We can look at the various sustainable investing strategies and note that while not all are going to be appropriate or of interest to all investors, there's actually a ton of choices, and a lot of versatility in the space.
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Behavioral Finance Series
Behavioral finance incorporates elements of psychology to explain the actual behavior of investors and the subsequent effect on markets, in contrast to traditional finance which posits purely rational investors and efficient markets. In a series of posts, we will go over the most common behavioral biases investors fall prey to and put them in the context of current market events.
Over the past decade, Sustainable Investing (SI) has rapidly grown and evolved, building a healthy base of assets under management (AUM) across the globe. This evolution of strategies available under the SI umbrella has subjected Sustainable Investing perceptions to anchoring bias. Anchoring bias occurs when we use pre-existing data as a reference point for all subsequent data. This can then skew our decision-making processes. Not exclusive to data, anchoring bias can also show up with ideas through pre-conceived notions.
For instance, interest rates being high or low is relative to the investor’s anchor. While some have an anchor of 5% for the 10-year treasury yield given the history of rates, those who became indoctrinated in markets post-GFC, would see a 10-year yield of 2.5% as high.
Turning to a megatrend, SI is often fraught with anchoring bias given the evolution it has experienced— For example negative inclusion, often thought of as version 1 of sustainable investing. While it is still important to the investment philosophy of many faith-based organizations and investors who want their investments to reflect their values, it’s not the entire landscape. Yet, many investors still commonly associate this type of SI with the choice set at large. The chart below shows the various SI strategies, while not all will be of interest or appropriate for all, the versatility in this emerging area offers options to investors.
While incorporating values is part of the space, SI can also involve using available data to make better informed investment choices. For instance, an investor can use an expanded set of ESG factors to make investment decisions. While not all alternative data available is applicable or relevant, through ESG integration analysts can apply financially material factors to their investment analysis at the industry, sub-industry and company level.
Relying too heavily on the first piece of information we receive is apt to lead to anchoring bias. To overcome this bias we must acknowledge breaks in the data leading to a new regime (think interest rates), stay open to emerging trends and check our assumptions continually.
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