Exam review:

1st 3 topics

Important concepts:
1.

2.

Fiduciary duties
General care and loyalty
Putting clients interest first
Treating all clients equally
Full disclosure of investment risk
Avoid conflicts of interest
Acting in good faith
Reasonable basis for investment advice
Seeking best execution for client trades
Memorize and know to calculate 3 formulas:
a. Beta: covar (Ri,Rm) / market volatility squared
b. Expected return = rf + (beta * rm rf)
c. Sharpe ratio = [E(r) rf ] / std dev of returns
d. See HW #1 canvas
3. Required readings last
Socially Responsible Investing (SRI)
-

What is SRI? Positive and/or negative screening of certain constraints to

achieve social as well as investment returns
Size of SRI market: $6.5 trillion, 18% of all managed assets in the US were in
SRI (2014)
Question on AUM, question on # funds (these are different)
Please note growth in AUM or # funds
AUM Growth: 3 trillion in 2010, to 4 trillion in 2012, and 6.5 trillion in 2014

Fiduciary
-

Can be part of common law, contract, or gov regulation- managers subject to

all of these
Managers of an ERISA plan are ERISA fiduciaries
Know some duties and how they might affect decision to invest in SRI funds
vs normal funds
ERISA = employee retirement income security act of 1974: governms private
pension plan investing, strictest fiduciary duty- manager must act in interests
of plan beneficiaries only (significant for shareholder activism)

What is the US Govts view on SRI?

-

Opinion letter, Robert Doyle- says ERISA managers may invest in SRI if they
find risk and return is competitive with available alternatives- must document
analysis of risk/reward comparison

SRI is consistent with fiduciary duty if risk/return is competitive with

alternatives
Dept of Labors current policy toward SRI changed importantly last year
(2015) under Obama administration: Obama believed Bush policies
discouraged SRI due to high burden of
Obama letter did not change the policy but instead signaled positive
regulatory attitude.
Also allowed you to consider the ESG policies of companies as potentially
improving the risk/return to a point where it is comparable or even better
than non-SRI alternatives.

Difference between Defined benefit plans vs. defined contribution plan

-

Defined benefit plan fund manager decides

Defined contribution plan manager decides on options in the plan,
participants choose among these options themselves

Charitable boards
-

Not official gov regulation but attitude: Charitable boards might have a
duty to consider SRI
In order to fulfill the responsibility to see the NGO meets its charitable
purposes, board members may have a duty to consider whether their
investments will further those purposes, or at least not run counter to them
(i.e. American Cancer Asosciation invest tobacco?)

ESG: environmental, social, governance, factors in investment decisions

Social: any social factor, relationship with stakeholders, returns: Rees: good
governance is considered inherently a social good and there is evidence it leads to
better outcomes for companies and thus for investors
-

ON EXAM: # SRI funds over time increased more than 10X between
1990 (20 funds) and 2014 (190 funds)
Note: leading ESG criteria are Governance, Sudan, ~200, then
Tobacco/Alcohol ~150, then Human rights, labor, military/weapons, gambling,
social, environmental ~100

Exam wont go into great detail for indices- thats more homework
But know different between SRI and normal index
Ex. MSCI KLD 400 Social Index (Aka Domini 400 Social Index) created by Amy
domini, designed to mimic S&P500 except with SRI screens
Professors paper: Is there a Cost for SRI?
-

Work looked only at mutual funds: how do you measure and analyze the cost
of SRI investing in mutual funds?
Couple topics:

Does the investor base their investment decision on prior track record
(alpha-creating managers)? The study found that the cost is a lot
higher when the investor does so
o 2nd way costs were found to be large was if the investor wanted a style
or factor tilt
Study looked at 4 factors: remember Profs lecture on Fama
French 3 factor model: momentum (MOM), growth (SMB),
value(HML), and MKT
But, Morningstar ratings show SRI funds are higher rated
than non-SRI
o EXAM: Study finds cost of SRI vs normal investing is relatively
insignificant unless the investor 1) wants a manager who
delivers alpha 2) wants style tilts or factors
o Re-read the Geczy study abstract + conclusions, no formulas,
understand what they were looking for and results, not great
detail
Summary: difference between expected costs of SRI vs non SRI (1.1
vs 1.3 expense ratio) is not large in Geczy study
o

Dont need to know impact measurement stuff on exam- next lecture

Moving on to Shareholder Activism (Topic 2):

-

What is it? Using a minority equity stake in a company to influence manager

actions
Financial activists want to increase share price
Nonfinancial shareholder activitsm wants to use quity stakes to bring about
social change by trying to impose costs on target companies (media
pressure) greater than the perceived cost of agreeing to demands- we expect
a rational manager to submit
Note: dont need shareholder action, sometimes just pressure and awareness
is enough
Proxy advisory, institutional shareholder services
Dodd Frank increased the power of shareholder activism

Question: is shareholder activism compatible with dicuary duty?

Answer: Maybe, but could also
-

CalPERS corporate engagement process has been the overarching objective

of improving alignment of interest between providers of capital (investors)
and cpmpany management. CalPERS believes that improved aligning of
interests will enable the fund to fulfill its fiduciary duty to achieve risk/returns
Critique of shareholders activism:
ERISA requires fund trustees to promote economic interests of plan
beneficiaries only
Firms like AFL-CIO actively file shareholder proposals against companies
whose workforces it is trying to organize

Dept of Labor in 2011 found pension fund proxy voting often unrelated to
economic benefits for plan beneficiaries
Larcker & Tayan argue that CalPERS and AFL-CIO provide little analysis
showing how proxy voting benefits the pension plan beneficiaries
Summary: US Dept of Labor is clear that using the pension funds
ownership position in a firm for advocacy purposes without proof of
economic benefit for the fund beneficiaries (pensioners) is a
violation of ERISA
Shareholder Activism information from Brandon Rees talk
Rees (AFL-CIO) Rebuttal to Larcker & Tayans critique of
Shareholder Activism
o Dept of Labor says you can be a shareholder activist with a
reasonable expectation that activism will enhance the economic value
of the plans investment in the corporation, after costs, and every
AFL-CIO shareholder resolution contains this analysis and statement
explaining how it will benefit economic interests
o CalPERS is actually run by the State of CA, not by unions
o Larcker & Tayan argue that AFL-CIO targeted Comcast because it was
resisting unionization, but AFL-CIO responded that Comcast was
targeted due to poor governance and depressed stock price
Research shows positive abnormal returns for companies engaged by
activists
Reading Active ownership not on exam, just know CSR activities, if
successful, create a positive abnormal return, but no effect if unsuccessful
EXAM: Question: Occupy Wall Street is this a form of socially
responsible shareholder activism, just without the shares? Some
success in changing management decisions?
Gadflies have greatest % of shareholder proposals (33%), but many are junkthe ones that really count are labor unions, religious, think tanks/institutions
Biggest % of shareholder proposals by type are 1) Environmental
2)Political spending/lobbying

Shareholder Activism: Community

-

EXAM QUESTION: SEC Rule 14-a-8 = what are the requirements to

get a shareholder resolution on the proxy ballot? Aka what factors
will require management consideration of an activist resolution?
MUST READ
1988: Avon Letter, says ERISA fiduciaries have a duty to vote shares
in portfolios. This is because voting rights are an economic benefit,
so to serve the economic interests of the beneficiaries, you must
vote these shares- must use the economic power, cant abstain
Know the key roles of ISS and of CalPERS
Question on Read Brad Barder Study- lecture notes
o In general, when CalPERs puts targeted company on its focus list it
tends to pursue it, AND that this causes stock price to increase
o CalPERS decided to keep the list a secret, because Brad Barbers
publications would let people use the CalPERS list as a long-only

strategy, and their own employees with knowledge could be insider

trading since the list is now secret, no more effect on stock price.
Also avoid the perverse effect that being targeted (presumably for bad
practices) would boost stock price.
Forms of shareholder activism instead of trying to pass resolution:
1) investment/divestment
Investing = create or increase equity stake to engage the
company
Divest = sell or threater selling to signal objection to
company actions, aka voting with your feet, The Wall
Street Walk = sell the shares and walking away, sending
a message without trying to work through shareholder
resolution
Divesting also can mean engaging a company to unload
its own investment in tobacco or Sudan, etc.
2) Proxy battles
Proxy battle = shareholder efforts to change the board
(replace board members), note Dodd-Frank regulation,
though not finalized and limited by court challenges, may
boost efforts to elect directors representing activist
shareholders
Currently, no non-financial activist has ever actually taken
over a company, but sometimes efforts are made to get a
rep on the board
Generally less successful hostile resolutions nowadaysusually management caves in earlierbut this doesnt
mean activism is not successful
Thus you cant judge success of activism by # of
resolution passed, because a sensible manager if they see
they might lose ,will quickly make the operational
changes to the company pre-emptively, rendering the
resolution obsolete
Some requirements to put a shareholder resolution
on the meeting agenda (from 14-a-8):
o Putting a resolution on the agenda depends on
individual company by-laws
o $2000 minimum investment (prevent gadfly swarm
owning 1 share)
o Attend meeting in person
o Some resolutions are non-binding
Cost of shareholder resolutions: shareholder
communication, lawyer fees, publicity
Evidence that active ownership increases returns
(Dimson and Li study)

18% success rates for SRI activist engagements vs. 4060% success rates for hedge funds financial activist
engagements
Conclude: CSR activism improves social welfare: increases
shareholder value when engagements succeed but
doesnt destroy value when engagements are
unsuccessful

Reading list:
-

Topic 1: dont need to know details of A. except 3 formulas

Topic 2:
Definitions of fiduciary duty
Stambaun/Levin study
Topic 3:
Brad Barber study!!!!
DImsum + Li not impt
Larcker & Tayan likely question
14-a-8: know list