpone the issue until it has “properly matured”, proven by a compact and universally accepted definition. After all, in conventional economics, there is no end of definitions, and in many branches of science, a problem lacking a clear definition is agreed to be a problem that cannot be solved.

      In this chapter, we argue that the lack of definition is due to the simple fact that the roots of sustainable finance have produced not one but three trunks—being very different in size, appearance, and power. Developing from a movement to include ethics into business in a general way, the necessity to act against environmental destruction has called for more effective instruments, and the risks emerging from the said transformation require consequent action—both quite independently from any value conceptions a person or company may or may not have.

      With the categorization into the three forms of value-driven, action-driven, and risk-driven sustainable finance, these very distinct and different approaches can be much better captured and described than with a one-size-fits-all definition, and it is much easier to capture their very different motivations, properties, stakeholders, and required measures.

      This categorization is developed in this chapter, and while the concept can by no means be considered a complete roadmap to the new landscape of sustainable finance, it is intended as a robust basis for a new, more differentiated approach and as a farewell message to the futile search for a one-sentence definition.

   9. Chapter 12. Custom ESG Indexing: How Direct ESG Indexing Can Solve Many Responsible Investing Problems

      Dirk Soehnholz

      Abstract

      Responsible investments are booming, but criticism has been growing, too. I start by outlining the different dimensions and characteristics of responsible investments. I also describe a free tool to develop bespoke, responsible investment policies that could serve as the basis to select appropriate funds.

      There are now many standard active and passive, so called responsible mutual funds available. I use a free fund selection tool to show that strict responsibility criteria are only used by rather few actively managed funds. I also describe several conceptual limits of responsible passive funds. In summary, since responsible investments can vary pretty much by investor, most standard funds may not be ideal for investors.

      Much of the legitimate criticism of responsible investing can be avoided with bespoke portfolios. I outline simple ways to customize responsible portfolios with direct investments, not limited to equity investments. There are many arguments for rather concentrated direct rule-based ESG investments. These (self-indexed) solutions could be efficiently delivered by wealth managers or used by self-directed investors. An (over-)diversification focus of mutual fund providers and investment advisors may be the biggest limitation for the growth of direct or custom ESG indexing. Most of the arguments apply to private and institutional investors alike, although institutional investors will probably diversify more than private investors.

   10. Chapter 13. Customized Portfolios Using Machine Learning: Interview with Stefan Klauser

       Karen Wendt, Stefan Klauser

       Abstract

       Interview with K. Wendt, Sustainable Finance, 31.1.2023

       Q1: Stefan, how do you imagine the future of asset management 10 years from now and what will be the role of AISOT in that transition?

6. Developments in China

   1. Frontmatter

   2. Chapter 14. Internet Finance, Private Firm Financing, and Investment: Evidence from China

      Na Shen, Lei Xu

      Abstract

      We examine a private firm’s borrowing behavior from Internet finance and other financial channels, including banks, small financial institutions, and private lending, in all provinces of China from 2013 to 2015. We seek answers to two questions: Does the development of internet finance facilitate private firms to borrow more and cheaply from internet finance? Do private firms borrow from internet finance to make new investments? To measure the development of internet finance, we adopt the internet finance development index. The results suggest that private firms borrow more from internet finance if they are in regions with high internet finance development. However, firms must pay high interest rates for internet finance. Moreover, internet finance does not help in private firms’ new investment. This study fills the research gaps in the internet finance literature. Our findings and implications are helpful for private firms, internet finance practitioners, researchers, and policymakers.

   3. Chapter 15. Corporate Tax Reform and Firm Share Price: Evidence from China

      Guodong Yuan, Ron McIver, Lei Xu

      Abstract

      We apply the event study method on China’s historical tax reform over a decade ago when dual-track corporate tax rates were terminated. The Enterprise Income Tax Law of 2008 (the Law) imposed equal income tax rates for both foreign and domestic firms, by removing tax concessions for foreign firms and lowering tax rates for domestic firms from 33% to 25%. This tax reform provides a natural experiment in the largest emerging market. Through listed firms on the Shanghai and Shenzhen Stock Exchanges, we find that the corporate income tax reform has significant and positive impact on firm share prices, moderated by ownership structure, tax aggressiveness, and stock exchange differences.

   4. Chapter 16. Over-Investment, Internal Control, and Government Intervention: Evidence from China’s State-Owned Enterprises

      Guodong Yuan, Ron McIver, Lei Xu

      Abstract

      While enterprise investment behavior affects own business performance, it also plays a key role in the sustainability and strength of a country’s economic development (Modigliani & Miller, 1958, p. 261; Goel & Thakor, 2005, p. 2255). In China, industries and regions have, to varying degrees, experienced an “overheated investment” phenomenon. This has led to problems such as energy and resource shortages, excess production capacity, distortion of economic structure, and duplication of construction. Additionally, state-owned enterprises (SOEs) are more likely to invest in projects with nonoptimal returns. So, how to restrain “overheated investment,” especially of SOEs, has become an urgent issue in the context of China’s economic development. In this context, China has initiated efforts to form the legal system around enterprise internal control by issuing a series of guiding documents on their establishment (Yuan et al., 2018, p. 284). China’s 2008 implementation of its Basic Internal Control Norms for Enterprises is a good example, where one of the goals of enterprise internal control is improving the efficiency of corporate operations.

   5. Chapter 17. Exploring Financial Institution Environmental Disclosures: Evidence from China

      Shidi Dong, Ron McIver, Lei Xu

      Abstract

      Against the background of the Task Force on Climate-related Financial Disclosures’ (TCFDs) promotion of climate-related disclosures for financial and nonfinancial companies, this study examines the environmental disclosures of China’s financial institutions over 2016–2020, presenting preliminary evidence on the current status of their environmental disclosures. Interpreting results through an institutional theory lens and using content analysis of 285 firm-year observations on listed financial institutions, this study identifies that China’s financial institutions have not sufficiently addressed reporting of environmental information. Compared to other CSR categories, environmental disclosures have not become a primary focus for China’s financial institutions. This is despite international bodies, governments, and stock exchanges’ gradual recognition of the financial sector’s role in contributing to achievement of a green, low-carbon economy. However, financial institutions’ awareness of their role in environmental sustainability is currently deepening due to the institutional pressures placed on this sector. In addition, sample financial institutions are not managing their environmental issues in a comprehensive way, with only 51.5% of sample institutions disclosing information on the direct environmental impact of their own business activities, with much lower levels of reporting of the environmental impacts of their investment and financing activities. Very few financial institutions disclose qualitative indicators, such as environment-related governance structure, strategies, and policies. The “top three” most frequently disclosed environmental indicators include “indirect greenhouse gas emissions and indirect natural resource consumption from purchased products and service,” “greenhouse gas emissions and natural resource consumption directly generated by operating,” and “resources and energy consumption saved or replaced by online business.”

7. Sustainable FinTech

   1. Frontmatter

   2. Chapter 18. Towards Its Digital and Sustainable Economy: A Review of Recent Fintech Policies and Developments in China

      Lei Xu

      Abstract

      This chapter reviews the recent Fintech policies and developments in China to support its transformation towards its digital and sustainable economy. Given China’s leading position in Fintech investments and market growth, a review of its recent Fintech policies and developments seems necessary to boost research in related areas. This review covers key aspects in Fintech, which include crypto currency, peer-to-peer (P2P) lending, supply chain finance (SCF), payment platforms, and banking enhancement.

8. Financing the Anthropocene

   1. Frontmatter

   2. Chapter 19. The Future Wealth of Nations

      Stefan Brunnhuber

      Abstract

      The text explains the missing gap in the entire sustainability debate, the monetary and financial system, and outlines a new set of financial engineering to fund, hedge and manage our common future. A modified monetary mandate for central banks (top-down) enabling a friendly co-existence of a parallel green central bank digital currency (CBDC), a private community currency system or a private corporate initiative (cryptocurrencies, earmarking, digital or blockchain-driven solutions, different channels) (bottom-up) would stabilise international financial markets, strengthen monetary regulatory efforts, reduce negative externalities, increase social Pareto optimality and stabilise democracy. This is the indispensable missing link, as crowding in private sector financing, conventional public sector funding (taxes and fees) and philanthropy are not enough in terms of scale and speed to finance our future.

9. Backmatter