1 THE UNIVERSITY OF MELBOURNE DEPARTMENT OF FINANCE FINAL EXAMINATION—SEMESTER 2, 2021 SUBJECT NUMBER: FNCE90087 SUBJECT NAME: Sustainable Investment EXAMINATION DURATION: 24 hours TOTAL MARKS: 90 NO. OF PAGES: 8 AUTHORISED MATERIALS This is an OPEN BOOK examination. INSTRUCTIONS TO STUDENTS The exam consists of three parts. Each part is worth 30 marks. You are required to answer ALL questions. On completion of the exam please upload your responses to each question onto the assignments section in CANVAS. Save your written responses in THREE separate files with the following filenames: “PART1_student#” “PART2_student#” “PART3_student#”. You will also be required to upload TWO excel files. Please name them “Data_student#.xlsx” “Efficient frontier with constraints_student#.xlsm”. where “student#” represents your student number. You may handwrite or type your responses. Please make sure that your files are legible. If not, you may receive zero marks. Stick to the word limits. Examiners have the right to stop reading if your responses are too long. We are seeking a concise and coherent response that addresses the important issues. Within each part, please carefully label the question (sub-question) you are answering. If you fail to answer a question/sub-question please list it and leave a blank space. Your submission is due Tuesday 16th before 9am. You have 24 hours to complete the test. How you manage your time is entirely up to you i.e you can use the entire 24-hour period if you wish. However, we have tried to design the questions so that the test can be completed in approximately 2-3 hours. Given the 24-hour window, we do not expect any technical consideration applications. If you leave your submission upload to the last 5 minutes in the 24-hour window you won’t be getting much sympathy if you don’t meet the deadline. 2 If you have any questions regarding the exam, please email the lecturer(s) for that section. - Be reasonable, we will NOT be online for the 24-hour period. - You cannot expect to send an email at 3am in the morning and get a response. - We can only guarantee that questions emailed between 9am to 5.30pm on Monday 15th will get a response. Emails sent outside those times may not get a reply. - As per the recent announcement, if you have a question for Claire and Mike regarding Part 1, please email both and use the following addresses:
[email protected],
[email protected]. Any collusion is strictly prohibited. Offenders will be dealt with very seriously. 3 PART 1 (30 MARKS Claire and Mike) Question 1 – ESG Ratings (7.5 marks, 200 words) Sam Jones is comparing the ESG risks of Shonky Building Supplies (SBS), a construction materials company, and Plummet Airways (PA), an airline. He is only considering 5 areas and rating companies either 1 for poor performance on the ESG issue, or 2 for good performance. He has finished his ratings on each issue and put together the table below: Company Name Shonky Building Supplies (SBS) Plummet Airways (PA) Industry Construction Materials Airlines GHG Emissions 1 1 Energy Management 2 2 Employee Health and Safety 2 2 Critical Incident Risk Management 1 2 Labour Practices 1 1 On this basis, he concludes that PA is a better performer and has lower risk because the sum of the scores is 8 (versus 7 for SBS). He takes his work to his boss, Loretta Liu, who tells Sam that his analysis would be improved if he considered the materiality of each issue for companies in that sector/industry as defined by SASB’s Materiality Map. A) Why is materiality important? Which issues are considered material by SASB for each company? B) Based on your answer to (A), and only using the information provided above and SASB’s Materiality Map, calculate ESG scores that incorporate materiality. Which company is the preferred investment on this basis? Briefly explain your answer. 4 Question 2 – Toolkit (7.5 marks, 200 words) Investor group FAIRR explains that antimicrobial resistance (AMR) is driven by the overuse and over-prescription of antibiotics across multiple industries, from animal agriculture to pharmaceuticals. Overuse of antibiotics by livestock farmers to promote growth in otherwise healthy animals (to take one example) is putting the long-term efficacy of these vital drugs at risk. (In other words, there is an increasing risk that antibiotics will in future no longer be effective treatments for human disease due to overuse and over-prescription.) You have recently become aware of AMR and are concerned by it. You have also realised that a large part (approx. 10%) of the portfolio you manage, and the relevant benchmark against which you’re measured, is invested in companies involved in livestock farming. A) Briefly describe what investment activities you would undertake to manage this issue in your portfolio as an ESG investor. Consider both integration and stewardship activities in the toolkit where relevant. B) Briefly explain how this issue could be considered a systemic risk by an ESG investor with a universal owner perspective? Specify the system it affects. C) Assume that there is a negative financial performance impact if these companies stopped using antibiotics. Despite this, how could an ESG investor with a universal owner perspective justify advocacy activities (such as lobbying governments) seeking to ban antibiotics in livestock farming? (Note: Further research or understanding of AMR beyond the above is not relevant or required.) Question 3 – Ethical Investment (7.5 marks, 200 words) You are a financial planner. A client – who invests only in Australian equities – comes to you and says: “I don’t want my money to be used to contribute to climate change” and asks you to design a portfolio. A) List 3 questions you would ask this client to help you design an optimal portfolio for them. B) Describe some of the implications potentially relevant screens may have on this client’s portfolio. 5 Question 4 – Governance (7.5 marks, 200 words) Murray Stroller is analysing the board of tyre manufacturer LackinGrip, which is in the ASX300. He compiles the following information: Name Title (per company disclosures) Tenure (years) Other ASX- listed company roles Skills and experience Other information Mr Graham Hill Non-executive chair 29 2 Financial services Graham is Damon’s father. Mr Damon Hill CEO/Managing director 25 1 Managing tyre manufacturing companies Damon owns 25% of the company. Mr Nino Farina Non-executive director 5 1 Accounting Farina worked at LackinGrip until last year as CFO. Mr Juan Manuel Fangio Non-executive director 4 5 (4 of these are chair roles) Cyber security Fangio buys LackinGrip tyres for his daughter’s car from the local tyre outlet. Mr Alberto Ascari Non-executive director 6 2 Opera singer Mr Mike Hawthorn Non-executive director 8 1 Accounting Hawthorn is Damon Hill’s godfather. Mr Jack Brabham Non-executive director 1 3 Lawyer To help the business Brabham was granted performance rights which vest if the company hits profit hurdles. Mr Jim Clark Non-executive director 0 2 Investment banker 6 A) Briefly describe any shortcomings/flaws of this board with respect to independence. B) Two of the directors (Nino Farina and Juan Manuel Fangio) are up for re-election. As an ESG investor state whether you would vote for or against each of these directors and give your reasons for doing so in the context of the overall board. Save your written responses as “PART1_student#”. PART 2 (Jon) (30 marks) Consider an ESG portfolio manager that seeks to perform an ESG integration strategy via a tilt. The ESG investment team has performed in depth analysis of the top 40 stocks in an index that consists of 200 stocks. The index is commonly used to track the value of the domestic equity market. The top 40 stocks represent approximately 60% of the index value (by market capitalisation). The ESG investment team has decided to create a highly concentrated portfolio that only considers the best 10 stocks identified by their ESG analysis. The portfolio will be targeted at investors who have a desire to invest in portfolios that have a low CO2 footprint and a gender diverse board. a) Briefly outline two alternative portfolio construction methodologies that may be employed to perform an ESG tilt using the 10 selected stocks. (3 marks) b) List one strength and one weakness of both portfolio construction strategies in this setting. (2 marks) The spreadsheet “Data.xlsx” contains daily prices on the index and the selected 10 stocks from 28/7/2016 to 31/7/2017. The worksheet page “ESG metrics” contains two ESG scores for each stock. The first is Scope 2 CO2 equivalent emissions in tonnes/1M USD in revenue. The second is a board gender diversity percentage (higher scores represent a more diverse board). You are also provided with the spreadsheet “Efficient frontier with constraints.xlsm” as discussed in lectures. c) Calculate the return variance-covariance matrix for the 10 stocks using all the observations provided in “Data.xlsx”. Save your spreadsheet by appending your student number to the filename i.e “Data_student#.xlsx”. (2 marks) 7 d) Use the variance-covariance matrix to construct the efficient frontier without ESG constraints by modifying the spreadsheet and VBA code provided in “Efficient frontier with constraints.xlsm”. Save all the output for the frontier by adding a new worksheet page to the “Efficient frontier with constrainst.xlsm” file. Label the new worksheet “Efficient frontier output”. Clearly label the frontier output as “NO ESG CONSTRAINTS”. Save your spreadsheet as “Efficient frontier with constraints_student#.xlsm”. (7 marks) Now consider an investor who has a maximum risk appetite of 17.5% annualised volatility. This equates to a daily return standard deviation of 1.1%. e) Using your output in part d), identify the point on the frontier that will maximise returns for the investor given their risk appetite. Highlight in yellow the appropriate row in your spreadsheet on the “Efficient frontier output” page. (1 mark) f) Calculate the CO2 footprint and Gender diversity % for the portfolio identified in part e). This will be your benchmark ESG metrics for part g). (2 marks) g) Using the ESG scores obtained in part f) calculate the efficient frontier for four ESG constrained portfolios. Each portfolio seeks to improve the ESG metrics relative to the unconstrained benchmark portfolio in part f). a. Portfolio 1: Decrease CO2 by 15% and increase board diversity by 15% (relative to ESG portfolio without constraints) b. Portfolio 2: Decrease CO2 by 15% and increase board diversity by 30% (relative to ESG portfolio without constraints) c. Portfolio 3: Decrease CO2 by 30% and increase board diversity by 15% (relative to ESG portfolio without constraints) d. Portfolio 4: Decrease CO2 by 30% and increase board diversity by 30% (relative to ESG portfolio without constraints). Save all the efficient frontier output for each portfolio in your spreadsheet in the “Efficient Frontier output” page of your “Efficient frontier with constraints_student#.xlsm” file. Clearly label the output for each portfolio (Portfolio 1, 2 ,3 4) (4 marks) h) Create a new page in your “Efficient frontier with constraints_student#.xlsm” file titled “Portfolios”. Copy the portfolio standard deviation, return and weight vector for the investor (with a maximum risk appetite of 1.1% daily) for each of the 5 portfolios considered (no ESG plus four ESG portfolios). (1 mark) 8 i) Write a brief report (300-400 words) outlining your findings. Your report should include a. The relative performance of the five efficient frontiers b. The impact of ESG constraints on the portfolio for the investor (with a maximum risk appetite 1.1% daily). Include a discussion of performance and the impact of ESG constraints on stock weight allocations. (8 marks) Save your written responses as “PART2_student#”. Make sure you also upload your TWO excel files: “Data_student#.xlsx” and “Efficient frontier with constraints_student#.xlsm” PART 3 (Jodi) (30 marks, 500 words) Impact investors make quick screening assessments of many companies for each one that proceeds to a more thorough due diligence. Please consider this Sydney-based sustainable packaging company: https://groundedpackaging.co/ . In 500 words or fewer, answer the questions below. Where information is not explicit in the content provided, please make reasonable inferences. You will be assessed on your ability to make reasonable judgements based on public-facing information. (Note: Further research or understanding of Grounded Packaging beyond the website content is not relevant or required.) 1. Purpose (2.5 marks) a. What is the company's purpose / raison d'être? b. In what way does the company create value for society? c. How does it get paid for that value creation? 2. Stakeholders (2.5 marks) a. What are the company's main stakeholders? b. What sustainability issues are likely to be material to those stakeholders 3. Externalities & impact (15 marks) a. Does the company generate serious externalities? Are they positive or negative? How do you assess the chances of these externalities to be internalized? b. Which of the SDGs (if any) does the company help achieve? Which negative SDG exposures (if any) does the company have? c. To what extent can the company’s impact be measured? Does the company report on its impact? How can its reporting be improved? 4. Attractiveness as an investment (10 marks) a. How attractive do you find the company as an investment? Please explain and refer to your answers above.
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