tag:theconversation.com,2011:/fr/topics/investor-23967/articlesInvestor – The Conversation2023-02-10T13:58:48Ztag:theconversation.com,2011:article/1996352023-02-10T13:58:48Z2023-02-10T13:58:48ZWhat are stock buybacks, which critics are blaming for hastening Bed Bath & Beyond’s bankruptcy? A finance professor explains<figure><img src="https://images.theconversation.com/files/522689/original/file-20230424-1075-lx31id.jpg?ixlib=rb-1.1.0&rect=175%2C18%2C3850%2C2661&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Bed Bath & Beyond has spent billions in recent years on share buybacks.</span> <span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/BedBathandBeyond/ea8ce516b7be471c88b518eef7cb9ec2/photo?Query=bed%20bath%20&mediaType=photo&sortBy=arrivaldatetime:desc&dateRange=Anytime&totalCount=117&currentItemNo=8">AP Photo/Ted Shaffrey</a></span></figcaption></figure><p><em>Bed Bath & Beyond <a href="https://www.marketwatch.com/story/bed-bath-beyond-bankruptcy-heres-what-happens-next-7697ed3d">filed for bankruptcy</a> on April 23, 2023, and <a href="https://wolfstreet.com/2023/04/23/after-wasting-11-6-billion-on-share-buybacks-to-return-value-to-shareholders-lol-bed-bath-beyond-goes-bankrupt-will-liquidate/">some analysts</a> <a href="https://news.yahoo.com/bed-bath-beyond-how-stock-buybacks-undermined-the-company-154202427.html">are blaming</a> the billions of dollars the retailer spent on share buybacks as one of the reasons for its downfall. In total, the company has spent nearly US$12 billion buying back its own stock since 2005, including $1 billion in 2021 alone – cash that could have potentially <a href="https://www.therobinreport.com/the-share-buyback-that-killed-bed-bath-beyond/">helped stave off bankruptcy</a>.</em></p>
<p><em>Bed Bath & Beyond is hardly alone in snapping up its own stock. Companies <a href="https://www.bloomberg.com/news/articles/2022-08-18/all-about-stock-buybacks-a-1-trillion-market-force-quicktake?sref=Hjm5biAW">have been buying back</a> record amounts of their own shares in recent years, which prompted President Joe Biden to <a href="https://www.nytimes.com/2023/02/08/us/politics/biden-state-of-the-union-transcript.html">propose quadrupling the tax on buybacks to 4%</a>.</em> </p>
<p><em>But what are stock buybacks, and why do some people consider them to be a bad thing? The Conversation tapped <a href="https://scholar.google.com/citations?user=VxWst50AAAAJ&hl=en&oi=ao">D. Brian Blank</a>, who studies company financial decision-making at Mississippi State University, to fill us in.</em> </p>
<h2>1. What are stock buybacks?</h2>
<p>Before we can answer that question, first we need to understand the basics of how stock works.</p>
<p>Stock <a href="https://www.investor.gov/introduction-investing/investing-basics/investment-products/stocks">represents an ownership interest in a company</a>, such that stockholders have a stake in the business. Companies use stock as one way to <a href="https://hbr.org/1989/11/everything-you-dont-want-to-know-about-raising-capital">raise capital</a> by selling their shares to investors, usually in an <a href="https://theconversation.com/investors-swoon-over-bumbles-ipo-but-what-exactly-is-an-initial-public-offering-155084">initial public offering</a>. </p>
<p>Most stockholders, however, obtain stock by buying it on a secondary market, like the New York Stock Exchange. In this case, <a href="https://thebusinessprofessor.com/en_US/investments-trading-financial-markets/primary-vs-secondary-market-definition">one person chooses to sell their ownership</a> in the company, while another person buys it.</p>
<p>As partial owners, shareholders see the value of their stock rise when the company does well. </p>
<p>One way investors can benefit from holding the stock is that some corporations <a href="https://www.investor.gov/introduction-investing/investing-basics/glossary/dividend">pay dividends</a>, which are payments made directly to shareholders. Another way that stockholders can benefit is by selling the stock for more than they paid for it. Together, this creates a return on investment.</p>
<p>And this brings us to share buybacks – and <a href="https://www.mckinsey.com/capabilities/strategy-and-corporate-finance/our-insights/how-share-repurchases-boost-earnings-without-improving-returns">why investors like them</a>.</p>
<h2>2. Why do companies buy back their own stock?</h2>
<p>When <a href="https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/us-companies-poised-to-prop-up-eps-with-share-buybacks-in-2023-72955469">companies have extra capital</a>, they might go into the secondary market and buy back stock from investors. This is often referred to as a stock repurchase or <a href="https://hbr.org/2001/04/is-a-share-buyback-right-for-your-company">buyback program</a>. Companies that are older and less focused on rapid growth tend to do them more often. </p>
<p>Companies do this for <a href="https://www.google.com/books/edition/Stock_Buyback_Motivations_and_Consequenc/bclgEAAAQBAJ?hl=en&gbpv=1">a variety of reasons</a>, <a href="https://doi.org/10.1111/j.1745-6622.2000.tb00040.x">such as because</a> they think their shares are undervalued and want to signal optimism to Wall Street, or because they simply want another way to distribute profits to shareholders – <a href="https://corpgov.law.harvard.edu/2018/05/23/why-shareholder-wealth-maximization-despite-other-objectives/">a key goal of any company</a> – <a href="https://doi.org/10.1111/j.1745-6622.2000.tb00040.x">other than through dividends</a>. </p>
<p>Shareholders like buybacks because companies <a href="https://corporatefinanceinstitute.com/resources/accounting/dividend-vs-share-buyback-repurchase/">often pay a premium</a> over market price. And when companies buy their own stock, this removes those shares from the market, which has the effect of lifting share prices as supply goes down, benefiting existing stockholders.</p>
<p>It’s estimated that American companies <a href="https://www.bloomberg.com/news/articles/2023-01-09/corporate-america-is-still-lining-up-to-buy-back-its-own-stock-shares?sref=Hjm5biAW">bought back a record $1 trillion</a> of their own stock in 2022. And Apple is the <a href="https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/us-companies-poised-to-prop-up-eps-with-share-buybacks-in-2023-72955469#:%7E:text=Apple%20Inc.%20is%20the%20biggest,of%20the%20S%26P%20500%20companies.">biggest user of buybacks</a>, having spent $557 billion over the past decade repurchasing its own shares. </p>
<figure class="align-center ">
<img alt="elderly white man with gray hair stands in front of lectern and appears to speak while gesticulating with his hands" src="https://images.theconversation.com/files/509315/original/file-20230209-23-aranpu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/509315/original/file-20230209-23-aranpu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/509315/original/file-20230209-23-aranpu.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/509315/original/file-20230209-23-aranpu.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/509315/original/file-20230209-23-aranpu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/509315/original/file-20230209-23-aranpu.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/509315/original/file-20230209-23-aranpu.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">President Joe Biden said companies should ‘do the right thing’ and stop buying back their own shares.</span>
<span class="attribution"><a class="source" href="https://newsroom.ap.org/detail/BidenOil/e9009d5ff31a4a7792593c5974d1d79f/photo?Query=biden%20union&mediaType=photo&sortBy=arrivaldatetime:desc&dateRange=Anytime&totalCount=2242&currentItemNo=1">AP Photo/Patrick Semansky</a></span>
</figcaption>
</figure>
<h2>3. Why do Biden and others dislike buybacks?</h2>
<p>Critics like Biden contend that share buybacks represent short-term thinking that doesn’t actually create any real value. They <a href="https://www.wsj.com/articles/biden-to-urge-quadrupling-new-1-tax-on-stock-buybacks-11675723035">argue instead</a> that companies should use more of their profits to invest in more productive activities like business operations, innovation or employees.</p>
<p>Returning money that a company makes to stockholders does mean <a href="https://www.cfo.com/corporate-finance/2021/02/shareholder-distributions-vs-reinvestment-the-gap-grows/">less capital is available</a> for other investments. In his speech, Biden specifically <a href="https://www.nytimes.com/2023/02/08/us/politics/biden-state-of-the-union-transcript.html">called out “Big Oil” companies</a> for using the <a href="https://www.cnbc.com/2023/02/08/big-oil-rakes-in-record-annual-profit-fueling-calls-for-higher-taxes.html">record profits</a> they’ve earned from high energy prices to buy back their stock rather than investing in new wells to increase supply – and <a href="https://www.washingtontimes.com/news/2023/feb/7/biden-rips-outrageous-big-oil-profits-calls-quadru/">help reduce gas prices</a>. </p>
<p>But the decision whether to invest to increase domestic production is a complicated one. For example, the reason companies aren’t investing in new wells right now is not simply because they are buying back stock. The reason has more to do with how oil companies, and their shareholders, don’t think it is profitable to invest in more supply for a <a href="https://www.npr.org/2021/03/06/973649045/hold-that-drill-why-wall-street-wants-energy-companies-to-pump-less-oil-not-more">whole host of reasons</a>, including the global push for greener energy by both policymakers and consumers, which is bound to reduce demand for fossil fuels in the future.</p>
<p>It’s also worth noting that while share repurchases are becoming <a href="https://onlinelibrary.wiley.com/doi/full/10.1111/j.1745-6622.2000.tb00040.x">increasingly common</a> and controversial, they remain very <a href="https://noahpinion.substack.com/p/stock-buybacks-dont-really-matter">similar to dividends</a>, which don’t prompt the same concerns among politicians. </p>
<h2>4. Would increasing the tax result in fewer buybacks?</h2>
<p>The 1% tax on buybacks is actually brand new. </p>
<p><a href="https://www.mayerbrown.com/en/perspectives-events/publications/2023/01/1-stock-buyback-tax-us-treasury-irs-release-interim-guidance">Congress passed the tax</a> in 2022 as part of the Inflation Reduction Act. It took effect at the beginning of 2023 and only affects buyback programs of $1 million or more. </p>
<p>Usually when an activity is taxed, it happens <a href="https://www.americanexperiment.org/tax-something-you-get-less-of-it-policymakers-have-always-known-that/">less frequently</a>. So, I expect the tax to nudge companies to spend less on buybacks and more elsewhere. While politicians intend more of the money to be used to invest in their productive capacity, companies may simply spend more on <a href="https://www.wsj.com/articles/biden-to-urge-quadrupling-new-1-tax-on-stock-buybacks-11675723035">paying shareholders dividends</a>.</p>
<p>Since the tax is new, it’s hard to evaluate its actual impact. <a href="https://www.kiplinger.com/investing/stocks/why-stock-buybacks-could-accelerate-in-q4">Companies reportedly accelerated</a> their repurchase programs in 2022 to avoid paying the tax.</p>
<p>But early data from 2023 suggests the 1% tax isn’t significantly deterring buybacks. <a href="https://www.bloomberg.com/news/articles/2023-02-02/stock-buybacks-hit-132-billion-as-companies-snub-all-warnings?sref=Hjm5biAW">Companies announced $132 billion</a> in buybacks in January, three times as much as a year earlier and the most for the month on record.</p>
<p>Biden’s <a href="https://www.reuters.com/world/us/biden-address-bring-buybacks-billionaire-tax-investor-focus-2023-02-07/">proposal to boost</a> the tax to 4% may alter corporate behavior more. But again, it may just lead to greater dividend payments, not the other types of investments he and others hope for.</p>
<p>In addition, given that Republicans control the House, and Democrats have only a narrow majority in the Senate, this proposal <a href="https://www.cnbc.com/2023/02/07/biden-buyback-tax-isnt-working-in-state-of-the-union-he-wants-more.html">has little chance</a> of becoming law anytime soon.</p>
<p>The reasons why large corporations make the decisions they do about where to allocate capital – whether to build a factory, hire more workers or buy back stock – are complicated and, in my view, never taken lightly. These decisions have many <a href="https://www.google.com/books/edition/Stock_Buyback_Motivations_and_Consequenc/bclgEAAAQBAJ?hl=en&gbpv=1">facets and implications</a>, and are not necessarily bad. I believe this is something worth remembering the next time you hear <a href="https://www.barrons.com/articles/corporate-stock-buyback-tax-51675805358">politicians</a> <a href="https://ca.finance.yahoo.com/news/president-biden-calls-out-stock-buybacks-in-state-of-the-union-address-104810205.html">saying</a> “<a href="https://www.cnn.com/interactive/2023/02/annotated-fact-checked-president-biden-sotu/">corporations should do the right thing</a>.”</p>
<p><em>This is an updated version of an article originally published on Feb. 10, 2023.</em></p><img src="https://counter.theconversation.com/content/199635/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>D. Brian Blank does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The retailer has spent nearly $12 billion buying back its own stock since 2005, money that could have been used to invest in its business.D. Brian Blank, Assistant Professor of Finance, Mississippi State UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1837062022-05-26T15:01:29Z2022-05-26T15:01:29ZWho really owns the oil industry’s future stranded assets? If you own investment funds or expect a pension, it might be you<figure><img src="https://images.theconversation.com/files/465531/original/file-20220526-13-wdtgf0.jpg?ixlib=rb-1.1.0&rect=170%2C0%2C5038%2C3368&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">More countries are discouraging fossil fuel use, but the industry is still pumping.</span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/an-off-shore-oil-platform-off-the-coast-in-huntington-beach-news-photo/1217468918">Leonard Ortiz/MediaNews Group/Orange County Register via Getty Images</a></span></figcaption></figure><p>When an oil company invests in an expensive new drilling project today, it’s taking a gamble. Even if the new well is a success, future government policies designed to slow climate change could make the project unprofitable or force it to shut down years earlier than planned.</p>
<p>When that happens, the well and the oil become what’s known as <a href="https://www.lloyds.com/strandedassets">stranded assets</a>. That might sound like the oil company’s problem, but the company isn’t the only one taking that risk.</p>
<p>In a <a href="https://www.nature.com/articles/s41558-022-01356-y">study published May 26, 2022</a>, in the journal Nature Climate Change, <a href="https://scholar.google.com/citations?user=9xh8Po0AAAAJ&hl=en">we</a> <a href="https://scholar.google.com/citations?user=1gais1MAAAAJ&hl=en">traced</a> the ownership of over 43,000 oil and gas assets to reveal who ultimately loses from misguided investments that become stranded.</p>
<p>It turns out, private individuals own over half the assets at risk, and ordinary people with pensions and savings that are invested in managed funds shoulder a surprisingly large part, which could exceed a quarter of all losses.</p>
<h2>More climate regulations are coming</h2>
<p>In 2015, almost every country worldwide signed the <a href="https://www.un.org/en/climatechange/paris-agreement">Paris climate agreement</a>, committing to try to hold global warming to well under 2 degrees Celsius (3.6 F) compared to pre-industrial averages. Rising global temperatures were already contributing to <a href="https://theconversation.com/heat-waves-hit-the-poor-hardest-a-new-study-calculates-the-rising-impact-on-those-least-able-to-adapt-to-the-warming-climate-175224">deadly heat waves</a> and <a href="https://theconversation.com/climate-change-and-wildfires-how-do-we-know-if-there-is-a-link-101304">worsening wildfires</a>. Studies showed the <a href="https://www.ipcc.ch/">hazards would increase</a> as greenhouse gas emissions, primarily from fossil fuel use, continue to rise.</p>
<p>It’s clear that meeting the Paris goals will <a href="https://www.iea.org/reports/net-zero-by-2050">require a global energy transition</a> away from fossil fuels. And many countries are developing climate policies designed to encourage that shift to cleaner energy. </p>
<p>But the oil industry is still launching new fossil fuel projects, which suggests that it doesn’t think it will be on the hook for future stranded assets. U.N. Secretary-General António Guterres called a <a href="https://www.euronews.com/green/2022/04/10/seven-new-oil-and-gas-projects-approved-since-ipcc-report-called-for-an-end-to-fossil-fuel">recent wave of new oil and gas projects</a> “<a href="https://www.un.org/press/en/2022/sgsm21228.doc.htm">moral and economic madness</a>.”</p>
<figure class="align-center ">
<img alt="Teenagers play in the water of the Caspian sea - one young man is flipping another, with several Soviet oil rigs behind them." src="https://images.theconversation.com/files/465401/original/file-20220525-12-1uqbl2.jpg?ixlib=rb-1.1.0&rect=0%2C19%2C4387%2C2946&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/465401/original/file-20220525-12-1uqbl2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=406&fit=crop&dpr=1 600w, https://images.theconversation.com/files/465401/original/file-20220525-12-1uqbl2.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=406&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/465401/original/file-20220525-12-1uqbl2.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=406&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/465401/original/file-20220525-12-1uqbl2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=510&fit=crop&dpr=1 754w, https://images.theconversation.com/files/465401/original/file-20220525-12-1uqbl2.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=510&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/465401/original/file-20220525-12-1uqbl2.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=510&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Much of the stranded asset risk falls on individuals.</span>
<span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/teenagers-from-a-boxing-school-take-part-in-a-training-news-photo/478734696">Kirill Kudryavtsev/AFP via Getty</a></span>
</figcaption>
</figure>
<h2>How risk flows from oil field to small investor</h2>
<p>When an asset becomes stranded, the owner’s anticipated payoff won’t materialize. </p>
<p>For example, say an oil company buys drilling rights, does the exploration work and builds an offshore oil platform. Then it discovers that demand for its product has declined so much because of climate change policies that it would cost more to extract the oil than the oil could be sold for.</p>
<p>The oil company is owned by shareholders. Some of those shareholders are individuals. Others are companies that are in turn owned by their own shareholders. The lost profits are ultimately felt by those remote owners.</p>
<p>In the study, we modeled how demand for fossil fuels could decline if governments make good on their recent emissions reduction pledges and what that would mean for stranded assets. We found that <a href="https://www.nature.com/articles/s41558-022-01356-y">$1.4 trillion in oil and gas assets</a> globally would be at risk of becoming stranded.</p>
<p>Stranded assets mean a wealth loss for the owners of the assets. We traced the losses from the oil and gas fields, through the extraction companies, on to those companies’ immediate shareholders and fundholders, and again their shareholders and fundholders if the immediate shareholders are companies, and all the way to people and governments that own stock in the companies in this chain of ownership. </p>
<p><iframe id="gQHve" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/gQHve/15/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<p>It’s a complex network.</p>
<p>On their way to ultimate owners, much of the loss passes through financial firms, including pension funds. Globally, pension funds that invest their members’ savings directly into other companies own <a href="https://www.ft.com/content/435a9384-8711-4b99-95a8-d55e962343c6">a sizable amount</a> of those future stranded assets. In addition, many <a href="https://www.investopedia.com/terms/d/definedcontributionplan.asp">defined contribution pensions</a> have investments through fund managers, such as BlackRock or Vanguard, that invest on their behalf.</p>
<p>We estimate that total global losses hitting the financial sector – including through cross-ownership of one financial firm by another – from stranded assets in oil and gas production could be as high as $681 billion. Of this, about $371 billion would be held by fund managers, $146 billion by other financial firms and $164 billion could even affect bondholders, often pension funds, whose collateral would be diminished.</p>
<p><iframe id="gnS6j" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/gnS6j/8/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<p>U.S. owners have by far the largest exposure. Ultimately, we found that losses of up to $362 billion could be distributed through the financial system to U.S. investors.</p>
<p>Some of the assets and companies in an ownership chain are also overseas, which can make the exposure to risk for a fund owner even more difficult to track.</p>
<h2>Someone will get stuck with those assets</h2>
<p>Our estimates are based on a snapshot of recent global share ownership. At the moment, with <a href="https://money.com/gas-prices-near-record-high-2022/">oil</a> and <a href="https://www.reuters.com/markets/commodities/europe-asia-gas-buyers-switching-long-term-supplies-beat-volatile-prices-2022-05-25/">gas</a> prices near record highs due to supply chain problems and the Russian war in Ukraine, oil and gas companies are paying splendid dividends. And in principle, every shareholder could sell off their holdings in the near future.</p>
<p>But that does not mean the risk disappears: Someone else buys that stock.</p>
<p>Ultimately, it’s like a game of musical chairs. When the music stops, someone will be left with the stranded asset. And since the most affluent investors have sophisticated investment teams, they may be best placed to get out in time, leaving less sophisticated investors and defined contribution pension plans to join the oil and gas field workers as losers, while the managers of the oil companies unfold their golden parachutes.</p>
<p>Alternatively, powerful investors could successfully lobby for compensation, as has happened repeatedly in the <a href="https://www.cga.ct.gov/PS98/rpt%5Colr%5Chtm/98-R-0392.htm">U.S.</a> and <a href="https://www.cleanenergywire.org/news/german-govt-adopts-coal-exit-fixes-hard-coal-compensation">Germany</a>. One argument would be that they couldn’t have anticipated the stricter climate laws when they invested, or they could point to governments asking companies to produce more in the short-term, as happened recently <a href="https://www.politico.com/news/2022/03/09/granholm-calls-oil-companies-increase-production-00015802">in the U.S.</a> to substitute for Russian supplies.</p>
<p>However, divesting right away or hoping for compensation aren’t the only options. Investors – the owners of the company – can also pressure companies to shift from fossil fuels to renewable energy generation or another choice with growth potential for the future.</p>
<p>Investors not only may have the financial risk, but also the related financial responsibility, and ethical choices may help preserve both the value of their investments and the climate.</p><img src="https://counter.theconversation.com/content/183706/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Gregor Semieniuk has previously received funding from the UK Research Councils and the ClimateWorks Foundation.</span></em></p><p class="fine-print"><em><span>Philip Holden has been funded through UK Research Councils, the European Commission and the Leverhulme Trust. </span></em></p>A study found $1.4 trillion in oil and gas industry assets would be at risk if governments follow through on their pledges to deal with climate change.Gregor Semieniuk, Assistant Research Professor of Economics, UMass AmherstPhilip Holden, Senior Lecturer in Earth System Science, The Open UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1837052022-05-24T18:58:08Z2022-05-24T18:58:08ZHow a sustainability index can keep Exxon but drop Tesla – and 3 ways to fix ESG ratings to meet investors’ expectations<figure><img src="https://images.theconversation.com/files/465092/original/file-20220524-13-6d13mw.jpg?ixlib=rb-1.1.0&rect=0%2C40%2C6720%2C4426&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Tesla CEO Elon Musk, shown at an electric vehicle factory, called ESG ratings 'a scam' after an index dropped Tesla. </span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/news-photo/tesla-head-elon-musk-talks-to-the-press-as-he-arrives-to-to-news-photo/1270402341">Maja Hitij/Getty Images</a></span></figcaption></figure><p><em>A major stock index that tracks sustainable investments <a href="https://www.indexologyblog.com/2022/05/17/the-rebalancing-act-of-the-sp-500-esg-index/">dropped electric vehicle-maker Tesla</a> from its list in May 2022 – but it kept oil giant ExxonMobil. That move by the S&P 500 ESG Index has set off a roiling debate over the value of ESG ratings.</em> </p>
<p><em>ESG stands for environmental, social and governance, and ESG ratings are meant to gauge companies’ performance in those areas. <a href="https://www.bloomberg.com/company/press/esg-may-surpass-41-trillion-assets-in-2022-but-not-without-challenges-finds-bloomberg-intelligence/">About</a> <a href="https://www.ussif.org/files/Trends%20Report%202020%20Executive%20Summary.pdf">one-third</a> of all investments under management use ESG criteria, yet many environmental problems <a href="https://unfccc.int/blog/what-is-the-triple-planetary-crisis">continue to worsen</a>. Tesla CEO Elon Musk called the ratings “<a href="https://twitter.com/elonmusk/status/1526958110023245829">a scam</a>,” and the U.S. Securities and Exchange Commission proposed <a href="https://www.sec.gov/news/press-release/2022-92">new disclosure rules</a> for funds that market themselves as ESG-focused.</em></p>
<p><em>We asked <a href="https://scholar.google.com/citations?user=JwLkuSIAAAAJ&hl=en">Tom Lyon</a>, a business economics professor at the University of Michigan who studies sustainable investing, to explain what happened and how ESG ratings could be improved to better reflect investors’ expectations.</em></p>
<h2>How does a company like Tesla, which makes electric vehicles, get dropped from the S&P 500 ESG index while Exxon is still there?</h2>
<p><a href="https://www.sustainability.com/thinking/rate-the-raters-2020/">ESG ratings agencies</a> typically rate companies against others within their industry, so oil and gas companies are rated separately from automotive companies or technology companies. Exxon stacks up fairly well relative to others in the oil and gas category on many measures. But if you compared Exxon to, say, Apple, Exxon would look terrible on its total greenhouse gas emissions.</p>
<p>Tesla may rate well on many environmental factors, but social and governance factors have been dragging the company down. <a href="https://www.indexologyblog.com/2022/05/17/the-rebalancing-act-of-the-sp-500-esg-index/">S&P listed allegations</a> of racial discrimination, poor working conditions at a Tesla factory and the company’s response to a federal safety investigation as reasons for dropping the company.</p>
<p>The way ESG criteria are measured also carries some biases. For example, the ratings consider a company’s direct greenhouse gas emissions <a href="https://theconversation.com/esg-investing-has-a-blind-spot-that-puts-the-35-trillion-industrys-sustainability-promises-in-doubt-supply-chains-170199">but not its Scope 3 emissions</a> – emissions from the use of its products. So Tesla doesn’t get as much credit as it might, and Exxon doesn’t get penalized as much as it might.</p>
<h2>What can be done to make ESG investments better reflect investors’ expectations?</h2>
<p>One strategy is for investment firms to <a href="https://www.trilliuminvest.com/esg/esg-integration-criteria">invest in a small number of carefully vetted companies</a> and then use their influence within those companies to monitor behavior and drive change.</p>
<p>Another is for raters to stop trying to aggregate all of the different measures into a single rating.</p>
<p>Investors concerned about ESG often value different objectives – one investor may really care about human rights in South America while another is focused on climate change. When ESG ratings try to force all of those objectives into a single number, they obscure the fact that there are trade-offs. </p>
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<p>ESG could be broken up so ratings instead focused on each piece individually. </p>
<p>Environmental issues tend to have a lot of available data, which make E the easiest category to rate in a consistent way. For example, scientific data is available on the increased health risks a person faces when exposed to benzene. The EPA’s <a href="https://www.epa.gov/toxics-release-inventory-tri-program">Toxic Release Inventory</a> shows <a href="https://enviro.epa.gov/triexplorer/chemical.html?pYear=2020&pLoc=0000071432&pParent=TRI&pDataSet=TRIQ1">how much benzene</a> various manufacturing facilities release. It’s then possible to create a toxicity-weighted exposure measure for benzene and other toxic chemicals. A similar measure can be created for air pollution.</p>
<p>Social issues and governance issues are much harder to aggregate up into single ratings. Within the G category, for example, how do you aggregate diversity in the board room with whether the CEO personally appointed all the board members? They are capturing fundamentally different things.</p>
<p>The SEC is considering a third strategy: <a href="https://www.natlawreview.com/article/sec-targeting-esg-investing-2022">enhancing disclosure requirements</a> so investors have access to better information about what is in their ESG portfolios. The SEC <a href="https://www.sec.gov/news/press-release/2022-92">proposed new reporting rules</a> for ESG funds and advisors on May 25, 2022, including proposing that some environment-focused funds be required to disclose the greenhouse gas emissions associated with the portfolio. </p>
<h2>What else do ESG ratings overlook?</h2>
<p>ESG ratings often omit important behaviors and choices. One that’s particularly important is <a href="https://doi.org/10.1177/0008125618778854">corporate political activity</a>. </p>
<p>A lot of companies like to <a href="https://doi.org/10.1177/1086026615575332">talk a green game</a>, but investors rarely know what these companies are doing behind the scenes politically. Anecdotally, there is evidence that many are actually <a href="http://doi.org/10.1073/pnas.1922175117">playing a fairly dirty game politically</a>. For example, a company might say it supports a carbon tax while <a href="https://www.opensecrets.org/industries/indus.php?Ind=E">donating to members of Congress</a> and <a href="https://oversight.house.gov/sites/democrats.oversight.house.gov/files/Analysis%20of%20the%20Fossil%20Fuel%20Industrys%20Legislative%20Lobbying%20and%20Capital%20Expenditures%20Related%20to%20Climate%20Change%20-%20Staff%20Memo%20%2810.28.21%29.pdf">lobbying groups</a> that oppose climate policies.</p>
<p>To me, that’s the most egregious failure in the ESG domain. But we don’t have the data to track this behavior adequately, since Congress has not required disclosure of all types of political spending, especially so-called “<a href="https://www.opensecrets.org/dark-money/basics">dark money</a>” from <a href="https://www.opensecrets.org/political-action-committees-pacs/super-pacs/2022">super PACs</a>. </p>
<p>A few organizations are gathering more detailed information on specific issues. <a href="https://influencemap.org/index.html">InfluenceMap</a>, for example, invests an enormous amount of time looking at companies’ annual reports, tax filings, press releases, advertisements and any information about lobbying and campaign spending to rate them. <a href="https://lobbymap.org/company/Exxon-Mobil">It gave ExxonMobil a grade of D-</a> for its political action on climate.</p>
<h2>What can investors looking for positive impact do if ESG ratings aren’t the answer?</h2>
<p>Investors can always take a more targeted approach and invest in specific categories that they believe will provide essential solutions for the future. For example, if climate change is their leading concern, that may mean investing in wind and solar power or electric vehicles.</p>
<p>ESG funds often claim that they outperform the market because companies with strong management in environment, social and governance areas tend to be better managed overall. And on average, firms <a href="https://doi.org/10.1016/j.jfineco.2015.12.003">with higher social performance</a> do have a <a href="https://doi.org/10.5465/amj.2011.0744">somewhat higher financial performance</a>. However, some insiders, like <a href="https://www.usatoday.com/story/opinion/2021/03/16/wall-street-esg-sustainable-investing-greenwashing-column/6948923002/">former Blackrock sustainable investment head Tariq Fancy</a>, argue that ESG portfolios today aren’t very different from non-ESG portfolios, and often hold almost all the same stocks.</p>
<p>There’s also a larger question in the background of all of this: Is investment pressure really what’s going to drive us toward a more sustainable future?</p>
<p>If you want to make a difference, consider spending time working with activist groups or <a href="https://doi.org/10.1016/j.oneear.2021.02.008">groups that support democracy</a>, because without public pressure and democracy, countries aren’t likely to make good environmental decisions.</p>
<p><em>This article was updated May 25, 2022, with the SEC proposing new disclosure rules.</em></p><img src="https://counter.theconversation.com/content/183705/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Tom Lyon does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Sustainable investing’s credibility took a hit when the S&P 500 ESG index dropped the electric vehicle-maker but kept the oil giant. The SEC is now considering new disclosure rules.Tom Lyon, Professor of Sustainable Science, Technology and Commerce and Business Economics, University of MichiganLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1701992021-11-09T19:40:31Z2021-11-09T19:40:31ZESG investing has a blind spot that puts the $35 trillion industry’s sustainability promises in doubt: Supply chains<figure><img src="https://images.theconversation.com/files/431157/original/file-20211109-23-l1r5vy.jpg?ixlib=rb-1.1.0&rect=0%2C44%2C7337%2C4858&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Environmental, social and governance problems in a company's supply chain can be hard for investors to track.</span> <span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/photo/container-cargo-port-ship-yard-storage-handling-of-royalty-free-image/1300225698">KDP via Getty Images</a></span></figcaption></figure><p>If you own stocks, chances are good you have heard the term <a href="https://theconversation.com/us/topics/esg-88758">ESG</a>. It stands for environmental, social and governance, and it’s a way to laud corporate leaders who take sustainability – including climate change – and social responsibility seriously, and punish those who do not.</p>
<p>In less than two decades since a <a href="https://www.unepfi.org/fileadmin/documents/freshfields_legal_resp_20051123.pdf">United Nations report</a> drew attention to the concept, ESG investing has evolved into a <a href="https://www.bloomberg.com/news/articles/2021-09-29/-wild-west-of-esg-ripe-for-a-crackdown-veteran-investor-says">US$35 trillion industry</a>. Money managers overseeing <a href="https://www.ussif.org/files/Trends%20Report%202020%20Executive%20Summary.pdf">one-third of total U.S. assets under management said they used ESG criteria in 2020</a>, and by 2025 global assets managed in portfolios labeled “ESG” are expected to reach <a href="https://www.bloomberg.com/professional/blog/esg-assets-may-hit-53-trillion-by-2025-a-third-of-global-aum/">$53 trillion</a>.</p>
<p>These investments have gained momentum in part because they cater to investors’ growing desire to have a positive impact on society. By quantifying a company’s actions and outcomes on environmental, social and governance issues, ESG measures offer investors a way to make informed trading decisions. </p>
<p>However, investors’ trust in ESG funds may be misplaced. As scholars in the field of <a href="https://carey.jhu.edu/faculty/faculty-directory/tinglong-dai-phd">supply chain management</a> and <a href="https://scholar.google.com/citations?user=Kk-QbksAAAAJ&hl=en">sustainable operations</a>, we see a major flaw in how rating agencies, such as Bloomberg, MSCI and Sustainalytics, are measuring companies’ ESG risk: the performance of their supply chains.</p>
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<h2>The problem with ignoring supply chains</h2>
<p>Nearly every company’s operations are backed by a <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3593540">global supply chain</a> that consists of workers, information and resources. To accurately measure a company’s ESG risks, its end-to-end supply chain operations must be considered.</p>
<p>Our <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3939968">recent examination</a> of ESG measures shows that most ESG rating agencies do not measure companies’ ESG performance from the lens of the global supply chains supporting their operations. </p>
<p>For example, Bloomberg’s <a href="https://www.oecd.org/finance/ESG-Investing-Practices-Progress-Challenges.pdf">ESG measure</a> lists “supply chain” as an item under the “S” (social) pillar. By this measure, supply chains are treated separately from other items, such as carbon emissions, climate change effects, pollutants, and human rights. This means all those items, if not captured in the ambiguous “supply chain” metric, reflect each company’s own actions but not their supply chain partners’. </p>
<p>Even when companies collect their suppliers’ performance, “selective reporting” can arise because there is no unified reporting standard. One recent study found that companies tend to report environmentally responsible suppliers and conceal “bad” suppliers, <a href="http://dx.doi.org/10.2139/ssrn.3700310">effectively “greenwashing” their supply chain</a>.</p>
<p>Carbon emissions are another example. Many companies, such as <a href="https://www.bloomberg.com/news/features/2021-07-13/why-former-executives-warn-of-false-gains-in-esg-frenzy">Timberland</a>, have claimed great successes in reducing emissions from their own operations. Yet the emissions from their supply chain partners and customers, known as “<a href="https://www.msci.com/www/blog-posts/scope-3-carbon-emissions-seeing/02092372761">Scope 3 emissions</a>,” may remain high. ESG rating agencies have not been able to adequately include Scope 3 emissions because of a <a href="https://www.scoperatings.com/#!search/research/detail/166389EN">lack of data</a>: Only 19% of companies in the manufacturing industry and 22% in the service industry disclose this data.</p>
<p>More broadly, without accounting for a company’s entire supply chain, ESG measures fail to reflect global supply chain networks that today’s big and small companies alike depend on for their day-to-day operations.</p>
<h2>Amazon and the third-party-supplier problem</h2>
<p>Amazon, for example, is among ESG funds’ <a href="https://ssir.org/articles/entry/the_world_may_be_better_off_without_esg_investing">largest</a> and <a href="https://www.ft.com/content/9e3e1d8b-bf9f-4d8c-baee-0b25c3113319">favorite</a> holdings. As a company <a href="https://www.businessinsider.com/amazon-bigger-than-walmart-overall-sales-2021-8">bigger</a> than Walmart in terms of annual sales, Amazon has reported emissions from shipping that are only <a href="https://www.businessinsider.com/walmart-target-amazon-among-biggest-maritime-polluters-overseas-shipping-impact-report-2021-7">one-seventh</a> of Walmart’s. But when researchers for two advocacy groups reviewed public data on imports, they found only about <a href="https://www.pacificenvironment.org/wp-content/uploads/2021/07/SIZ_Shady-Ships-Report.pdf">15% of Amazon’s ocean shipments</a> could be tracked. </p>
<p>In addition, Amazon’s figure does not reflect emissions generated by its many third-party sellers and their suppliers who operate outside the U.S. This difference matters: Whereas Walmart’s supply chain relies on a centralized procurement strategy, Amazon’s supply chain is highly decentralized – <a href="https://www.statista.com/statistics/259782/third-party-seller-share-of-amazon-platform/">a large percentage</a> of its revenue comes from third-party suppliers, about <a href="https://www.barrons.com/articles/safety-first-for-online-markets-or-customers-may-shop-elsewhere-51598370480">40%</a> of which sell directly from China, which further complicates emissions tracking and reporting.</p>
<figure class="align-center ">
<img alt="Looking down on a worker at a computer in a large warehouse" src="https://images.theconversation.com/files/431156/original/file-20211109-19-503xf3.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/431156/original/file-20211109-19-503xf3.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/431156/original/file-20211109-19-503xf3.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/431156/original/file-20211109-19-503xf3.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/431156/original/file-20211109-19-503xf3.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/431156/original/file-20211109-19-503xf3.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/431156/original/file-20211109-19-503xf3.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Retailers are skilled at tracking supply chain goods once they arrive, but the impact those goods may already have had on the climate and workers in other countries is often overlooked.</span>
<span class="attribution"><a class="source" href="https://www.gettyimages.com/detail/photo/top-view-of-warehouse-worker-using-laptop-to-check-royalty-free-image/1324728773">Kmatta via Getty Images</a></span>
</figcaption>
</figure>
<p>Another important ESG metric concerns consumer protection. Amazon prides itself as “<a href="https://www.aboutamazon.com/about-us">Earth’s most customer-centric company</a>.” However, when its customers have been injured by products sold by third-party sellers on its platform, Amazon has <a href="https://static.reuters.com/resources/media/editorial/20200924/bolgervamazon--appellopinion.pdf">argued that</a> it should not be held liable for the damage, because it functions as an “online marketplace” matching buyers and sellers. Amazon’s foreign third-party sellers are <a href="https://www.jdsupra.com/legalnews/is-amazon-liable-for-third-party-9783896/">often not subject to U.S. jurisdiction</a> so <a href="https://www.barrons.com/articles/safety-first-for-online-markets-or-customers-may-shop-elsewhere-51598370480">can’t be held accountable</a>.</p>
<p>Yet major ESG rating agencies do not appear to reflect the supply chain implication on customer protection when measuring Amazon supply chain performance. </p>
<p>For example, in 2020, <a href="https://www.msci.com/our-solutions/esg-investing/esg-ratings/esg-ratings-corporate-search-tool/issuer/amazoncom-inc/IID000000002157075">MSCI</a>, the largest ESG ratings agency, upgraded Amazon’s ESG rating from BB to BBB, reflecting its strength in areas such as <a href="https://www.fool.com/investing/stock-market/types-of-stocks/esg-investing/esg-rating/">corporate governance and data security</a>, despite its <a href="https://www.modernretail.co/platforms/amazon-briefing-why-amazons-product-liability-risk-is-growing/">consumer liability risk</a>. </p>
<p>These gaps are also concerns for ratings of companies such as <a href="https://fortune.com/2020/07/25/ppe-supply-chain-national-security/">3M</a>, <a href="https://greenalphaadvisors.com/the-s-in-esg-moderna-vs-exxonmobil/">ExxonMobil</a> and <a href="https://www.forbes.com/sites/timabansal/2021/05/13/how-green-is-tesla-really/?sh=5676ee9b1576">Tesla</a>.</p>
<h2>Other countries are adding pressure</h2>
<p>Currently there is no unified reporting standard, so different companies may cherry-pick certain ESG performance measures to report to boost their sustainability and social ratings. </p>
<p>To improve consistency, the next step would be for ESG rating agencies to redesign their methodology to take into account what may be environmentally harmful and unethical operations across the entire global supply chain. ESG rating agencies could, for example, create incentives for companies to collect and disclose their supply chain partners’ activities, such as Scope 3 emissions. </p>
<p>In June 2021, the German Parliament passed the <a href="https://www.loc.gov/item/global-legal-monitor/2021-08-17/germany-new-law-obligates-companies-to-establish-due-diligence-procedures-in-global-supply-chains-to-safeguard-human-rights-and-the-environment/">Supply Chain Due Diligence Act</a>, which will become effective in 2023. Under this new law, large companies based in Germany will be responsible for social and environmental issues arising from their global supply chain networks.</p>
<p>This includes prohibitions on child labor and forced labor, and attention to occupational health and safety throughout the entire supply chain. Those who violate the law face a <a href="https://www.loc.gov/item/global-legal-monitor/2021-08-17/germany-new-law-obligates-companies-to-establish-due-diligence-procedures-in-global-supply-chains-to-safeguard-human-rights-and-the-environment/">fine of up to 2%</a> of their annual revenues.</p>
<p>The European Union’s new <a href="https://www.spglobal.com/marketintelligence/en/news-insights/blog/what-is-the-impact-of-the-eu-sustainable-finance-disclosure-regulation-sfdr">Sustainable Finance Disclosure Regulation</a>, which went into effect in March 2021, adds pressure in a different way. It requires funds to report details on how they integrate ESG characteristics into their investment decisions. That has led <a href="http://bloomberg.com/news/articles/2021-09-29/fund-managers-start-axing-esg-buzzword-as-greenwash-rules-bite">some money managers to drop the phrase</a> “ESG integrated” from some of their assets, Bloomberg reported.</p>
<p>Without similar laws in the U.S., we believe ESG rating agencies could fill an important gap. To be sure, surveying a company’s entire supply chain’s ESG performance is far more complex. Yet by tying all the ESG dimensions to a company’s supply chain end-to-end operations, rating agencies can nudge corporate leaders to be responsible for actions across their supply chains that would otherwise be kept in the dark.</p>
<p>[<em>Over 115,000 readers rely on The Conversation’s newsletter to understand the world.</em> <a href="https://theconversation.com/us/newsletters/the-daily-newsletter-3?utm_source=TCUS&utm_medium=inline-link&utm_campaign=newsletter-text&utm_content=100Ksignup">Sign up today</a>.]</p><img src="https://counter.theconversation.com/content/170199/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Christopher S. Tang has been a consultant to Amazon, HP, IBM, Nestlé (USA), GKN (UK) and Accenture.</span></em></p><p class="fine-print"><em><span>Tinglong Dai does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Two supply chain experts see a major flaw in how ratings agencies measure companies’ environmental, social and governance performance.Tinglong Dai, Professor of Operations Management & Business Analytics, Carey Business School, Johns Hopkins UniversityChristopher S. Tang, Professor of Supply Chain Management, University of California, Los AngelesLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1257852019-10-25T12:33:02Z2019-10-25T12:33:02ZWeWork debacle exposes why investing in a charismatic founder can be dangerous<figure><img src="https://images.theconversation.com/files/298579/original/file-20191024-170484-6foi43.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">WeWork wanted to be a lot more than a shared workspace. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/new-york-nyusamay-10-2018-wework-1278091729?src=9xiaJ5BmEePlhpkb52WWiA-1-12">rblfmr/Shutterstock.com</a></span></figcaption></figure><p>WeWork went from <a href="https://www.wsj.com/articles/the-fall-of-wework-how-a-startup-darling-came-unglued-11571946003">unicorn darling</a> with a nearly US$50 billion valuation to a cautionary tale for gullible investors <a href="https://www.wsj.com/articles/softbank-to-take-control-of-wework-11571746483?mod=hp_lead_pos2">worth just $8 billion</a> in a matter of months. It did so in part by wrapping its real estate sublet business in the cloak of a tech startup destined to “change the world.”</p>
<p>Were investors like SoftBank and JPMorgan duped by the hype of a charismatic founder, as happened with <a href="https://www.cnbc.com/2019/03/20/hbos-the-inventor-how-elizabeth-holmes-fooled-people-about-theranos.html">Elizabeth Holmes and Theranos</a>? </p>
<p>As a <a href="https://csbapp.uncw.edu/data/fs/vita.aspx?id=25472">lecturer in finance</a> and someone who managed investments for 20 years, I believe that there was some of that, coupled with <a href="https://www.investopedia.com/articles/investing/050813/4-behavioral-biases-and-how-avoid-them.asp">behavioral biases</a> that lead people to make bad decisions. But I also think something else was going on that should give investors pause the next time they stumble across a visionary founder promoting a “change the world” branding strategy. </p>
<h2>‘We’ will change the world</h2>
<p>WeWork was founded in 2011 as a <a href="https://www.businessinsider.com/the-founding-story-of-wework-2015-10">co-working venture</a>. </p>
<p>But Adam Neumann crafted and pitched a vision for his company that went well beyond office sharing and real estate. He said the “we” culture he was building would change the world.</p>
<p>“The influence and impact that we are going to have on this Earth is going to be so big,” <a href="https://www.wsj.com/articles/this-is-not-the-way-everybody-behaves-how-adam-neumanns-over-the-top-style-built-wework-11568823827?shareToken=st3fcd4c5c55d94ffc80b5721a8aa6ffa2">he told staff</a> during a music festival-like retreat, where he suggested the company could “solve the problem of children without parents” and even eradicate world hunger. </p>
<p>Such statements weren’t uncommon from him. But moreover, they fit neatly in the messianic-like Silicon Valley tech world, where companies believe their inventions can actually <a href="https://www.gq.com/story/the-most-bullshit-motivational-slogans-in-silicon-valley">“free the world.”</a> </p>
<p>Neumann’s ambitious plans hit reality recently as <a href="https://www.bloomberg.com/news/articles/2019-10-22/neumann-clings-to-billionaire-status-after-wework-gets-a-bailout">investors soured on the company</a> in the runup to a planned initial public offering. On Oct. 23, existing investor SoftBank agreed to rescue the embattled company with <a href="https://group.softbank/en/corp/set/data/news/press/sb/2019/20191023_01/pdf/20191023_01.pdf">billions in additional capital</a> in exchange for increasing its ownership stake to 80%. The deal pushed out Neumann, who will get US$1.7 billion despite burning through earlier investments. </p>
<p>Neumann’s “exit” package may be unusual in its scale, but otherwise similar fates have befallen numerous other founders, such as Theranos’ Holmes and <a href="https://www.washingtonpost.com/technology/2019/09/30/inside-new-uber-weak-coffee-vanishing-perks-fast-deflating-morale/">Uber’s Travis Kalanick</a>. Even Elon Musk, CEO of Tesla and founder of SpaceX, often seems to be <a href="https://www.businessinsider.com/elon-musk-shocking-quotes-tweets-2018-10">one outrageous tweet</a> away from his own ignominious end. </p>
<p>Each of these leaders embodied varying traits that <a href="https://www.salon.com/2017/05/20/silicon-valleys-ceo-worship-problem/">inspired almost cult-like followings</a> among investors who forked over billions to be a part of their rise. In cases like Tesla and Uber, the companies have managed to become successful despite their CEOs’ shortcomings. Theranos and WeWork are examples of what can go wrong when the founder is both owner and executive in a venture capital-backed startup.</p>
<h2>Principals and agents</h2>
<p>Finance scholars like myself think about this in terms of the <a href="https://www.cfainstitute.org/en/research/foundation/2014/the-principalagent-problem-in-finance">principal-agent relationship</a>, an issue that is crucial to the management of almost every business and organization. </p>
<p>The principal is a party or group that enlists the agent to manage some asset or process in their best interest.</p>
<p>In a healthy corporate structure, the alignment of principal and agent is accomplished through governance and executive compensation policies that provide management incentives to act in the best interest of owners. For example, the CEO’s compensation might include stock in the company that vests over some period of years and is dependent upon specific performance targets. </p>
<p>In the case of WeWork, Neumann was acting in both roles: He was principal as the investor with the controlling stake and agent as the executive tasked with running the company. Even the <a href="https://www.sec.gov/Archives/edgar/data/1533523/000119312519220499/d781982ds1.htm#toc781982_1">prospectus</a> for the company’s ill-fated IPO included language that would have given him <a href="https://www.bloomberg.com/opinion/articles/2019-08-19/we-looks-out-for-our-selves">control for life</a>.</p>
<h2>Why it’s a problem</h2>
<p>You might wonder what the problem is with this arrangement given that it’s common for managers to be owners, as is the case with small businesses and family-owned companies. </p>
<p>When it’s their own money at stake, surely they’ll be looking out for their own best interests, right? In those situations, yes, and the downside risk is assumed by the owner-managers. </p>
<p>The difference between those types of companies and the likes of WeWork and Theranos is that startups typically have significant outside investment capital. SoftBank, for one, was also a principal in WeWork. In such situations, the interest of a founder like Neumann may not necessarily align with those of the company itself and its other investors. </p>
<p>During WeWork’s buildup, for example, Neumann borrowed hundreds of millions of dollars <a href="https://www.wsj.com/articles/softbank-to-take-control-of-wework-11571746483?mod=hp_lead_pos2%20%22%22">against his stock in the company</a>, leaving himself and WeWork exposed depending on the shares’ future valuation. He also charged his own company $5.9 million for trademark rights to the word “we” – <a href="https://www.businessinsider.com/wework-ceo-gives-back-millions-from-we-trademark-after-criticism-2019-9">a sum he gave back</a> after intense criticism.</p>
<p>Even in leaving the company, he was able to <a href="https://www.bloomberg.com/opinion/articles/2019-10-23/how-do-you-like-we-now">negotiate a generous go-away package</a>, including the ability to cash out almost $1 billion in stock and receive a $185 million consulting fee. This at the same time that the company’s future is uncertain and it’s <a href="https://www.theguardian.com/business/2019/oct/15/wework-sack-staff-workers-adam-neumann">laying off 2,000 workers</a> – which it delayed doing because <a href="https://www.wsj.com/articles/softbank-offers-to-put-6-5b-into-wework-including-5b-loan-11571687872">it couldn’t afford their severance</a>. </p>
<p>Unemployed workers and wasted capital are the collateral damage when investors fall prey to the principal-agent problem. And unfortunately, I don’t think this will be the last time.</p>
<p>[ <em>You respect facts and expertise. So do The Conversation’s authors and editors.</em> <a href="https://theconversation.com/us/newsletters?utm_source=TCUS&utm_medium=inline-link&utm_campaign=newsletter-text&utm_content=yourespect">You can read us daily by subscribing to our newsletter</a>. ]</p><img src="https://counter.theconversation.com/content/125785/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Greg Putnam does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Adam Neumann both controlled and managed the co-working company he founded in 2011. A finance scholar explains why that can be a serious problem in venture capital-backed startups.Greg Putnam, Lecturer in Finance, University of North Carolina WilmingtonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1220032019-08-21T12:32:30Z2019-08-21T12:32:30ZHow to invest if you’re worried a recession is coming<figure><img src="https://images.theconversation.com/files/288605/original/file-20190819-123727-5d7g7l.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Even the pros don't know what's up. </span> <span class="attribution"><span class="source">AP Photo/Richard Drew</span></span></figcaption></figure><p>Although the U.S. economy <a href="https://www.cnbc.com/2019/07/26/us-gdp-second-quarter-2019.html">continues to grow</a> and <a href="https://finance.yahoo.com/news/july-2019-jobs-report-bls-215030223.html">add jobs</a>, <a href="https://www.cnbc.com/2019/08/15/trump-wants-fed-rate-cuts-unclear-if-they-would-help.html">talk</a> of a <a href="https://finance.yahoo.com/news/recession-will-be-a-slow-motion-accident-strategist-131602319.html">recession</a> is <a href="https://trends.google.com/trends/explore?date=all&geo=US&q=Recession">increasingly in the air</a> due to a number of worrying signs.</p>
<p><a href="https://www.bloomberg.com/opinion/articles/2019-08-14/u-s-businesses-are-stuck-in-trade-war-uncertainty">Business investment</a> and <a href="https://www.bloomberg.com/news/articles/2019-08-16/trump-economy-loses-luster-for-independents-in-2020-warning-sign?srnd=premium">consumer confidence</a> are taking a hit due to the growing economic jitters and uncertainty over the ongoing trade war with China. An important bond market recession warning – known as an <a href="https://fred.stlouisfed.org/graph/fredgraph.png?g=mtiz">inverted yield curve</a> – <a href="https://www.washingtonpost.com/business/2019/08/14/stocks-tank-another-recession-warning-surfaces">is spooking investors</a>. And policymakers are actively taking steps to bolster the economy, such as the Federal Reserve’s recent decision to lower short-term borrowing costs. The Trump administration <a href="https://www.washingtonpost.com/politics/trump-confirms-hes-considering-a-payroll-tax-cut-amid-mounting-economic-concerns/2019/08/20/2c97e500-c37a-11e9-9986-1fb3e4397be4_story.html">is even mulling a payroll tax cut</a> to avert a downturn. </p>
<p>A question I’m often asked as a <a href="https://scholar.google.com/citations?user=JfUEmSUAAAAJ&hl=en&oi=ao">finance professor</a> and a <a href="https://www.cfainstitute.org/en/programs/cfa/charter">CFA charterholder</a> is what should people do with their money when the economy is slowing or in a recession, which typically causes riskier assets like stocks to decline. Fear causes many people to run for the hills. </p>
<p>But the short answer, for most investors, is the exact opposite: Stick to your long-term plan and ignore day-to-day market fluctuations, however frightening they may be. Don’t take my word for it. The tried and true approach of passive investing is backed up by a lot of evidence.</p>
<h2>Most of us have money at risk</h2>
<p>While we usually associate investing with hotshot Wall Street investors and hedge funds, the truth is most of us have a stake in financial markets and their ups and downs. <a href="https://www.federalreserve.gov/publications/files/scf17.pdf">About half of American families own stocks</a> either directly or through institutional investment vehicles like mutual funds. </p>
<p>Most of the invested wealth average Americans hold is managed by professional investors who look after it for us. But the <a href="https://www.cnbc.com/2017/01/04/a-brief-history-of-the-401k-which-changed-how-americans-retire.html">continued growth</a> of defined contribution plans like 401(k)s – which require people to make choices about where to put their money – means their financial security increasingly depends on their own investment decisions.</p>
<p>Unfortunately, most people are not good investors. Individual investors who trade stocks <a href="http://dx.doi.org/10.2139/ssrn.219228">underperform the market</a> – and passive investors – by a wide margin. The more they trade, the worse they do. </p>
<p>One reason is because the pain of losses is about <a href="https://www.behavioraleconomics.com/resources/mini-encyclopedia-of-be/loss-aversion/">twice as strong</a> as the pleasure of gains, which leads people to act in counterproductive ways. When faced with a threatening situation, our instinctive response is often to run or fight. But, like trying to outrun a bear, exiting the market after suffering losses is not a good idea. It often results in selling at low prices and buying higher later, once the market stress eases.</p>
<p>The good news is you don’t need a Ph.D. in finance to achieve your investment goals. All you need to do is follow some simple guidelines, backed by evidence and hard-earned market wisdom. </p>
<h2>Investing checklist</h2>
<p>First of all, don’t make any rash moves because of the growing chatter about recession or any wild gyrations on Wall Street. </p>
<p>If you have a solid investment plan in place, stick to it and ignore the noise. For everyone else, it’s worth going through the following checklist to help ensure you’re ready for any storm on the horizon.</p>
<ol>
<li><p>Define clear, measurable and achievable investment goals. For example, your goal might be to retire in 20 years at your current standard of living for the rest of your life. Without clear goals, people often approach the path to getting there piecemeal and end up with a motley collection of investments that don’t serve their actual needs. As baseball legend Yogi Berra <a href="https://www.goodreads.com/quotes/499411-if-you-don-t-know-where-you-re-going-you-ll-end-up">once said</a>, “If you don’t know where you are going, you’ll end up someplace else.” </p></li>
<li><p>Assess <a href="https://www.investopedia.com/articles/pf/07/risk_tolerance.asp">how much risk</a> you can take on. This will depend on your investment horizon, job security and attitude toward risk. A good rule of thumb is if you’re nearing retirement, you should have a smaller share of risky assets in your portfolio. If you just entered the job market as a 20-something, you can take on more risk because you have time to recover from market downturns. </p></li>
<li><p><a href="https://money.usnews.com/investing/investing-101/articles/why-diversification-is-important-in-investing">Diversify your portfolio</a>. In general, riskier assets like stocks compensate for that risk by offering <a href="https://www.investopedia.com/ask/answers/042415/what-average-annual-return-sp-500.asp">higher expected returns</a>. At the same time, safer assets such as bonds tend to go up when things are bad, but offer much lower gains. If you invest a big part of your savings in a single stock, however, you are not being compensated for the risk that the company will go bust. To eliminate these uncompensated risks, diversify your portfolio to include a wide range of asset classes, such as foreign stocks and bonds, and you’ll be in a better position to endure a downturn. </p></li>
<li><p>Don’t try to pick individual stocks, identify the <a href="https://www.vanguard.com/pdf/icrwmf.pdf">best-performing actively managed funds</a> or time the market. Instead, stick to a diversified portfolio of passively managed stock and bond funds. Funds that have done well in the recent past <a href="https://www.thebalance.com/past-performance-is-no-guarantee-of-future-results-357862">may not continue to do so</a> in the future. </p></li>
<li><p>Look for low fees. Future returns are uncertain, but investment costs will certainly take a bite out of your portfolio. To keep costs down, invest in index funds whenever possible. These funds track broad market indices like the Standard & Poor’s 500 and tend to <a href="https://www.thebalance.com/investing-in-low-cost-index-funds-357951">have very low fees</a> yet <a href="https://www.cnbc.com/2019/03/15/active-fund-managers-trail-the-sp-500-for-the-ninth-year-in-a-row-in-triumph-for-indexing.html">produce higher returns</a> than the <a href="https://ssrn.com/abstract=1356021">majority of actively managed funds</a>. </p></li>
<li><p>Continue to make regular contributions to your investments, even during a recession. Try to set aside as much as you can afford. Many employers <a href="http://longevity.stanford.edu/sightlines-financial-security-special-report-mobile/">even match</a> all or some of your personal retirement contributions. Unfortunately, most Americans are <a href="http://longevity.stanford.edu/sightlines-financial-security-special-report-mobile/#retirement">not saving enough</a> for retirement. <a href="https://financialengines.com/docs/financial-engines-401k-match-report-050615.pdf">One in 4 Americans</a> enrolled in employer-sponsored defined contribution plans does not save enough to get the employer’s full match. That’s like letting your employer keep part of your salary. </p></li>
<li><p>There’s one exception to my advice about standing pat. Let’s suppose your long-term plan calls for a portfolio with 50% in U.S. stocks, 25% in international stocks and 25% in bonds. After U.S. stocks have a good run, their weight in the portfolio may increase a lot. This changes the risk of your portfolio. So <a href="https://www.vanguard.com/pdf/ISGPORE.pdf">about once a year</a>, rebalance your portfolio to match your long-term allocation targets. Doing so can make a <a href="https://www.forbes.com/sites/investor/2011/11/16/does-portfolio-rebalancing-work/#1fc4f9548393">big difference in performance</a>.</p></li>
</ol>
<p>Always keep in mind your overall investment plan and focus on the long-term goals of your portfolio. Many market declines that were scary in real time look like small blips on a long-term chart. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/288824/original/file-20190820-170922-1a1wkr5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/288824/original/file-20190820-170922-1a1wkr5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=402&fit=crop&dpr=1 600w, https://images.theconversation.com/files/288824/original/file-20190820-170922-1a1wkr5.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=402&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/288824/original/file-20190820-170922-1a1wkr5.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=402&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/288824/original/file-20190820-170922-1a1wkr5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=505&fit=crop&dpr=1 754w, https://images.theconversation.com/files/288824/original/file-20190820-170922-1a1wkr5.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=505&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/288824/original/file-20190820-170922-1a1wkr5.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=505&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Warren Buffett knows a thing or two about investing.</span>
<span class="attribution"><a class="source" href="http://www.apimages.com/metadata/Index/Earns-Berkshire-Hathaway/d7c1206a7ac2405ca58abc0667ae43e1/57/0">AP Photo/Nati Harnik</a></span>
</figcaption>
</figure>
<h2>Turbulence ahead</h2>
<p>In the long run, this approach is likely to produce better results than trying to beat the market – which <a href="https://www.investopedia.com/ask/answers/12/beating-the-market.asp">even pros</a> tend to have a hard time doing.</p>
<p><a href="https://www.cnbc.com/2017/10/03/after-winning-bet-against-hedge-funds-warren-buffett-says-hed-wager-again-on-index-funds.html">Billionaire investor Warren Buffett</a> demonstrated this by easily winning a bet that a simple S&P 500 index fund could beat a portfolio of hedge funds – <a href="https://www.investopedia.com/articles/investing/042015/10-most-famous-hedge-fund-managers.asp">supposedly the savviest investors</a> out there, at least judging by the high fees they charge.</p>
<p><a href="http://jasonzweig.com/a-note-on-benjamin-graham/">In the words</a> of legendary investor Benjamin Graham: “The investor’s chief problem and even his worst enemy is likely to be himself.” Graham, who mentored Buffett, meant that instead of making rational decisions, many investors let their emotions run wild. They buy and sell when their gut – rather than their head – tells them to. </p>
<p>Trying to outsmart the market is <a href="https://ssrn.com/abstract=1622184">akin to gambling</a> and it doesn’t work any better than playing a lottery. Passive investing is admittedly boring but is a much better bet long-term. </p>
<p>But if you follow these guidelines and fasten your seatbelt, you’ll be able to ride out the current turbulence. </p>
<p>[ <em><a href="https://theconversation.com/us/newsletters?utm_source=TCUS&utm_medium=inline-link&utm_campaign=newsletter-text&utm_content=expertise">Expertise in your inbox. Sign up for The Conversation’s newsletter and get a digest of academic takes on today’s news, every day.</a></em> ]</p><img src="https://counter.theconversation.com/content/122003/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alexander Kurov does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>A growing number of investors, policymakers and others say the US economy may be at risk of spiraling downward. A finance professor explains how to ride it out.Alexander Kurov, Professor of Finance and Fred T. Tattersall Research Chair in Finance, West Virginia UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1073722018-12-06T11:05:48Z2018-12-06T11:05:48ZBitcoin’s successor? More consistent values might make ‘stablecoins’ a safer cryptocurrency option<figure><img src="https://images.theconversation.com/files/249232/original/file-20181206-128187-1rslglc.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/fluctuations-forecasting-exchange-rates-virtual-money-1221348409?src=s5SU9NtxQR1Vyak0CveZBA-6-9">hiv360/Shutterstock</a></span></figcaption></figure><p>Bitcoin has plunged from a high of almost US$20,000 in December 2017 to as <a href="https://business.financialpost.com/technology/blockchain/bitcoins-deepening-crash-now-approaches-its-worst-bear-markets?utm_medium=Social&utm_source=Twitter#Echobox=1543248857">low as US$3,675</a>. So it’s understandable that some cryptocurrency users might be looking for more stability. With the <a href="https://www.forbes.com/sites/davidpetersson/2018/11/21/bitcoin-crashed-are-stablecoins-the-way-forward/">future of Bitcoin</a> and other cryptocurrencies uncertain, a possible new solution known as “stablecoins” has emerged. This cryptocurrency aims to hold its value better than others, which could offer investors more stability.</p>
<p>Cryptocurrencies are digital tokens that act as a form of currency, effectively allowing people to perform transactions without a bank or intermediary. Most cryptocurrencies have no intrinsic value, and get their price from <a href="https://coinmarketcap.com/">what others will pay</a>. This, <a href="https://www.cnbc.com/2017/06/23/bitcoin-speculation-markets-trading.html">alongside price speculation</a> from those hoping values will rise, has led to <a href="https://www.fool.com/investing/general/2015/12/06/fiat-currency-what-it-is-and-why-its-better-than-a.aspx">significant price volatility</a> in cryptocurrencies. </p>
<p>Unlike other cryptocurrencies, stablecoins aim to maintain their worth better by being redeemable for something else of tangible value, like <a href="https://www.fool.com/investing/general/2015/12/06/fiat-currency-what-it-is-and-why-its-better-than-a.aspx">regular fiat currencies</a> such as US dollars, or even gold. </p>
<p>The stablecoins’ underlying asset (the monetary value that investors expect it to trade at) would normally be deposited with a trusted bank. If people are confident they can redeem these coins in exchange for said currency, and that the issuer has sufficient reserves for all coins in circulation, the price of the stablecoin shouldn’t fall below the underlying asset value.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/249230/original/file-20181206-128193-1cyy8t9.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/249230/original/file-20181206-128193-1cyy8t9.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/249230/original/file-20181206-128193-1cyy8t9.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/249230/original/file-20181206-128193-1cyy8t9.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/249230/original/file-20181206-128193-1cyy8t9.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/249230/original/file-20181206-128193-1cyy8t9.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/249230/original/file-20181206-128193-1cyy8t9.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Tether is one popular stablecoin option, currently worth US$1.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/concept-tether-or-usdt-equals-to1-1019913901?src=SdpQD7nVdgOpeHuslTIhAg-1-2">Akarat Phasura/Shutterstock</a></span>
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<p>The most widely used stablecoins are <a href="https://tether.to/">Tether</a>, <a href="https://www.trusttoken.com/trueusd/">TrueUSD</a> and <a href="https://www.centre.io/usdc">USD Coin</a>, which bind their value to the US dollar. Tether experienced some <a href="https://www.coindesk.com/price-of-tether-stablecoin-tanks-to-18-month-low">short-term volatility</a>, fluctuating between $0.989 and $0.95. TrueUSD has held stable, but USD Coin has had slight instability – though even its biggest drop still remained within 1.8% of the dollar. Compared with other cryptocurrencies, then, stablecoins have remained stable. </p>
<p>But there’s nothing technical keeping the price of stablecoins at a fixed value. If people lose confidence that the issuer has enough assets reserved to honour the value of all coins if redeemed, it could <a href="https://www.bloomberg.com/news/articles/2018-10-14/why-crypto-traders-are-so-worried-about-tether-quicktake-q-a">lead to significant price variations</a>. The price could also rise if demand outstrips supply of a stablecoin. </p>
<h2>Why are stablecoins becoming popular?</h2>
<p>The <a href="https://theconversation.com/you-may-not-actually-own-your-bitcoin-legal-expert-107307">recent crash of Bitcoin</a> and <a href="https://cointelegraph.com/news/after-yesterdays-bloodbath-losses-continue-for-major-cryptos-xrp-overtakes-ethereum">other cryptocurrencies</a>, alongside <a href="https://www.cnbc.com/2017/12/12/why-bitcoin-prices-are-different-on-each-exchange.html">inconsistent trading prices</a> across exchanges, have influenced the perception that cryptocurrencies are unpredictable. The idea of a cryptocurrency with a fixed value has understandable appeal, especially among those wanting to <a href="https://www.ft.com/content/591ad374-e33f-11e8-8e70-5e22a430c1ad">make purchases with cryptocurrencies</a>.</p>
<p>Cryptocurrency exchanges are also moving away from interacting with banking systems because of heightened regulatory interest and attention in cryptocurrency operations. In <a href="https://www.bloomberg.com/news/articles/2018-05-24/bitfinex-said-to-find-bank-in-puerto-rico-after-wells-fargo-exit">some</a> <a href="https://www.bloomberg.com/news/articles/2018-11-02/bank-tied-to-tether-goes-quiet-on-relationship-with-crypto-firm">notable cases</a>, exchanges have even had their <a href="https://www.cryptoglobe.com/latest/2018/10/canadian-bank-freezes-28m-belonging-to-cryptocurrency-exchange/">funds frozen by banks</a>. This has led some popular cryptocurrency exchanges to no longer allow transactions <a href="https://newconomy.media/article/cryptocurrency-exchanges-without-the-support-of-fiat-provide-most-of-the-trading-volume-on-the-market/">between cryptocurrencies and real money</a>. So, in order to buy on these exchanges, people need existing cryptocurrencies – making stablecoins a good option for starting out. </p>
<h2>Will computer algorithms maintain stability?</h2>
<p><a href="https://multicoin.capital/2018/01/17/an-overview-of-stablecoins/">Seigniorage-based stablecoins</a> are the latest development. These use computer algorithms to control the stablecoin’s availability by buying and selling it automatically based on real-time prices, ideally keeping the coin’s price stable. If prices rise, coins from reserves would be made available to buy, which increases supply and reduces price. If the price falls, the algorithm can buy back coins (using other cryptocurrencies held in reserves) to reduce supply and increase the price.</p>
<p>But if supply increases too rapidly, the algorithm won’t have sufficient funds to buy back enough coins to stabilise the price. This could cause the value to plummet, especially if people lose confidence in the coin issuer. However, this can also happen to <a href="https://www.investopedia.com/terms/h/hyperinflation.asp">regular fiat currencies</a>, <a href="https://www.smithandcrown.com/cryptoeconomics-seignorage-shares-look-basis-carbon/">not just stablecoins</a>, as currencies are only valuable if others will accept it – otherwise, it significantly loses worth.</p>
<h2>The future</h2>
<p>Stablecoins might present a solution to short-term volatility, provided the currency backing its value remains stable in worth. But they won’t fix confidence losses, especially if the value of the stablecoin’s reserved assets is questioned. If the ability to redeem this currency is at risk, the stablecoin’s price <a href="https://www.marketwatch.com/story/pressure-mounts-on-tether-as-stablecoin-proves-not-so-stable-2018-10-15">will likely fall</a>. </p>
<p>Seigniorage-based cryptocurrencies may handle limited volatility if they have enough reserves to control supply with algorithmic buying and selling. But this still requires people to willingly hold or accept the coin. Flash price crashes that occur when lots of a cryptocurrency is sold in a short time are <a href="https://www.cnbc.com/2017/06/22/ethereum-price-crash-10-cents-gdax-exchange-after-multimillion-dollar-trade.html">not unheard of</a>, showing the real potential for extreme volatility due to large transactions.</p>
<p>There’s also a significant <a href="https://thenextweb.com/hardfork/2018/10/16/tether-premium-cryptocurrency-exchange/">premium for using stablecoins</a> to purchase other cryptocurrencies. At time of writing, it cost <a href="http://www.untether.space/">almost US$118 per unit</a> more to buy one Bitcoin using Tether than US dollars, despite both supposedly having the same underlying value. If the market saw stablecoins as a solution to cryptocurrency volatility, the price would be the same as it is with cash. </p>
<p>While stablecoins might reduce the amount of risk buyers see in cryptocurrency, especially related to price instability, it’s unlikely they’ll actually be used more generally.</p>
<p>Using stablecoins for day-to-day transactions has many challenges, especially if the system can’t make more coins available if demand increases. Stablecoins also aren’t protected by the <a href="https://www.fscs.org.uk/">compensation schemes</a> some cash bank accounts are, making it unlikely most people will replace their cash accounts. </p>
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<strong>
Read more:
<a href="https://theconversation.com/you-may-not-actually-own-your-bitcoin-legal-expert-107307">You may not actually own your Bitcoin – legal expert</a>
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<p>Regular cryptocurrencies also offer potentially higher returns than stablecoins, which appeals to risk-takers. <a href="https://www.nytimes.com/2018/05/02/technology/bitcoin-goldman-sachs.html">Major investment banks</a> are also exploring ways to take advantage of cryptocurrencies’ price volatility, as this creates more opportunity for profit and will attract investors. </p>
<p>This isn’t to say stablecoins have no future. People living in countries with <a href="https://www.reuters.com/article/us-venezuela-bitcoin-idUSKCN0HX11O20141008">unstable local currencies</a> could use stablecoins to digitally hold a more stable foreign currency. However, while stablecoins could be more secure than real currencies in some situations, the values will still fluctuate if people lose confidence in their worth. </p>
<p>Despite the volatile market, cryptocurrencies like Bitcoin remain popular with investors and ordinary people hoping to <a href="https://finance.yahoo.com/news/meet-people-getting-rich-bitcoin-181650451.html">become Bitcoin millionaires</a>. While stablecoins might seem a shrewd alternative, it’s unlikely people will trade their chance to earn millions for security.</p><img src="https://counter.theconversation.com/content/107372/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Greig Paul has received funding from EPSRC on the Transactive Energy Supply Arrangements project (EP/R002312/1), exploring how blockchain-related technology could be used to facilitate peer-to-peer trading of energy. </span></em></p>Market volatility and value fluctuations are scaring some investors away from Bitcoin – but stablecoins could be one solution.Greig Paul, Lead Security Engineer, University of Strathclyde Licensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/881472017-12-10T23:00:10Z2017-12-10T23:00:10ZHow divesting of fossil fuels could help save the planet<figure><img src="https://images.theconversation.com/files/198232/original/file-20171207-11335-1l3pcpr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">A polar bear walks over sea ice floating in the Victoria Strait in the Canadian Arctic Archipelago in July 2017. Research suggests that divesting in fossil fuels could help nations meet their climate change goals. </span> <span class="attribution"><span class="source"> (AP Photo/David Goldman, file)</span></span></figcaption></figure><p>Recently, a number of institutional investors, including <a href="http://nationalpost.com/pmn/news-pmn/why-canadian-pension-plans-must-divest-of-fossil-fuel-investments">Caisse de dépôt et placement du Québec</a> in Canada and <a href="https://www.nytimes.com/2017/11/16/business/energy-environment/norway-fund-oil.html">Norway’s sovereign wealth fund</a>, announced their intent to reduce their exposure in investments linked to fossil fuels.</p>
<p>The announcements show that investors withdraw their funds to either mitigate financial risks or for ethical reasons. But the question remains whether divestment and divestment announcements have a financial impact on the share price of fossil fuel companies. </p>
<p>We’re a team of researchers at the School of Environment, Enterprise and Development (SEED) at the University of Waterloo. We recently conducted an analysis that suggests divestment announcements have a statistically significant negative impact on the price of fossil fuel shares. Our study aggregates the impact of more than 20 announcements across 200 publicly traded fossil fuel companies. </p>
<p>The results suggest that share prices dropped on the days that institutional investors announced they were divesting of fossil fuels.</p>
<p>We’ve concluded that investors, and the market as a whole, perceive divestment as integral to the long-term valuation of the fossil fuel industry. Lower share prices increase the costs of capital for the fossil fuel industry, which in turn decreases their ability to explore new resources and exploit proven resources. </p>
<p>And if the majority of proven reserves remains in the ground, we may be able to meet our climate change goals.</p>
<h2>Reserves must stay grounded</h2>
<p>The continued exploitation of fossil fuel reserves alone has the potential to increase greenhouse gases and global temperature well beyond the 2°C threshold required to prevent the worst effects of climate change. </p>
<p>To achieve the 2°C target, however, <a href="https://doi.org/10.1038/nature08017">no more than one-fifth of the current proven fossil fuel reserves can be burned</a>.</p>
<p>The necessity to keep the resources in the ground has a direct impact on the valuation of fossil fuel industry assets. They are predominantly influenced not only by production, but also by the value of proven fossil-fuel reserves. In other words, if these resources cannot be exploited, their value will depreciate. </p>
<p>A sudden depreciation would lead to a burst of the so-called <a href="https://www.carbontracker.org/terms/carbon-bubble/">carbon bubble,</a> leaving fossil fuel investments stranded.</p>
<p>To avoid the risk of stranded assets, <a href="https://www.arabellaadvisors.com/wp-content/uploads/2016/10/Measuring-the-Growth-of-the-Divestment-Movement.pdf">a number of influential private and institutional investors</a> have pledged to reduce their fossil fuel investments or divest from the fossil fuel industry entirely. </p>
<h2>Ethical motivations</h2>
<p>Other investors are motivated to divest from fossil fuel shares for ethical reasons. They do not want to be part of an industry that is one of the main drivers of climate change.</p>
<p>To explore the financial impact of divestment announcements on the share price of fossil-fuel sector companies, we analyzed 24 divestment announcements, endorsements and campaign events between 2012 and 2015 (see the list below).</p>
<p>These events received a lot of media coverage, with stories appearing in publications that included the Financial Times and the Wall Street Journal. </p>
<p>Our sample of fossil fuel industry representatives included 200 coal, oil and gas firms listed in <a href="https://fossilfreefunds.org/carbon-underground-200/">Carbon Underground 200</a>, which identifies the top publicly traded companies with the highest potential greenhouse gas emissions based on their reserves.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/196600/original/file-20171128-2009-16yvk0f.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/196600/original/file-20171128-2009-16yvk0f.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=1127&fit=crop&dpr=1 600w, https://images.theconversation.com/files/196600/original/file-20171128-2009-16yvk0f.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=1127&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/196600/original/file-20171128-2009-16yvk0f.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=1127&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/196600/original/file-20171128-2009-16yvk0f.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1416&fit=crop&dpr=1 754w, https://images.theconversation.com/files/196600/original/file-20171128-2009-16yvk0f.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1416&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/196600/original/file-20171128-2009-16yvk0f.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1416&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Divestment announcements, endorsements and campaigns.</span>
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<p>A comparison of the share prices of fossil fuel shares and a global benchmark at the time of a divestment announcement suggests significant differences. </p>
<p>While the general benchmark — the MSCI All Country World Index (ACWI) — has not been affected by the announcements, the fossil fuel share prices decreased, as shown below:</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/197452/original/file-20171203-5381-lyiv2g.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/197452/original/file-20171203-5381-lyiv2g.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/197452/original/file-20171203-5381-lyiv2g.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=268&fit=crop&dpr=1 600w, https://images.theconversation.com/files/197452/original/file-20171203-5381-lyiv2g.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=268&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/197452/original/file-20171203-5381-lyiv2g.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=268&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/197452/original/file-20171203-5381-lyiv2g.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=336&fit=crop&dpr=1 754w, https://images.theconversation.com/files/197452/original/file-20171203-5381-lyiv2g.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=336&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/197452/original/file-20171203-5381-lyiv2g.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=336&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Expected returns and real returns of fossil-fuel industry share prices on event days.</span>
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<p>The results suggest that fossil fuel companies experienced statistically significant negative abnormal returns on the day of a divestment announcement, and in the days following the announcement. Furthermore, our findings demonstrate that more recent divestment announcements had a stronger impact on share prices than earlier such announcements, suggesting a snowball effect.</p>
<p>In May 2014, for example, <a href="https://news.stanford.edu/news/2014/may/divest-coal-trustees-050714.html">Stanford University’s divestment announcement</a> resulted in a negative abnormal return of .009 per cent in the ensuing 10 days for companies listed on the Carbon Underground 200.</p>
<p>A few months later, in September 2014, the <a href="https://www.rbf.org/about/divestment">Rockefeller Foundation divestment announcement</a> resulted in a negative abnormal return of -.22 per cent over the following 10 days. And two months after that, the divestment announcement by the <a href="https://www.theguardian.com/environment/2015/mar/16/norways-sovereign-wealth-fund-drops-over-50-coal-companies">Norwegian sovereign wealth fund</a> resulted in -.24 percent for the shares of the companies listed on the Carbon Underground 200. </p>
<h2>Markets respond</h2>
<p>It seems financial markets are increasingly aware of the importance of divestment. </p>
<p>Divestment announcements by prominent investors signal financial risks to the market, which in turn depress share prices. Therefore, divestment announcements can have a measurable impact on the fossil fuel industry.</p>
<p>The market response to divestment can be either direct or indirect. Market players might directly perceive the announcements of big institutional investors as signalling an increased financial risk to the divested industry. If big market players announce that they divest, others follow.</p>
<p>Alternatively, divestment announcements might have an indirect impact on the reputation of fossil fuel companies. Tarnished reputations weaken confidence and trust in the long-term value of these shares and decreases their price.</p>
<p>Whether the impact is direct or indirect, decreasing share prices make acquiring financial capital more expensive for the fossil fuel industry.</p>
<p>This in turn lowers their ability to explore new resources, exploit proven reserves and secure long-term growth. In other words, lowering fossil fuel industry share prices via divestment can lead to lower productive capacity — and, consequently, to lower greenhouse gas emissions.</p><img src="https://counter.theconversation.com/content/88147/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Olaf Weber receives funding from Social Sciences and Humanities Research Council of Canada (SSHRC).</span></em></p><p class="fine-print"><em><span>Truzaar Dordi and Vasundhara Saravade do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Fossil fuel divestment apparently works. Research suggests announcements of divestments have a significant impact on the fossil fuel industry’s share prices.Olaf Weber, Professor of Sustainable Finance and Banking, University of WaterlooTruzaar Dordi, PhD Candidate, Sustainable Finance, University of WaterlooVasundhara Saravade, Masters Candidate in Environmental Finance and Sustainability Management, University of WaterlooLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/813192017-07-31T19:54:55Z2017-07-31T19:54:55ZThree charts on: who is the typical investor in the Australian property market?<p>Contrary to the image a property investor might conjure up - a wealthy full-time property speculator - most residential investors in Australia don’t actually rely on it as their primary source of income.</p>
<p>In reality, Australia’s residential investment market is dominated by people who, having bought their own home, have moved onto buying an investment property. These small-scale investors own 83% of all investment properties.</p>
<p><a href="http://www.tandfonline.com/doi/abs/10.1080/02673039608720844">Previous research shows</a> that real estate investors tend to be married, wealthy males with <a href="http://onlinelibrary.wiley.com/doi/10.1111/j.1540-6229.2008.00210.x/full">high income and full-time employment</a>.</p>
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Read more:
<a href="https://theconversation.com/why-chinese-investors-find-australian-real-estate-so-alluring-76310">Why Chinese investors find Australian real estate so alluring</a>
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<p>A <a href="http://www.tandfonline.com/doi/abs/10.1080/02673030050134547">typical rental housing investor</a> is a high-income earner or family partnership, owning one or two dwellings as an extra income source. The probability of becoming a residential investor <a href="http://www.rba.gov.au/publications/submissions/housing-and-housing-finance/inquiry-into-home-ownership/proportion-investment-housing-relative-owner-occ-housing.html">tends to increase with age and homeowner status</a>, but declines <a href="http://www.abs.gov.au/ausstats/abs@.nsf/mf/5609.0">after the age of 65</a>.</p>
<iframe src="https://datawrapper.dwcdn.net/QtbE9/2/" scrolling="no" frameborder="0" allowtransparency="true" allowfullscreen="allowfullscreen" webkitallowfullscreen="webkitallowfullscreen" mozallowfullscreen="mozallowfullscreen" oallowfullscreen="oallowfullscreen" msallowfullscreen="msallowfullscreen" width="100%" height="509"></iframe>
<p>With home ownership rates in Australia at around 70%, the <a href="http://www.abs.gov.au/ausstats/abs@.nsf/mf/5609.0">Australian Bureau of Statistics (ABS)</a> reports that residential investment represents, on average, 35% of all housing finance, while the rest are all owner-occupiers. This means residential investment is an important part of the mortgage market and banking system. </p>
<p>Most residential investment is centred around rent or resale; only a small proportion goes on construction of new homes. And residential investment by corporations or big companies represents only 8% of the market.</p>
<p>Private data from a major mortgage provider used in my research (for the period 2003-09) reveals what the typical real estate investor looks like. They are on average 42 years old; 72% are married; and fewer than two-thirds of investors get finance with a co-borrower. Only a third of investors are female. </p>
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<span class="attribution"><span class="source">The Conversation</span>, <a class="license" href="http://creativecommons.org/licenses/by-nd/4.0/">CC BY-ND</a></span>
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<p>According to the same data, residential investors have an average net monthly income of A$8,600, or A$103,200 a year. But if we exclude the 100 investors with a net monthly income over A$100,000, the average net monthly income becomes A$6,617, or A$79,404 a year. </p>
<p>Residential investors, financing the property with a mortgage, have on average A$934,091 in net wealth (50% of investors have A$581,541 in net wealth). Some of them have diverse portfolios; 6% of investors also own shares with an average value of A$4,884.</p>
<p>The data also show that direct residential investors are mainly professionals, in management positions, small business-owners, or workers with a skilled trade. Overall, 27% are self-employed, relative to the 19% of self-employed owner-occupiers.</p>
<h2>Where they invest</h2>
<p>The data reveal that direct residential investors invest mainly on existing houses, as do owner-occupiers when buying a property. The <a href="http://www.abs.gov.au/ausstats/abs@.nsf/mf/5609.0">ABS</a> reports only 3% of investors’ financial commitments are destined for construction of new dwellings.</p>
<p>Our data shows that residential investors are more willing to invest interstate or in a different postcode than owner-occupiers. While almost half of residential investors invest in a property located in a different postcode to where they live, 11% of residential investors buy properties in states other than the state where they live.</p>
<p>Most residential investors choose rural and regional areas to invest. Many residential investors choose to buy property in big metropolitan cities like Sydney and Melbourne. </p>
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<p>However, the top 10 postcodes chosen by residential investors to buy property (between 2003 and 2009) include Cairns (QLD), Mandurah (WA), Torquay (VIC), Mackay (QLD) and Launceston (TAS).</p>
<h2>Why do they invest?</h2>
<p>Our research shows the main reasons for accessing finance to buy a house, other than to live in it, are income and wealth accumulation. </p>
<p>Some investors invest because they see it as a long-term, secure, <a href="http://www.tandfonline.com/doi/abs/10.1080/02673030050134547">“bricks and mortar” investment</a>. To these investors other types of assets (such as shares and bonds) may seem harder to understand and it may be more costly to enter these markets. </p>
<p>A proportion of real estate investors see it as <a href="http://www.jstor.org/stable/2109831">a source of permanent income</a>, while others speculate on the potential capital gains in real estate and invest <a href="https://opus.lib.uts.edu.au/handle/10453/23699">expecting to increase their wealth</a>. </p>
<p>This reason becomes more prominent during periods of strong house price appreciation. For example, between 2003 and 2009 year-to-year average house price inflation has been 8.9%.</p>
<p><a href="http://journals.sagepub.com/doi/abs/10.1177/0042098013484544">Academics have also argued</a> that the Australian taxation system motivates – rather than facilitates – housing investment, as investors are able to access 50% deduction on capital gains <a href="http://journals.sagepub.com/doi/abs/10.1080/0042098993592">and negative gearing</a>. Another motivator to invest in real estate may be more mortgage finance access; for example, between 2003 and 2009 the average 12-month housing credit growth has been of 14.6%. </p>
<p>Of course there are <a href="https://opus.lib.uts.edu.au/handle/10453/23699">other reasons to invest</a>, such as moving up or down and maintaining other property as an investment, or getting a holiday home and keeping it as an investment too. There are also <a href="http://www.tandfonline.com/doi/abs/10.1080/02673039608720844">“unintentional” real estate investors</a> that may have inherited or acquired property.</p>
<p>Most residential investors are your average Australians, who invest in rural or regional areas as a secondary source of income and to gain equity. So when thinking about who is the typical Australian retail investor, you could probably look at your neighbour.</p><img src="https://counter.theconversation.com/content/81319/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Maria Yanotti carried her PhD work with ARC funding support, and has received funding from AHRC. She belongs to the Placemaking Economics Group (<a href="http://sites.rmit.edu.au/placemakingeconomicsgroup/">http://sites.rmit.edu.au/placemakingeconomicsgroup/</a>) . She is also a member of the Board of Directors at The Migrant Resource Centre North.</span></em></p>Individual households in Australia, on average, own 83% of all investment dwellings rented to private tenants or resold. They are people who usually have another main source of income.María Yanotti, Lecturer of Economics and Finance Tasmanian School of Business & Economics, University of TasmaniaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/694222016-12-11T19:08:22Z2016-12-11T19:08:22ZAustralia is ripe for shareholder activism<p>Compared to other developed financial markets, Australia’s conditions favour shareholders when it comes to engaging with the companies they invest in. This is not only because of the rules in <a href="http://asic.gov.au/for-business/running-a-company/members-of-a-company/">Australia’s Corporations Act of 2001,</a> but also because of the large and growing pool of superannuation savings.</p>
<p>Like many other countries, shareholders in Australia vote on executive remuneration reports, commonly known as “say on pay”. This is helped by an increased amount of quality information disclosed to shareholders and companies prioritising shareholder engagement before annual general meetings. </p>
<p>Shareholder activism is done mainly in meetings closed to the general public. Information is only made public if it’s strategically beneficial to someone in the meeting. So it’s hard to verify the exact role shareholder activists play. </p>
<p>According to <a href="http://www.fticonsulting.com/about/newsroom/press-releases/fti-consultings-global-shareholder-activism-map-revealsincreased-shareholder-activism-around-the-globe">FTI Consulting</a>, Australia ranks third in the world on the “activism threat level”.</p>
<h2>Australia’s investing conditions</h2>
<p>The greater power afforded to shareholders partly comes down to the <a href="http://asic.gov.au/for-business/running-a-company/members-of-a-company/">Corporations Act of 2001</a>. </p>
<p>The first power is the two-strike rule, which allows just 25% of shareholders to vote down a company’s remuneration proposal and ultimately spill the boards of directors. <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2876925">According to a study</a> based on 4,145 say-on-pay votes between 2011 and 2013, 306 (7.4%) firms received first strikes, of which 51 (16.7%) received second strikes. This resulted in 12 board spills, with all but 8 directors returned to office. </p>
<p>The study also showed that directors’ accountability increased as shareholders were allowed to vote on remuneration. However, the market considers this type of action, especially when shareholders vote against remuneration, as destroying some of the value of the company. This is reflected in a negative market reaction. </p>
<p>Another measure that affords shareholders some power is the relatively low threshold of 5% of issued shareholdings that’s required to call an extraordinary general meeting. These meetings are used to convey shareholders’ dissatisfaction and demand a change in board composition, or to force strategic business decisions, such as closing down an unprofitable business unit.</p>
<p>One more aspect of Australia’s financial landscape that makes it attractive to shareholder action is its pension savings pool. It’s <a href="https://www.australianshareholders.com.au/news/shareholder-activism-australia-seen-equity-magazine">the fourth largest in the world</a>, at approximately A$2 trillion (forecast to be about A$6 trillion by 2035). These super funds have the voting power to exert influence on board decisions and, given their long-term investments, they have genuine interest in the success of the firm. </p>
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<h2>Active shareholders in Australia</h2>
<p>Many of Australia’s shareholder activist groups or individuals, such as Sandon Capital, Sir Ron Brierley and Thorney Opportunities, are short-term investors. This means they target companies to change the board composition, business strategy and restructure capital.</p>
<p>For example, <a href="http://www.sandoncapital.com.au/site/images/pdfs/1506_Sandon_BSL_AU_presentation.pdf">after publicly releasing</a> an analysis of BlueScope in mid-2015, Sandon Capital worked with other shareholders and the company to restructure its operations. Sandon proposed mothballing the Port Kembla mill, to enable it to pay dividends, save costs and improve performance.</p>
<p>Sandon Capital also campaigned for substantial board changes in mid-2015 at biotech company <a href="http://www.couriermail.com.au/business/sandon-capital-seeks-to-turf-out-biotech-alchemia-founder-tracie-ramsdale-and-chairman-tim-hughes/news-story/174485ccb58faaa1a963475dd08a8f26">Alchemia</a> when it accumulated a loss of A$145 million. This resulted in the retirement of Tim Hughes as chairman of the board and the appointment of Sandon’s proposed Ken Poutakidis as a board director.</p>
<p>Shareholder activity is also concentrated around firms with small to medium-sized market capitalisation. Between 2013 and 2016,
<a href="https://www.abl.com.au/Shareholder-activism-1">86%</a> of the activists targeting Australian companies were from small domestic funds with a maximum of around A$6 billion to invest.</p>
<p>Recently added to this list of activists are long-term investors such as UniSuper, Australian Super and the Australian Council of Superannuation Investors (ACSI). The ACSI represents industry funds such as Cbus, HESTA and Hostplus. </p>
<p>In November, more than 25% of shareholders including these super funds voted down the remuneration proposal at Commonwealth Bank. This is an unprecedented event in the history of Australian markets. It signalled a new era of activism from passive super funds. </p>
<p>The three largest US-based passive funds - BlackRock, Vanguard and State Street – are also shoring up their presence in Australian companies. </p>
<p>According to <a href="http://www.smh.com.au/business/markets/blackrock-vanguard-state-street-are-not-passive-on-corporate-governance-20161030-gseb74.html">Morningstar research</a>, BlackRock owns 5% or more of 43 companies on the ASX, including Bendigo and Adelaide banks, CSL, Rio Tinto, Suncorp and Transurban. State Street Global Advisors holds 5% or more of nine companies, mostly REITs, while Vanguard sits on 32 companies including Tabcorp, Aristocrat Leisure and Mirvac. </p>
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<p>Australian regulatory and institutional environments favour more active shareholder engagements. There isn’t much evidence, though, of any long-term benefits to all shareholders from this type of activism by short-term investors in Australia. <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2656325">Evidence</a> from around the world on this is at best mixed. </p>
<p><a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2505261">Other research suggests</a> the growing power of super investors, with the accumulation of retirement savings in superannuation, will translate into more engagement with the companies they invest in. This also increases the value for other shareholders of the company, its corporate governance and performance. </p>
<p>If we’re looking to the future as to what this trend will bring, perhaps superannuation funds should consider strategically expending the regulatory “tools” afforded to them as shareholders, to add value to companies they invest in with a long-term, rather than short-term, focus.</p><img src="https://counter.theconversation.com/content/69422/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Shams Pathan receives funding from 2013-2016 Australian Research Council Discovery Early Career Research Award (ARC DECRA) # DE140100253. </span></em></p>Australia’s rules on how investors engage with companies, coupled with the clout of superannuation investor groups, means there’s potential for more shareholder activism.Shams Pathan, Senior Lecturer, Finance, The University of QueenslandLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/694182016-12-06T19:09:28Z2016-12-06T19:09:28ZTwitter influences investor behaviour whether companies intend it to or not: new research<p>Companies that tweet corporate news and financial results can significantly affect stock prices even if the company’s tweets contain no new information beyond what is already posted through the stock exchange platform, <a href="http://aaapubs.org/doi/abs/10.2308/isys-50994">my research shows</a>.</p>
<p>I studied 3,516 corporate announcements published by Australian listed companies throughout 2008-2013 at the Australian Stock Exchange (ASX). I found that corporate information sent out on social media can unintentionally influence investor decisions in an unequal way.</p>
<p>Investors often turn to communication and financial disclosure statements to make decisions on where to allocate money. While the volume of information that is disclosed is closely watched by the company law and listing rules, my research shows that breadth and depth of dissemination of financial information is equally important.</p>
<p>While a common belief is that prices in the market reflect all available information, the reality is far from this. Individual investors are limited in time and resources and are unable to track all securities and release of all new information. </p>
<p>So, companies that put extra effort to reach their investors are rewarded; they are able to grab the investors’ attention and lead them closer to the decision to invest. In line with this, there has been a recent influx in the business use of social media in Australia. </p>
<p><a href="http://www.abs.gov.au/ausstats/abs@.nsf/mf/8129.0">A report from the Australian Bureau of Statistics (2015)</a> shows that near a third of all businesses have a social media presence, while almost half have some sort of web presence. For Australian listed companies, this number is even higher. </p>
<p><a href="http://buchanwe.com.au/asx200-social-media-survey-results-and-other-resources/">A 2013 report</a> identified that 78% of Standard & Poor’s (S&P)/ASX 2005 companies use at least one social media channel and 66% intended to increase their social media activity. At the time, the leading position among social media belonged to Twitter (47%) and LinkedIn (58%). While LinkedIn is used predominantly for recruitment purposes, Twitter is more popular for company communication and investor relations. </p>
<p>My research shows that where social media presence is higher for larger businesses – companies that employ more than 200 people – the effect of web presence and social media is more pronounced than for smaller businesses. Smaller companies have less press coverage and financial analysts following and are generally less visible to investors. However, these less visible companies tend to be more effective in employing Twitter to engage with investors.</p>
<p>Australian companies exhibit different patterns of using Twitter. While large companies tweet more often, the <a href="http://get.simplymeasured.com/twitter-study-pm.html">smaller companies tend to share</a> more hyperlinks and use more hashtags in their tweets. </p>
<p>While hashtags provide a way to label messages posted on Twitter, they are used to promote firms and specific topics making it easier to find and share information related to them. Similarly, hyperlinks usage in tweets is shown to increase retweeting, promote information diffusion and attract users’ attention.</p>
<p>Unlike other common ways to promote the existing financial information, for example business press and financial analysts, social media give companies more control. The company can send out more information and can establish a direct rapport with their existing or potential investors. Social media also allows companies to promote the release of financial information and engage with investors through multiple channels.</p>
<p>However, it is not always that simple. Social media can become a powerful weapon as well. </p>
<p>In 2012-13 several ASX-listed companies, including David Jones and <a href="http://www.smh.com.au/business/whitehaven-joins-asic-to-fight-hoax-20130107-2ccr4.html">Whitehaven Coal</a>, suffered a significant drop in their stock prices due to market rumours spreading over social media channels. These cases led the ASX to introduce <a href="http://www.asx.com.au/documents/rules/Guidance_Note_8.pdf">Guidance Note 8</a>, which requires all ASX-listed companies to monitor social media for rumours and potential announcement leaks.</p>
<p>With additional corporate resources required to comply with this guidance, social media becomes a critical point that requires attention from the side of investors, companies, regulators and IT experts alike.</p><img src="https://counter.theconversation.com/content/69418/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Maria Prokofieva does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Social media communication like Twitter can influence investor decisions in an unequal way and whether the company intends it or not, research finds.Maria Prokofieva, Senior lecturer in Accounting and Finance, Victoria UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/697722016-12-06T03:55:23Z2016-12-06T03:55:23ZFive ways to spend with more social purpose this Christmas<p>It’s the season of giving – and spending. While the common adage is that money can’t buy happiness, others have suggested that if your money isn’t buying you happiness, <a href="https://www.ted.com/talks/michael_norton_how_to_buy_happiness">then you are spending it in the wrong way</a>. </p>
<p>Research is showing that the money you would usually spend on presents can become part of a social movement and address problems in our society. Here are five global trends that are creating change for good and enable you to take action.</p>
<h2>1. Civic crowdfunding</h2>
<p><strong>Action: Get rewarded for donating to online campaigns</strong></p>
<p>Many online platforms have emerged that enable citizens to raise awareness about causes, post and manage campaigns, and raise donations. These include <a href="https://startsomegood.com">StartSomeGood</a> and <a href="https://chuffed.org">Chuffed</a>. The volume of the overall global crowdfunding market is estimated at <a href="http://crowdexpert.com/crowdfunding-industry-statistics/">US$34 billion</a>, with reward and donation-based crowdfunding worth around US$5.5 billion of that total market. </p>
<p><a href="http://reports.crowdsourcing.org/?route=product/product&product_id=54">Reports</a> indicate that a growing number of campaigns offer <a href="https://chuffed.org/christmas">perks or rewards</a> in return for donations. What this means is that instead of just donating to, say, a refugee rooftop garden in the inner city, you receive in return the experience of having dinner in that garden using its produce. Or your donation to rescue chickens provides you with a monthly carton of eggs. </p>
<p>Now some may say that this is to the detriment of altruism – only giving if you get something in return. This may be true, but another way of viewing this trend is seeing how this shift from donations to value-exchange (reward) transactions begins to disrupt models of giving. This shift enables access to the retail spending market – a much bigger funding opportunity than donations. </p>
<h2>2. Social enterprise and social entrepreneurship</h2>
<p><strong>Action: Buy your gift baskets, with goods from social enterprises</strong> </p>
<p>These days <a href="http://www.uts.edu.au/about/uts-business-school/management/news/every-entrepreneur-social-entrepreneur-hartigan">all entrepreneurs need to be social entrepreneurs</a>, yet how you organise a business to achieve both social and financial returns <a href="https://ssir.org/articles/entry/in_search_of_the_hybrid_ideal">presents many options and challenges</a>. </p>
<p>This includes: finding the correct legal structure, financing, tensions between serving customers and beneficiaries (if they are not the same group) and employees that understand this model. Debate still continues as to whether Australia <a href="http://www.employeeownership.com.au/a-community-interest-company-structure-in-australia/">needs a new legal structure</a> for social enterprises or <a href="https://chuffed.org/blog/the-social-benefit-company">not</a>.</p>
<p><a href="https://au.whogivesacrap.org">WhoGivesACrap</a> is an example of a social enterprise generating stakeholder value (as opposed to only shareholder value). It’s a for-profit firm where 50% of profit from selling toilet paper and paper towels goes to building toilets and other projects in developing countries. </p>
<p>Another is <a href="https://thankyou.co">Thankyou.co</a>, which sells bottled water, body care and food products and has raised over A$3.7 million for safe water, hygiene and sanitation, and food security programs. It <a href="https://thankyou.co/structure">donates 100% of its profits</a> and consumers can track their individual impact through impact trackers on each product. </p>
<p>These business models have become increasingly attractive to consumers, creating a competitive advantage for firms. But it’s also also putting these organisations under increased <a href="http://www.smh.com.au/national/fundraiser-thankyou-water-drops-support-for-evangelical-group-20130820-2s987.html">scrutiny</a> with demands to be transparent about their onward donations.</p>
<h2>3. BCorporation certification</h2>
<p><strong>Action: Purchase gifts and services from certified BCorporations</strong></p>
<p>Nearly 10 years ago, <a href="https://en.wikipedia.org/wiki/B_Lab">BLab</a> was created – a non-profit organisation that certifies companies as a BCorporation. This means the company is achieving certain levels of social and environmental performance, checked and certified by the organisation.</p>
<p>It’s based on the premise the businesses have a responsibility not only to shareholders but to the community and planet. In “<a href="http://bcorporation.com.au">using business as a force for good</a>”, there are now over 1,900 certified BCorporations in 50 countries, across 130 industries from food and homewares to manufacturing and services. </p>
<p>Increasingly, BCorporation firms are networking with each other, <a href="http://www.afr.com/leadership/entrepreneur/b-corporation-movement-wins-rich-backers-in-australia-20131119-jy9n4">building a global community of products and services</a>. As with other certification systems, a BCorporation stamp holds companies to account for their financial and social performance. For example, online craft platform and BCorp-certified Etsy was recently <a href="https://www.ft.com/content/74db0a52-50da-11e5-8642-453585f2cfcd">questioned about its tax practices</a>. </p>
<p><a href="https://www.bcorporation.net/become-a-b-corp/how-to-become-a-b-corp/performance-requirements">Certification</a> (and re-certification every two years) requires submission of supporting documents, disclosure statements and background checks of applicants. BCorporation certification is described as the business equivalent of a <a href="https://en.wikipedia.org/wiki/Fairtrade_certification">Fairtrade</a> certification on coffee. </p>
<h2>4. Microfinance</h2>
<p><strong>Action: Make a micro loan to a very small business</strong></p>
<p>It might be the season of giving by lending too. Microfinance has been around for over 30 years, with early proponents now <a href="https://en.wikipedia.org/wiki/Muhammad_Yunus">having won Nobel prizes</a> for their efforts. </p>
<p><a href="https://en.wikipedia.org/wiki/Microfinance">Microfinance</a> refers to lending small amounts of money (say $25) to individuals or groups that mainstream banking often neglects. For example, <a href="http://www.grameen.com">Grameen Bank</a> was established to provide micro loans to rural women of Bangladesh. Some of these women use the loans to buy a cow, to then produce and sell milk in their village, and are then able to repay their loan. </p>
<p>Despite becoming more mainstream and global, microfinance still <a href="http://knowledge.wharton.upenn.edu/article/the-dark-side-of-microfinance-an-industry-where-the-poor-play-cameo-roles/">has its issues</a>. One concern is that many loans are now being used for consumption rather than to start or grow an enterprise (resulting in borrowers struggling to repay loans). Author <a href="http://www.cgdev.org/blog/hugh-sinclair-replies">Hugh Sinclair</a> and others argue that the sector needs more regulation and transparency. </p>
<p>Despite these concerns, microfinance plays an important role in social enterprise development, especially where other financial services are difficult to access. </p>
<p><a href="https://www.kiva.org/about">Kiva</a> is one of the more successful platforms in this space, connecting individual entrepreneurs (micropreneurs) or groups of entrepreneurs and NGOs with lenders anywhere in the world. Similar to other platforms, it uses an online payment system to transfer money as loans (minimum US$25) to entrepreneurs in developing and developed countries. </p>
<p>Since it began in 2005, Kiva has lent over US$936 million from 1.6 million lenders to <a href="https://www.kiva.org">over 2 million entrepreneurs across 82 countries</a>. It relies on ratings and transparency to make the platform work and to provide lenders in particular with a sense of security. </p>
<p>Amazingly, Kiva has 97.1% repayment rate. So it is highly likely that your loan of US$25 or more comes back to you, enabling you to lend it out again.</p>
<h2>5. Impact investing</h2>
<p><strong>Action: Consider superannuation funds or investment managers who invest ethically and for social impact</strong></p>
<p>Impact investing seeks a social and financial return. It is not an asset class, but rather a <a href="https://theconversation.com/impact-investing-grabbing-a-piece-of-the-650-billion-market-24837">lens through which to make investment decisions</a>. </p>
<p>Consumers and their investment managers are offering more strategies that achieve social impact. The global and growing impact investment market is <a href="https://theconversation.com/impact-investing-grabbing-a-piece-of-the-650-billion-market-24837">estimated to be worth $650 billion by 2030</a>. This coincides with the <a href="https://theconversation.com/fossil-free-superannuation-is-an-idea-thats-going-to-snowball-31464">fossil fuels divestment</a> movement.</p>
<p>This is also supported by shifts in philanthropy towards impact investing. For example, groups such as <a href="http://theimpact.org">The Impact</a>, led by Rockerfeller’s grandchildren, are redirecting family wealth into impact investing opportunities.</p>
<p>Market infrastructure (such as rules, ratings, platforms, assessors) is also emerging, such as the <a href="http://giirs.nonprofitsoapbox.com/about-giirs/how-giirs-works/159">Global Impact Investing Rating System</a> and even <a href="https://theconversation.com/social-stock-exchanges-do-we-need-them-35898">social stock exchanges</a> (platforms that connect investors and enterprises) to help direct funds into impact investment opportunities. </p>
<p>So, disrupting the retail spending market for good can start with individual purchasing power and transform into a bigger movement for social change. The business and organisational models are already there to increase opportunities for spending and investing - not just to avoid harm but to do good.</p><img src="https://counter.theconversation.com/content/69772/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Danielle Logue has received research funding from the Department of Foreign Affairs & Trade.</span></em></p>Five tips on how to spend in a way that contributes to social movements this Christmas.Danielle Logue, Associate Professor in Innovation, Entrepreneurship & Strategy, University of Technology SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/657932016-09-22T20:28:17Z2016-09-22T20:28:17ZAustralian investors want bankable projects that help us adapt to climate change<figure><img src="https://images.theconversation.com/files/138713/original/image-20160922-21695-nn2tan.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Projects to adapt to climate change have come a long way since the 1960s when piles of cars were used to fight beach erosion.</span> <span class="attribution"><a class="source" href="http://app.griffith.edu.au/sciencesimpact/seawall-engineering/">Griffith University</a>, <span class="license">Author provided</span></span></figcaption></figure><p>Australia faces increasing costs of adapting to climate change over the coming years, but new research shows that, despite an appetite from investors to buy green bonds designed to deal with this, there are barriers that prevent this type of financing. </p>
<p>The <a href="https://www.nccarf.edu.au/content/research-projects">Griffith University research</a> involved interviews with 29 public and private sector stakeholders representing 25 organisations. These included all levels of government, institutional investors, bankers, insurers, consultants, advisors and legal experts. </p>
<p>In the past few years, the challenges of climate change have become increasingly apparent. The impacts and costs are evident, whether through record-breaking average temperatures, extreme events such as coastal erosion from East Coast Lows, droughts in north Queensland and Tasmania, or floods in Tasmania and Victoria. The need to adapt to climate change is essential, and will be expensive. </p>
<p>Globally, investment in adaptation amounts to <a href="http://unctad.org/en/PublicationChapters/wir2014ch4_en.pdf">US$20-25 billion, leaving a $60-$100 billion investment gap</a>. In Australia, <a href="http://australianbusinessroundtable.com.au/assets/documents/Report%20-%20Social%20costs/Report%20-%20The%20economic%20cost%20of%20the%20social%20impact%20of%20natural%20disasters.pdf">the economic cost of natural disasters</a> exceeded A$9 billion last year alone. It is forecast to rise to A$33 billion per year by 2050 – according to conservative calculations. </p>
<p>Government at all levels will not be able to pay for adaptation. Therefore, there is a need to think about how best to promote adaptation as an opportunity for the finance sector. </p>
<p>The research shows investors are looking for green bonds that support bankable and scalable projects helping Australia adapt to climate change and mitigate its effects, but that also generate a return on investment. However, there are no agreed ways to demonstrate when a city, infrastructure or coast has successfully adapted to climate change. So not only are there no standards around green bonds for adaptation, these bonds don’t exist yet in Australia. </p>
<p>The bonds that governments and corporations use to raise capital for projects are different to bank loans. They are issued over a specific time and have a set face value when issued that is paid back upon maturation. </p>
<p>Most green bonds demonstrate green credentials through projects that reduce carbon emissions, which mitigates climate change. Green adaptation bonds would incorporate elements or projects that “climate-proof” investments or increase resilience to extreme events caused by climate change.</p>
<p>Green bonds have performed extraordinarily well in the market. For example, the global value of these bonds has <a href="https://www.climatebonds.net/market/history">tripled from to US$11 billion in 2013 to over US$36 billion in 2014</a> and <a href="https://www.climatebonds.net/files/files/CBI-HSBC%20report%207July%20JG01.pdf">almost US$56 billion mid-2015</a>. However, there is still a need for these bonds to support adaptation projects in Australia such as seawalls, beach restoration or stormwater upgrades. </p>
<p>A key problem in getting green adaption bonds financed is that the bulk of responsibility for adaptation falls on local governments, which typically do not have the means to negotiate directly with investors, let alone access private sector funds. </p>
<p>Another barrier is that many adaption projects aren’t aggregated. The research shows that, to bring adaptation projects to the notice of investors, projects have to be substantial in size – at least A$20-25 million.</p>
<p>At the moment several large adaptation projects would need to be aggregated to make up a green bond, which are usually issued at around A$300-400 million. Suitable investments also must demonstrate a cash flow and return on investment, but the size of this is variable.</p>
<p>Yet the research findings still provide some hope that private sector financing for adaptation can become a reality. There is substantial interest and willingness to finance adaptation bonds in the private sector. As one research participant, Emma Herd, <a href="http://www.igcc.org.au/resources/Documents/IGCC_Adaptation_Guidance_web_Full_FINAL.pdf">CEO of the Investor Group on Climate Change (IGCC), stated</a>:</p>
<blockquote>
<p>“Investors know that a certain level of climate change is now locked into the system and will increase the physical risks and costs for business, infrastructure and the economy. Investing today to increase resilience to the physical impacts of the future is critical for reducing the costs of climate change.” </p>
</blockquote>
<p>In addition to this, private sector financiers in Australia already have some experience dealing with the risks posed by climate change, often as part of their environment, social and corporate governance requirements. Investors can build on this existing knowledge and protocols to seek out the opportunities represented by adaptation bonds. </p>
<p>All of this is backed up by Australia’s strong track record in climate finance. For example, the Victorian government and the National Australia Bank (NAB) are recognised leaders in the development of large-scale climate or green bond investment, along with the likes of the European Investment Bank. NAB issued Australia’s first climate (certified) bond in 2014, while the Victorian government recently <a href="http://www.premier.vic.gov.au/victorian-green-bonds-an-australian-and-world-first/">made headlines</a> as the first state or federal government in the world to issue a climate-certified green bond. </p>
<p>The research calls for rethinking and reforming partnerships between local and state government and private sector investors. An example is amending treasury standards to allow local governments to work with the private sector for investment. It also highlights the need for developing adaptation bond standards. </p>
<p>In some cases, a combination of public and private funding may be the only way forward. Still, any private sector investment is a way to stretch public money for adaptation further, something that will be increasingly important over time.</p><img src="https://counter.theconversation.com/content/65793/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Zsuzsa Banhalmi-Zakar receives funding from the National Climate Change Adaptation Research Facility. </span></em></p><p class="fine-print"><em><span>David Rissik does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>To pay for the increasing costs of climate change Australia should have green bonds that finance projects that help us adapt. However research shows there are barriers to financing these bonds.Zsuzsa Banhalmi-Zakar, Visiting Research Fellow at Griffith Institute for Tourism, Griffith UniversityDavid Rissik, Deputy Director (General Manager), National Climate Change Adaptation Research Facility, Griffith UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/653282016-09-14T20:16:04Z2016-09-14T20:16:04ZShadow banking increases the risk of another global financial crisis<p>Banks may still be evading increased regulation by shifting activities to shadow banking. This system is well established as part of the financial sector, but it provides products that separate an investor from an investment, making it more difficult to evaluate risk and value.</p>
<p>This lack of transparency increases the risk in our financial system overall, making it vulnerable to the types of shocks that caused the 2008 global financial crisis. A current example is the so-called <a href="http://www.bustle.com/articles/136706-what-is-a-bespoke-tranche-opportunity-the-big-short-ends-with-a-big-warning">“bespoke tranche opportunity”</a> offered by shadow banks. This is similar to the notorious collateralised debt obligations, packages made up of thousands of mortgage loans some of which were sub-prime, blamed for the global financial crisis.</p>
<p>Shadow banking is comprised of hedge funds, private equity funds, mutual funds, pension funds and endowments, insurance and finance companies providing financial intermediation without explicit public liquidity and credit guarantees from governments. Shadow banking is usually located in lightly regulated offshore financial centres.</p>
<p>In the period leading up to the global financial crisis, a large portion of financing of securitised assets that allowed regulated banks to exceed limitations on their risk-taking was handled by the shadow banking sector.</p>
<p>To this day, shadow banking continues to make a significant contribution to financing the real economy. For example, <a href="http://www.fsb.org/2015/11/global-shadow-banking-monitoring-report-2015/">according to the Financial Stability Board</a>, in 2013 shadow banking assets represented 25% of total financial system assets. While the average annual growth in assets of banks (2011-2014) was 5.6%, shadow banking growth stood at 6.3%.</p>
<p>A comparison of country-based share of shadow banking assets between 2010 and 2014 reveals the largest rise for China from 2% to 8%, while the USA maintains its dominance of the shadow banking markets with around 40%. </p>
<p>The failure of private sector guarantees to help shadow banking endure the global financial crisis can be traced to underestimated tail risks by credit rating agencies, risk managers and investors. Credit rating agencies <a href="https://theconversation.com/why-credit-rating-agencies-economic-advice-shouldnt-be-trusted-63253">lack of transparency</a>, when it comes to explaining their methods (often disguised as “commercial-in-confidence”), continue to make it difficult for a third party to check assessments.</p>
<p>An excess supply of inexpensive credit also contributed to risk before the global financial crisis of 2008. This was because investors overestimated the value of private credit and liquidity enhancements.</p>
<p>One of the key challenges for regulators now is to devise rules and standards requiring shadow markets to hold enough liquidity to be sufficiently sensitive to risk. However, where investors and financial intermediaries fail to identify new risks, it is less likely that the regulators – who have fewer resources – will succeed. </p>
<p>Raising capital requirements can limit the capacity of financial intermediaries to expand risky activities, although monitoring overall bank leverage may be better. This is because credit ratings cannot be relied upon in the presence of neglected risks. Similarly, monitoring rising exposure of regulated banks to shadow banking or untested financial innovations can also become part of the regulator’s arsenal. </p>
<p>But there remains a major problem that is unlikely to be resolved by any regulation. Regulation is meant to strike a fine balance between close supervision and allowing space for financial innovation because loss of diversity can create stronger channels of transmission and could expose financial systems to greater systemic risk. </p>
<p>Too little regulation encourages excessive risk taking, while too tight a regulation is bound to strangle the financial sector that provides the lifeline for the economy. Striking such a fine balance is next to impossible in a dynamic, global financial sector.</p>
<p><a href="https://theconversation.com/au/topics/basel-iii-2557">The Basel Accords</a>, set up to strengthen regulation after the financial crisis, will continue to play a key role in helping manage systemic risk like this. For example regulations can collect data that would be useful in macroprudential regulation, taking action to reduce various risks and remaining alert to unfolding trends on the ground. </p>
<p>Regulators need to heed the trends in shadow banking as part of this, to ensure transparency. However the nature of this sector, the long chains and multiple counterparties with unclear financial obligations, will continue to make the job of the regulator very difficult.</p><img src="https://counter.theconversation.com/content/65328/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Necmi K Avkiran does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The financial products offered by the shadow banking sector allow investors to be further removed from their investments and banks to escape regulation, increasing the risk in the sector overall.Necmi K Avkiran, Associate Professor in Banking and Finance, The University of QueenslandLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/626902016-07-19T20:09:05Z2016-07-19T20:09:05ZBusiness Briefing: The hurdles, pitfalls and payoffs of investing in Indonesia<figure><img src="https://images.theconversation.com/files/131044/original/image-20160719-13859-1345ght.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">A typical street business in Jakarta, Indonesia.</span> <span class="attribution"><span class="source">Michelle Robinson/Flickr</span>, <a class="license" href="http://creativecommons.org/licenses/by-nc-nd/4.0/">CC BY-NC-ND</a></span></figcaption></figure><p>As Indonesia’s middle class grows, so too does demand for services and products, such as education, health and processed food. Australia is well placed to supply these, however businesses must first tackle layers of regulation and bureaucracy. </p>
<p>There are signs Australia and Indonesia may be moving towards a free trade agreement but this won’t address the problems not related to tariffs like specifications on labelling, marketing and competing with local firms. </p>
<p>What many Australian investors and businesses don’t understand is that there isn’t much rule of law in Indonesia, says Matthew Busch, a PhD candidate at the University of Melbourne who has been studying the country’s political economy. So if there’s a problem, the courts can’t be relied on to fix it.</p>
<p>However there are ways to avoid the pitfalls of doing business in Indonesia, as Busch explains.</p><img src="https://counter.theconversation.com/content/62690/count.gif" alt="The Conversation" width="1" height="1" />
When it comes to doing business in Indonesia, some Australian businesses have a lot to learn.Jenni Henderson, Section Editor: Business + EconomyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/618012016-07-04T20:09:26Z2016-07-04T20:09:26ZCompanies may be misleading investors by not openly assessing the true value of assets<p>Some companies are taking years to recognise asset impairments, and may be misleading investors who are not privy to the valuation decisions. <a href="http://onlinelibrary.wiley.com/doi/10.1111/acfi.12194/abstract;jsessionid=28E40CB08241FC768F2A5AD93B5C07E5.f04t03">Research</a> shows this is because managers of many firms think or hope that assets are not overvalued. </p>
<p>This occurs when companies either don’t recognise, or delay the recognition of asset impairments. These asset impairments represent a downward adjustment in the value of assets, to what is called “recoverable amount”. This is determined by either the value the asset could be sold for, or its value to the business right now. </p>
<p>One example of this process of recognising asset impairments can be easily seen in Nine Entertainment Corporation Ltd in 2015. Through the first half of 2015 the share market value declined significantly, and by year end its book value (the value of net assets on the balance sheet) would have exceeded the firm’s market value. </p>
<p>This was probably occurring as investors revised their estimates of future returns in response to changes in the television industry and increasing competition from pay television, internet-based television and other online media. These factors are indicators of declining asset values, which are explicitly identified in the regulation, and this requires a test for asset impairment by the firm. </p>
<p>Next, Nine would have determined the recoverable amount of the assets. The company would have had to estimate future returns and, while there are extensive guidelines on how this should be done, considerable judgement is still required. The end result in this case was an asset impairment of A$792 million that resulted in Nine reporting a loss for the year. </p>
<p>The Australian Securities and Investment Commission (ASIC) regularly reviews the financial reports of listed firms. Where necessary, it seeks their explanations for particular accounting treatments. Risk-based criteria are used to select which firms are reviewed and in some instances this leads to material changes in their reports.</p>
<p>The most recent review by the corporate regulator into <a href="http://www.asic.gov.au/about-asic/media-centre/find-a-media-release/2016-releases/16-205mr-asic-review-of-31-december-2015-financial-reports/">end-of-year financial reports</a> for 2015 found the biggest number of the queries (11 out of 24) into accounting related to the valuation of assets. </p>
<p>It is unlikely this is a consequence of poor regulation. The regulation sets out clear criteria, identifying the circumstances when asset impairment should be formally considered (i.e., where indicators of impairment exist) and the basis for calculating the amount of asset impairment. </p>
<p>In some cases determination of asset impairments should be straight forward. For example, where firms are unprofitable and the book value exceeds the market value of equity, the indicators of impairment are readily observable to all because it can be identified using “firm level” information. </p>
<p>However, in other cases it is not so straightforward and determining whether impairments are necessary and calculating the recoverable amount is then much more difficult. </p>
<p>Asset impairments are required to be evaluated at the level of business units, or what the regulation refers to as “cash-generating units”, rather than at the firm level. Accordingly, while asset impairments may be necessary in some business units, the need for or amount of asset impairments may be obscured in firm-level information. </p>
<p>For example, Arrium is clearly experiencing financial problems and has made a number of asset impairments. But it is not all bad; some of its business units are profitable. When the firm level information is considered it may start to mask the very poor performance in other business units. Hence, whether the need for asset impairment is obviously necessary will depend on relative size and number of poorly performing business units. </p>
<p>Significant judgement will be required in these cases. This includes defining business units and attributing assets to them. Only then can future returns be estimated, and this can never be done with certainty. If there are problems with the exercising of this judgement, then maybe the assumptions on which asset impairment decisions are based should be made clear and disclosed. </p>
<p>Unfortunately, the people who use these financial statements, such as investors, are often kept in the dark because firms are only required to disclose the assumptions behind their judgements if an impairment is actually made. However if these disclosures were always made, it would either support the asset values reported, or alternatively confirm that asset impairments are really necessary.</p>
<p>In the absence of these disclosures, investors and other users of financial statements do not get important up-to-date information about future returns that would underpin share prices. </p>
<p>It’s time to amend the regulation and reveal the explanations for not recognising asset impairments. Whenever there are indicators that impairment is necessary, companies should be required to disclose their assumptions even if the decision is not to impair.</p>
<p>Doing this will highlight how asset impairments are being (or, more critically, not being) determined and assets valuation will always be more transparent.</p><img src="https://counter.theconversation.com/content/61801/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Managers of well-known Australian companies are misleading investors by taking years to recognise asset impairments and not disclosing that information in financial reporting.Peter Wells, Professor, Accounting Discipline Group, University of Technology SydneyBrett Govendir, Lecturer, University of Technology SydneyRoman Lanis, Associate Professor, Accounting, University of Technology SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/596592016-05-25T03:04:08Z2016-05-25T03:04:08ZReducing energy use is a big winner for business and the climate<figure><img src="https://images.theconversation.com/files/123873/original/image-20160525-25205-22unho.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Airlines have saved energy by changing flight routes and modifying wings for better fuel use.</span> <span class="attribution"><span class="source">Plane image from www.shutterstock.com</span></span></figcaption></figure><p>Companies could improve their profits by 2-10% each year by saving energy. That’s just one of the findings of ClimateWorks Australia’s <a href="http://energyproductivity.net.au/">Energy Productivity Index</a>, a world-first attempt to assess companies’ energy performance and help investors make better decisions. </p>
<p>Investors are increasingly engaging with companies to address the <a href="http://www.mercer.com.au/services/investments/sustainable-growth/climate-change-report-2015.html">risks associated with climate change</a>. Extreme weather events, carbon-intensive assets and greenhouse gas emissions are becoming part of a routine risk assessment on the impact of a company’s profitability. </p>
<p>While a company’s energy use can have a significant impact on its bottom line and environmental credentials, energy productivity and efficiency have traditionally been difficult for investors to assess. This is mainly due to a lack of tools to measure and assess energy use and poor levels of disclosure by companies.</p>
<p>My colleagues and I have developed a guide to help investors figure out how potential investments are performing. We assessed 70 companies across six industrial sectors: airlines, automobiles, paper, steel, chemicals and construction. </p>
<h2>Saving energy …</h2>
<p>Many industrial companies spend a huge part of their operating expenditure on energy – <a href="http://energyproductivity.net.au/">typically more than 15%</a>. </p>
<p>Energy productivity generally refers to the amount of revenue per unit of energy, so improving energy productivity can greatly improve a business’s investment value.</p>
<p>We found that more than 70% of the companies analysed have significant room for improvement in their energy use. Even more startling is the wide variation between companies in the same sector.</p>
<p>In some sectors, the leaders are achieving energy productivity levels up to five times the levels of poorer performers.</p>
<p>For example, in the automobile sector, Toyota produces eight times more vehicles per gigajoule of energy used than the least productive company, Daimler.</p>
<h2>… making money</h2>
<p>We also found that improving energy efficiency (by using less energy) could significantly boost a company’s profit. Of all the sectors analysed, airline companies reported the largest savings. </p>
<p>United Continental reported annual savings of US$343 million in 2014. This was achieved through initiatives that reduce fuel use, such as improved flight planning, replacing old planes, washing engines and installing <a href="http://www.airspacemag.com/flight-today/how-things-work-winglets-2468375/?no-ist">winglets</a>.</p>
<p>And despite operating in an energy-intensive sector, steel company Arcelor Mittal achieved almost US$200 million in energy savings in 2014.</p>
<p>The analysis also shows that one-third of the companies analysed could boost their profit margins by more than 5% a year if they matched the performance of leaders in their sector. </p>
<p>Even accounting for upfront capital costs needed to achieve best practice, energy efficiency can still increase profits by 2-10% each year. Most energy initiatives could be paid off in less than three years.</p>
<p>Even a 2% improvement in profits for companies in the automobile sector would be equal to about US$100 million. To achieve an equivalent increase in profits from revenue growth, a company would need to sell an extra 90,000 cars each year.</p>
<h2>Ranking companies</h2>
<p>Several factors affect a company’s energy performance. We looked at three:</p>
<ul>
<li><p>Resilience to energy costs measured through how much a company spends on energy and its profitability. A company that spends less on energy and has greater profitability is more resilient to changes in energy prices.</p></li>
<li><p>Energy productivity measured by a company’s current ability to generate revenue or increase its production per unit of energy used.</p></li>
<li><p>Energy efficiency measured by a company’s efforts in identifying and implementing energy savings. We included the extra financial gain of a company matching the energy efficiency of leading performers.</p></li>
</ul>
<p>While we were able to rank many companies, we found that many others are not disclosing sufficient data on energy use to be assessed. Of 181 companies that reported in the six sectors analysed, 73 had incomplete or insufficient data for benchmarking. Much improvement is needed on data availability and data quality. </p>
<h2>The global goal</h2>
<p>While improving energy performance may be great for the bottom line, there’s another big reason energy use is so important. <a href="https://www.iea.org/publications/freepublications/publication/MediumTermEnergyefficiencyMarketReport2015.pdf">According to the International Energy Agency</a>, energy-efficiency gains could achieve about 40% of the emissions reductions required by 2050 to limit global warming to less than 2°C. </p>
<p>Engaging with companies in their portfolios to improve their energy productivity is a measurable and profitable way to reduce emissions and avoid dangerous climate change. </p>
<p>Improving energy productivity has benefits not just for those investors and companies directly involved, but for all of us.</p><img src="https://counter.theconversation.com/content/59659/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Wei Sue does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Companies could improve their profits 2-10% each year by saving energy, according to a world-first attempt to assess energy performance.Wei Sue, Business analyst, ClimateWorks Australia, Monash UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/555052016-03-08T04:15:36Z2016-03-08T04:15:36ZNegative gearing changes won’t drive all investors from the housing market – here’s why<p>After Labor announced proposed <a href="https://theconversation.com/shorten-policy-hits-tax-breaks-for-negative-gearing-and-capital-gains-54700">changes to negative gearing and the capital gains tax</a> discount, Prime Minister Malcolm Turnbull <a href="http://parlinfo.aph.gov.au/parlInfo/search/display/display.w3p;query=Id%3A%22chamber%2Fhansardr%2Fdff2f362-577c-44bb-a29c-3d98a57a635a%2F0101%22">told</a> parliament that the policy would </p>
<blockquote>
<p>administer two contradictory shocks, massive shocks, to the residential housing market. They are proposing to remove from the market for established dwellings one-third of demand. All investors would be gone. When I say all investors, I mean all investors. </p>
</blockquote>
<p>That assertion was questioned by <a href="https://twitter.com/search?q=turnbull%20all%20investors&src=typd">some listeners</a> at the time, including <a href="http://www.theguardian.com/australia-news/live/2016/feb/24/liberal-mp-revives-tony-abbotts-indigenous-lifestyle-choices-debate-politics-live?page=with:block-56cd2083e4b068fe3e801424&CMP=share_btn_tw#block-56cd2083e4b068fe3e801424">The Guardian’s Katharine Murphy</a>.</p>
<p>Does the prime minister’s claim stack up? </p>
<h2>Not all property investors negatively gear</h2>
<p>Data is not directly available on what proportion of home purchases are made by investors. Data on new home lending from <a href="http://www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPage/5671.0Dec%202015?OpenDocument">The Australian Bureau of Statistics’ Lending Finance</a> figures indicates that between one-third and half of new lending is to investors. And <a href="http://www.abs.gov.au/ausstats/abs@.nsf/Lookup/by%20Subject/1370.0%7E2010%7EChapter%7ELevels%20of%20home%20ownership%20(5.4.3)">ABS census data</a> shows that just under a third of existing properties are owned by investors.</p>
<p>But not all of them negatively gear. Some do not borrow, and others do not borrow enough to be negatively geared: that is, their rental income is greater than the expenses and loan interest. The <a href="https://www.ato.gov.au/About-ATO/Research-and-statistics/In-detail/Tax-statistics/Taxation-statistics-2012-13/?anchor=indiv_detailed#indiv_detailed">tax stats</a> show us that about two-thirds of all housing investors are negatively geared. This suggests that around 20% of housing buyers are negatively geared investors.</p>
<h2>Investor demand for housing will reduce – but not disappear</h2>
<p>Labor’s proposed changes will reduce the after-tax returns on property investment. </p>
<p>Although negative gearing has attracted more attention, Labor’s proposed changes to capital gains tax will have a bigger impact on returns. Reducing the discount from 50% to 25% will increase the effective tax rates on capital gains, bringing the tax rates closer to those that apply to other sources of investment income such as rental income and bank interest. </p>
<p>Labor’s proposed changes to negative gearing will also have an impact. Under the policy, investors who make rental losses – because their rental income is less than their costs, including loan interest costs – will no longer be able to write-off those losses against wage and salary income. But for people investing in new housing there will be no change: they will still able to write-off losses against all forms of individual income. </p>
<p>For most investors in existing properties, the changes to negative gearing mainly affect the timing, not the amount, of tax deductions. Losses can still be deducted against investment income, including subsequent capital gains. But negative gearing may lose some of its psychological appeal. While there is no hard research for Australia, some <a href="http://www.smh.com.au/money/investing/negative-gearing-time-to-rethink-your-approach-20111203-1oc58.html">investment advisors have warned</a> against placing too much emphasis on tax breaks (particularly tax breaks on wages) and not enough on the financial returns to the investment.</p>
<p>Together these policies will reduce investor demand for housing. Indeed, one of Labor’s stated aims of the policy is to make it easier for first home buyers to get into the market.</p>
<p>Some investors will switch to other investment opportunities that offer higher post-tax returns. Others might choose to spend more and invest less. But some will also continue to invest in the housing market, and either borrow less, or simply accept a lower return on investment.</p>
<p>The extent to which investors will vacate the property market will ultimately depend on how much post-tax returns fall, and how sensitive is investor demand for property to changes in returns (what economists would call the “elasticity of demand”). </p>
<p>Our estimates suggest that the changes in effective tax rates from Labor’s policy are relatively modest. </p>
<p>Consider an investor in the top tax bracket, paying 45 cents in the dollar on their marginal income and earning a 6% nominal return on their property (half from rental income, half from capital gain). Let’s say the investor buys a property and then sells it after seven years. </p>
<p>Effective tax rates calculate how much tax is paid on the profit made by the taxpayer. If the investor buys the property outright, the effective tax rate will increase from 33% to 35% under Labor’s policy. If the same investor borrows 40% of the house value then effective tax rates increase from 19% to 22%. And for a negatively geared investor borrowing 80% of the property value, the effective tax rate changes from 5% to 9%. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/113989/original/image-20160307-30467-5ajcud.JPG?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/113989/original/image-20160307-30467-5ajcud.JPG?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=415&fit=crop&dpr=1 600w, https://images.theconversation.com/files/113989/original/image-20160307-30467-5ajcud.JPG?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=415&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/113989/original/image-20160307-30467-5ajcud.JPG?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=415&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/113989/original/image-20160307-30467-5ajcud.JPG?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=522&fit=crop&dpr=1 754w, https://images.theconversation.com/files/113989/original/image-20160307-30467-5ajcud.JPG?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=522&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/113989/original/image-20160307-30467-5ajcud.JPG?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=522&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption"></span>
<span class="attribution"><span class="license">Author provided</span></span>
</figcaption>
</figure>
<p>And any changes in post-tax returns under Labor’s policies may be swamped by annual fluctuations in property prices. As the Commonwealth Bank of Australia Chief Executive Ian Narev recently <a href="http://www.smh.com.au/business/comment-and-analysis/tax-reform-needs-to-be-done-properly-or-not-at-all-so-malcolm-turnbull-was-right-to-dump-it-20160304-gnacdx.html">noted</a>:</p>
<blockquote>
<p>I can tell you having a $400 billion home loan book – your assumptions on unemployment and what’s happening in global interest rates will dwarf whatever assumptions you’ve got on the modelling about the impact of negative gearing by a factor of… I can’t tell you the number but it’s a big number.</p>
</blockquote>
<h2>A massive shock?</h2>
<p>Under Labor’s policy, other passive investments that generate capital gains, such as shares, will also be subject to a more stringent tax treatment. Other investments that will be relatively more attractive after the change – for example, superannuation and bank deposits – have a very different profile of risk, return and liquidity.</p>
<p>No-one can ever perfectly predict investor behaviour. Ultimately, there are a whole host of factors that people take into account when investing in property, including rental returns (particularly for the one third of positively geared investors), risk perception, familiarity with the asset class and ability to obtain bank finance. In our opinion, modest changes in tax treatment are unlikely to change the decision-making calculus for the majority of investors. </p>
<p>Indeed, looking at other countries with less generous tax treatment for investment properties – US, Canada, Germany and France, for example – there is still <a href="http://www.abs.gov.au/ausstats/abs@.nsf/Lookup/by%20Subject/1370.0%7E2010%7EChapter%7EInternational%20comparisons%20(5.4.6)">plenty of investor activity in housing</a>.</p>
<p>Given the evidence we have seen, it is overreach for the prime minister to say that Labor’s policy will drive away <em>all</em> investors away.</p><img src="https://counter.theconversation.com/content/55505/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Grattan Institute began with contributions to its endowment of $15 million from each of the Federal and Victorian Governments. In order to safeguard its independence, Grattan Institute’s board controls this endowment. The funds are invested and Grattan uses the income to pursue its activities.</span></em></p><p class="fine-print"><em><span>John Daley does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Prime Minister Malcolm Turnbull has warned that Labor’s negative gearing policy would deliver “massive shocks” to the residential housing market and drive all investors away. Does that claim stack up?Danielle Wood, Fellow, Australian Perspectives, Grattan InstituteJohn Daley, Chief Executive Officer , Grattan InstituteLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/551302016-02-24T23:04:11Z2016-02-24T23:04:11ZCrowd-sourced funding: Australia needs to learn from Italy’s mistakes<figure><img src="https://images.theconversation.com/files/112662/original/image-20160224-32745-1o5w4dz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The proposed changes to the Corporations Act might protect investors in crowd funding but it limits the types of businesses that can use these platforms.</span> <span class="attribution"><span class="source">From www.shutterstock.com</span></span></figcaption></figure><p>Australia can learn from Italy’s mistake in limiting companies that can access crowd-sourced funding, as the government examines changes to the Corporations Act.</p>
<p>The <a href="http://www.aph.gov.au/Parliamentary_Business/Bills_Legislation/Bills_Search_Results/Result?bId=r5588">Corporations Amendment (Crowd-sourced Funding) Bill 2015</a> proposes changes that are designed to encourage small businesses to use crowd-sourced funding, while providing protection to investors. However, the restrictions it is placing on business present a key obstacle to the promotion of entrepreneurship.</p>
<p>Crowd-sourced funding uses online platforms to allow businesses to raise small amounts of money from a large number of investors in order to fund a particular project. In return for their investments, investors receive securities in the form of shares in the company.</p>
<p>In Australia, the Corporations Act has played a role in limiting the development of this form of finance. The legislation requires a public company to issue costly disclosure documents to the general public before it is able to raise any equity funds from the market. </p>
<p>Even though the Corporations Amendment Bill allows companies to raise a maximum of five million via this type of funding, only a very restrictive amount of companies are able to rely on this form of finance. In fact, 99.7% of companies, the majority of which are small and medium enterprises, are unable to rely on crowd-sourced funding.</p>
<p>This is because the bill only allows public unlisted companies with share capital to rely on this form of finance. Companies also need total assets of less than five million and an annual revenue of less than five million.</p>
<p>The bill assumes that companies that fulfil these requirements will be small and medium enterprises. However, the total assets and revenue tests combined with the governance costs of running a public company will deter these same businesses. </p>
<p>The only other country which had imposed strict restrictions on companies that can access crowd-sourced funding, similar to those on the table for Australia, is Italy.</p>
<p>Italian law only permitted businesses classified as “innovative startups” to rely on crowd-sourced funding. Very strict rules apply to this classification: the definition requires a business to have been in existence for no more than 48 months and be recognised as “innovative” by the Chamber of Commerce, a concession that has to be updated every six months. </p>
<p>A business may be viewed as innovative if its purpose, for example, is <a href="http://www.mediagraphic.it/public/normative/Decreto_sviluppo_bis_Gu-coordinato.pdf">“the development and commercialization of high-tech value products or services”</a>. The strict classification excludes a number of businesses including many startups, which goes against the reason for having introduced the legislation in the first place. </p>
<p>Consequently, since the introduction of the exemption less than <a href="http://bebeez.it/wp-content/blogs.dir/5825/files/2015/04/Moodys_Innovative-SME_Crowdfunding_Full-Report.pdf">20 projects</a> have been able to rely on crowd-sourced funding to raise the capital necessary for them to get off the ground.</p>
<p>Further, the total amount raised through the crowd-sourced funding exemption <a href="http://bebeez.it/wp-content/blogs.dir/5825/files/2015/04/Moodys_Innovative-SME_Crowdfunding_Full-Report.pdf">has been less than €1.5 million</a>. For this reason, in 2015, the Italian government expanded the eligibility criteria from “innovative start-ups” to “innovative small to medium enterprises”.</p>
<p>The Australian Corporations Amendment Bill tries to tackle this problem by providing some incentive for these companies to convert into public companies. It notes that limited governance requirements for five years may apply if a company has just been created or they have recently been converted to a public company and they plan to raise capital via crowd-sourced funding. </p>
<p>There are concessions for such companies. For its first five years, a company is not required to hold an annual members’ general meeting, it is only required to provide online financial reports to shareholders and the restrictions do not apply until it raises more than A$1 million from crowd-sourced funding or other offers requiring disclosure.</p>
<p>Despite this effort, the bill exemptions are unlikely to encourage a proprietary company to convert into a public company as the current concessions are really minimal. One of the concessions is the fact that a company who is converted into a public company does not need to appoint an auditor. However, this concession will not apply if the same company successfully raises more than A$1 million.</p>
<p>Further, costly continuous obligations under the Corporations Act 2001 will apply as the company will be deemed as unlisted disclosing entities. Half-yearly reports will also then be required to be provided by such companies. Broader concessions may be needed to ensure that the company does not have continuous disclosure obligation imposed on it for a certain period of time. </p>
<p>Another big gap in the bill is that it completely ignores social enterprises and not for profit organisations who may really benefit from crowd-sourced funding. </p>
<p>The bill does make a positive step in enhancing investor and consumer protection. A A$10,000 cap per investor in a period of 12 months (with the possibility of altering this cap by regulation) will be introduced. However, this cap is the maximum amount that can be raised by an individual on one platform and in the same company. This encourages investors to diversify their investments and will allow them to invest in other companies if they wish to do so.</p>
<p>To provide further protection to investors, the legislation has to support financially literacy. This could be achieved in the form of a questionnaire that test investors’ understanding of the risks involved with crowd-sourced funding and the factors that investors should consider when investing through crowd-sourced funding. </p>
<p>The bill need more work to achieve its aims of promoting entrepreneurship while at the same time providing the necessary protections to investors.</p><img src="https://counter.theconversation.com/content/55130/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Marina Nehme receives funding from Centre for International Finance and Regulation</span></em></p>The Italian government tried to limit the type of companies that could use crowd-sourced funding with poor results, Australia can learn from this.Marina Nehme, Senior Lecturer, Faculty of Law, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/548942016-02-19T04:15:30Z2016-02-19T04:15:30ZLimiting startup tax incentives could exclude an important group of early stage investors<figure><img src="https://images.theconversation.com/files/112075/original/image-20160219-12655-go4n28.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Restricting the tax offsets for investing in start-ups to just those with plenty of money will hurt entrepreneurs.</span> <span class="attribution"><span class="source">RicardoCorralT/flickr</span>, <a class="license" href="http://creativecommons.org/licenses/by-nc-nd/4.0/">CC BY-NC-ND</a></span></figcaption></figure><p>As part of its innovation agenda the Coalition government is offering a tax offset of 20 cents for every dollar invested into a startup, as well as an exemption from capital gains tax for up to 10 years. However, it has emerged that this incentive could be limited to only ‘sophisticated’ investors, defined as those earning more than $250,000 per annum or having a net worth of more than $2.5 million.</p>
<p>Placing this restriction on startup investment could potentially disadvantage a key group of seed capital providers namely family and friends or informal investors. Family and friends provided $66 billion of startup capital to <a href="http://www.angelcapitalassociation.org/data/Documents/Press%20Center/What%20Ents%20Should%20Know%20About%20Angels%202009.pdf">emerging ventures in the United States</a> This is about three times more than either venture capitalists or professional angel investors. </p>
<p>Many of today’s largest listed US companies took seed capital from informal investors. For example <a href="http://www.businesspundit.com/fortune-500-rags-to-riches/">Whole Foods Market</a>, a $10 billion American organic food company, was started with founder savings and capital provided by family and friends. </p>
<p>These investors each provide anywhere between $1,000 to $30,000 in seed funding, yet many of them would not qualify as sophisticated investors under the Australian government’s definition.</p>
<p>Australian startups face serious challenges in accessing capital at almost every stage in their growth cycle. In particular, difficulties in accessing seed capital, needed to help turn an idea into an operating business, appears to be a critical road block for many aspiring Australian entrepreneurs. </p>
<p>For example, <a href="http://www.abs.gov.au/AUSSTATS/abs@.nsf/Latestproducts/8167.0Main%20Features62013-14?opendocument&tabname=Summary&prodno=8167.0&issue=2013-14&num=&view=">one in five startups cite</a> restricted access to capital as a major barrier to innovation. </p>
<p>So where can startups access very early stage capital? It appears the sources are limited. The <a href="http://www.avcal.com.au/documents/item/1169">latest data</a> from the Australian Venture Capital Association shows that very few seed investments are made in Australia by venture capitalists. </p>
<p>Further, the angel and incubator community is only just <a href="http://www.startupsmart.com.au/finance-2/venture-capital/spreets-founder-dean-mcevoy-says-australia-needs-to-get-better-at-angel-investment/">emerging</a>, with only about 12 active groups across the country. This further points to the important role that informal investors can play in filling the capital cap that occurs at a venture’s seed stage. </p>
<p>It is true that informal investors stand to lose a greater proportion of their wealth in comparison to high net worth individuals when investing in startups. However another important innovation agenda reform, <a href="http://www.innovation.gov.au/page/access-crowd-sourced-equity-funding">equity crowdfunding</a> whereby ordinary mum and dad investors can take an equity stake in a startup through an online portal, would allow them to diversify their risks across many ventures, beyond those in which they have personal connections.</p>
<p>With this in mind, there are several reasons to believe that encouraging, rather than penalising small unsophisticated investors, is an important step to help young Australian startups to grow.</p>
<p>Family and friend investors have a personal connection with the founder, and typically will invest out of loyalty, trust and a belief in the founder’s ability. Such relationship characteristics are difficult to replicate with professional investors, who will often price down a company’s value to account for the possibility of moral hazard or unscrupulous founder motives. </p>
<p>In fact, if a start-up can grow through family and friend investments, often venture capitalist and angels <a href="http://www.forbes.com/2010/02/12/funding-for-startups-entrepreneurs-finance-zwilling.html">become more inclined to offer follow-on funding</a>, because the fact that informal investors have put their trust (and money) in the founder is a strong signal of the entrepreneur’s integrity and ability. </p>
<p>Bringing on formal or sophisticated investors too early can also <a href="https://hbr.org/1992/11/bootstrap-finance-the-art-of-start-ups">stifle innovation</a>. Venture capitalists are certainly not patient. They look for an exit in five years. Angel investors are a little more patient, but still look at a 10 year time frame. Often developing an innovative business can take much longer. For example, Glenn Martin the founder of <a href="http://www.martinjetpack.com/history">Martin Jetpack</a>, a Kiwi startup that listed on the ASX last year, first started work on the jet pack in 1981. </p>
<p>Further, a slower start to a venture is often a safer start, where the entrepreneur can take a “try it, fix it” approach and has ample opportunity to correct errors from poor decisions. Informal investors are more likely to be hands-off in their investment approach and thus far more likely to tolerate such an uncertain environment. </p>
<p>On the other hand, professional investors are much more hands-on and may prefer the safe proven routes learnt from previous investments, when in fact an experimental try-it, fix-it approach may be more conducive to innovation.</p>
<p>In order to ensure that our taxation system creates incentives that promote a successful startup ecosystem, careful consideration should be given to how early stage ventures are developed in other successful startup environments. </p>
<p>The Australian government’s efforts to recently <a href="http://www.startupsmart.com.au/growing/australian-entrepreneurs-to-get-access-to-a-startups-paradise-that-once-housed-uber-and-spotify/">secure a “landing-pad”</a> in San Francisco’s highly successful <a href="https://rocketspace.com/">RocketSpace hub</a>, is exactly the kind of initiative that will help Australians learn how to foster a more vibrant domestic startup ecosystem. </p>
<p>While this will not directly address the seed capital gap, helping founders to access valuable networks and to develop their ideas through co-working with others, will certainly enhance their future capital raising capabilities.</p><img src="https://counter.theconversation.com/content/54894/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jason Zein receives funding from the Australian Research Council. </span></em></p>The government should be encouraging informal investors to put their money into start-ups, not barring them from tax offsets that encourage them to do so.Jason Zein, Associate Professor, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/529292016-01-15T12:12:01Z2016-01-15T12:12:01ZPeople invest their money illogically – but trying to help them can make things worse<figure><img src="https://images.theconversation.com/files/108058/original/image-20160113-10417-mpu555.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">We never learn</span> <span class="attribution"><a class="source" href="http://www.shutterstock.com/cat.mhtml?lang=en&language=en&ref_site=photo&search_source=search_form&version=llv1&anyorall=all&safesearch=1&use_local_boost=1&autocomplete_id=&search_tracking_id=PuDOxO3Ey4SaiA6DTFTiXg&searchterm=bad%20investment&show_color_wheel=1&orient=&commercial_ok=&media_type=images&search_cat=&searchtermx=&photographer_name=&people_gender=&people_age=&people_ethnicity=&people_number=&color=&page=1&inline=104369201">Minerva Studio</a></span></figcaption></figure><p>In a world where financial experts are frequently proven badly wrong, it is hardly surprising that many people take charge of saving for their retirements themselves. The realities of the financial world don’t make this easy, though. And neither does the peculiar psychology of investing – as research in which I have been involved helps to show. </p>
<p>One common way of saving for the future is investment funds, in which finance professionals pool together the savings of a large number of people and invest them in things like the stock market, bonds and foreign exchange. According to financial theory, the <a href="http://tmtfree.hd.free.fr/albums/files/TMTisFree/Documents/Economy/Reflections%20on%20the%20Efficient%20Market%20Hypothesis%20-%2030%20Years%20Later,%20%202005.%20B%20G%20Malkiel.pdf">best strategy</a> for choosing a fund is to pick the one with the lowest investment fees and stick with it for as long as possible. This follows from the <a href="http://www.investopedia.com/terms/e/efficientmarkethypothesis.asp">efficient-markets hypothesis</a>, which says that financial markets are full of skilled professionals who try to make as much money as possible, so no easy opportunities to make above-average profits remain in the market for long. </p>
<p>Yet in practice, many investors choose funds that have performed well in the past, and chop and change between them – incurring new investment fees each time. The fund industry <a href="http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00232/abstract">actively encourages</a> such behaviour by prominently advertising its most successful funds.</p>
<p>Past performance might seem a logical criterion, but research <a href="http://www.seligson.fi/resource/carhart.pdf">shows it has</a> absolutely no bearing on future performance. On the other hand, the level of investment fees makes a substantial difference. Fees are charged as a percentage of the amount invested, ranging from around 0.05% to about 1.5% a year. These might seem like low amounts, but the differences in compounding can be dramatic. If you invested US$1,000 in the US stock market in 1970 without paying any investment fees, for example, by the end of 2015 you would have had US$108,968 (a 10.7% <a href="http://www.econ.yale.edu/%7Eshiller/data/ie_data.xls">average annual return</a>). If you had paid a 1% annual fee, the final investment amount would have been US$71,792 – a reduction of US$37,177. </p>
<h2>The regulatory conundrum</h2>
<p>The question for regulators is what to do about all the unhelpful marketing. In the UK, for example, there are already rules about how the fund companies can market their funds. All information about past performance has to show the ten-year performance, for instance, which stamped out the old trick of emphasising the performance period over which a fund had had its best run. Other marketing tricks are still legitimate, however, such as putting all the emphasis on your most successful funds while saying less about the laggards. </p>
<p>One option for regulators is to make the fund owners show the data on investment fees and past performance as an actual amount rather than a percentage. Previous research has <a href="http://www.ncbi.nlm.nih.gov/pmc/articles/PMC2872995/">already shown</a> that large investors are more sensitive to fees if they are a financial amount, and make better investment choices as a result. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/108060/original/image-20160113-10409-1o1q2qe.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/108060/original/image-20160113-10409-1o1q2qe.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/108060/original/image-20160113-10409-1o1q2qe.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=401&fit=crop&dpr=1 600w, https://images.theconversation.com/files/108060/original/image-20160113-10409-1o1q2qe.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=401&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/108060/original/image-20160113-10409-1o1q2qe.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=401&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/108060/original/image-20160113-10409-1o1q2qe.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=504&fit=crop&dpr=1 754w, https://images.theconversation.com/files/108060/original/image-20160113-10409-1o1q2qe.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=504&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/108060/original/image-20160113-10409-1o1q2qe.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=504&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">What to do about the little guy?</span>
<span class="attribution"><a class="source" href="http://www.shutterstock.com/cat.mhtml?lang=en&language=en&ref_site=photo&search_source=search_form&version=llv1&anyorall=all&safesearch=1&use_local_boost=1&autocomplete_id=&search_tracking_id=jl0SQt9hRANpd29YHgpPlw&searchterm=small%20investor&show_color_wheel=1&orient=&commercial_ok=&media_type=images&search_cat=&searchtermx=&photographer_name=&people_gender=&people_age=&people_ethnicity=&people_number=&color=&page=1&inline=342709367">Gajus</a></span>
</figcaption>
</figure>
<p>To develop this we carried out two experiments, each with 1,000 would-be investors. In each experiment, we asked half of the participants to play the part of a large investor and the remainder to play the part of a small investor. The large investors were given hypothetical portfolios of US$1m to invest, while the small investors were each given US$1,000. </p>
<p>In the first experiment, we asked them all to choose between two funds. One fund had a fee of 1% per annum and a past annual rate of return of 1%, while the other had a 1.5% fee and a 1.5% performance. But instead of giving everyone the information as percentages, half of the small investors and half of the large investors were given the fee information for the first year as a financial charge – US$10/$15 for the small investors, US$10,000/$15,000 for the large investors. In both cases we made clear this was for year one only, and would increase through compound interest in years to come. The rest of the small investors and large investors were given all the data as percentages. </p>
<p><strong>Experiment 1</strong></p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/108195/original/image-20160114-2352-1o4aquz.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/108195/original/image-20160114-2352-1o4aquz.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=119&fit=crop&dpr=1 600w, https://images.theconversation.com/files/108195/original/image-20160114-2352-1o4aquz.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=119&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/108195/original/image-20160114-2352-1o4aquz.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=119&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/108195/original/image-20160114-2352-1o4aquz.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=150&fit=crop&dpr=1 754w, https://images.theconversation.com/files/108195/original/image-20160114-2352-1o4aquz.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=150&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/108195/original/image-20160114-2352-1o4aquz.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=150&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<p>The results showed that the large investors were more likely to choose a fund on the basis of the fees when the fees were expressed to them as an amount. But, as we had suspected, the small investors did the opposite. They virtually ignored the US$10/$15 charges, believing them to be “peanuts”. It didn’t matter that the charges were still significant in percentage terms, and would rise in years to come. </p>
<h2>And it gets worse …</h2>
<p>In the second experiment, the investors were given the same two funds to choose from, but this time we varied the way the past-performance data was presented while always listing the fees as percentages. Half the large and small investors were asked to choose between funds whose past performance had been US$10/$10,000 per annum and US$15/$15,000, while the other half were given the performance data as a percentage. The funds had clear disclaimers identical to the ones that appear in real life, saying that past performance makes no difference to future performance. </p>
<p><strong>Experiment 2</strong></p>
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<a href="https://images.theconversation.com/files/108197/original/image-20160114-2365-16tfzxr.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/108197/original/image-20160114-2365-16tfzxr.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/108197/original/image-20160114-2365-16tfzxr.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=116&fit=crop&dpr=1 600w, https://images.theconversation.com/files/108197/original/image-20160114-2365-16tfzxr.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=116&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/108197/original/image-20160114-2365-16tfzxr.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=116&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/108197/original/image-20160114-2365-16tfzxr.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=146&fit=crop&dpr=1 754w, https://images.theconversation.com/files/108197/original/image-20160114-2365-16tfzxr.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=146&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/108197/original/image-20160114-2365-16tfzxr.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=146&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<p>The small investors did the same thing in this experiment, but now with a better result: they largely ignored the past returns of US$10 and US$15, and correctly chose the low-fee fund. Translating past returns into small currency amounts helped the small investors to finally ignore what they should have been ignoring in the first place. As a result, in this experiment they outperformed the larger investors overall. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/108059/original/image-20160113-10399-15r67nn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/108059/original/image-20160113-10399-15r67nn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/108059/original/image-20160113-10399-15r67nn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=399&fit=crop&dpr=1 600w, https://images.theconversation.com/files/108059/original/image-20160113-10399-15r67nn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=399&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/108059/original/image-20160113-10399-15r67nn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=399&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/108059/original/image-20160113-10399-15r67nn.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=501&fit=crop&dpr=1 754w, https://images.theconversation.com/files/108059/original/image-20160113-10399-15r67nn.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=501&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/108059/original/image-20160113-10399-15r67nn.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=501&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Yesterday’s gone, yesterday’s gone.</span>
<span class="attribution"><a class="source" href="http://www.shutterstock.com/cat.mhtml?lang=en&language=en&ref_site=photo&search_source=search_form&version=llv1&anyorall=all&safesearch=1&use_local_boost=1&autocomplete_id=&search_tracking_id=Y4QWRNMSHHQWTNNGhn5vWQ&searchterm=past%20and%20future&show_color_wheel=1&orient=&commercial_ok=&media_type=images&search_cat=&searchtermx=&photographer_name=&people_gender=&people_age=&people_ethnicity=&people_number=&color=&page=1&inline=63535978">Gunnar Pippel</a></span>
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<p>The conclusion? Large investors and small investors can value the same information differently, which makes it difficult to regulate them all in the same way. Not only that, the benefits to different investors vary depending on which variable you are talking about. In short, one apparently obvious way of improving the marketing information on investment funds may be more trouble than it’s worth. </p>
<p>Our experiments give an insight into the difficulties of regulating investment products in a landscape of complex products and ordinary humans. Economists tend to build models that treat us as hyper-rational consumers. If only it were true.</p><img src="https://counter.theconversation.com/content/52929/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Philip Newall does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Investors are encouraged to make bad financial decisions from the way that saving products are marketed. New research shows that fixing this is a can of ugly worms.Philip Newall, Pre-Doctoral Researcher in Behavioural Science, University of StirlingLicensed as Creative Commons – attribution, no derivatives.