IMPACT COMMENTARY

Children have a way of putting the world into perspective. It was years ago that a month before Christmas, my five year old son turned to me and asked, “Dad, am I on the naughty list?” I looked at him quizzically and stated, “Absolutely not!” After several moments of silence, he looked at me and said, “Daddy, I think I’m on the naughty list.” I then asked him why he thought this and he stated, “I’ve been mean to Benjamin”, his brother. I was left reflecting on not only his sweet demeanor and obvious guilt, but whether I myself might be on the naughty list. 

It’s about this time of year that many of us (in between holiday shopping, parties, and the year end business crunch) begin to think about our accomplishments (good or bad) from this current year and what we plan for next year. We look forward to the New Year as it’s as much of a time to celebrate what we are looking forward to, as much as we are celebrating what we are leaving behind. It’s a time for renewal, a time perhaps to remove ourselves from the “naughty list”, and a time to reflect on how we do better.

As I reflect on the thinking of my five year old, on our fragile world and economy, and on my responsibility as a citizen and as a human being, I am reminded that there is a world that we live in that is desperately in need of help. While I am certain that we can work ourselves out of many of the issues currently at hand, I am also certain that we won’t succeed unless we treat these issues like national emergencies and work together in fixing them. Nothing could be more important. 

At the heart of our work is understanding how we can influence others to make change, whether they be individuals or corporate citizens, and collaborate with one another to achieve this goal. Our ongoing objective is to get more people and more corporations off of the “naughty list” and on to the “nice list”, and we have made some big changes at Newday this past year so that we can more easily accomplish this objective. 

A New and More Experienced Investment Team

In June of 2021, we hired Gordon Telfer as Chief Investment Officer to oversee all of Newday’s investment portfolios and investment strategy. In September we hired Shireen Eddleblute as Head of ESG Research, Portfolio Manager, and Chief Diversity Officer. Each of them bring decades of investment leadership experience to the Newday team and their contributions are playing out significantly and contributing to stronger investment performance with better ESG outcomes in our investment portfolios. 

Broader ESG Analytics Coverage

We have expanded our analytics coverage that includes a more multi-cap global focus, providing us with not only a larger universe of the world’s most responsible companies to choose from, but better and more complete information to make informed investment decisions.

Stronger Institutional Focus

While we remain committed to delivering institutional quality products and services to all investors, this year we will be delivering these solutions in a more effective way. Beginning at the end of March 2022, we will no longer be servicing retail accounts through the Newday mobile platform, however, the Newday App will remain as an information and reporting tool. Going forward, Newday investment portfolios can be accessed through a number of Newday distribution partners. Please contact us for more information on how and where to access Newday’s Impact investment portfolios. 

Expanded Set of Impact Partnerships

We have expanded our impact partnerships to include some of the world’s most recognized impact leaders and their organizations including Jane Goodall and the Jane Goodall Institute, Georgie Badeil and the Georgie Badiel Foundation, Philippe Cousteau and Earth Echo International, Eliza Nemser and Climate Changemakers, and Generation Unlimited/Unicef which we will more formally announce in January. We will continue to support our impact partners by contributing 5% of our revenues to their organizations, to further drive direct impact across our set of impact initiatives. 

THE COMING YEAR

2022 will be an important year for Newday and our new and existing clients, as we deliver new ESG and impact solutions to responsibly-minded individual and institutional investors. 

Greater Access to Unique ESG and Impact Investment Solutions

Plans are underway to deliver a subset of the Newday Impact Investment Portfolios to a larger more global set of investors through unitized investment vehicles. As these products and services become available, we will notify members of the Newday community in the coming months.

More Impact Education and Engagement Opportunities

We are in the process of finalizing our impact education and engagement events for the first half of 2022. On January 29th, we will be hosting an important event for families entitled “Locking Arms: How Family Offices Can Change The World Using ESG Principles”. A very special event is planned for the 29th anniversary of World Water Day on March 22nd in association with the Georgie Badiel Foundation in New York City, and a transatlantic impact event is being planned around Earth Day with several of our impact advocates in California, New York, and London.

Improved Impact Outcomes

We are wrapping up our 2021 Impact Report which will be distributed to clients by the end of January. Additionally, this year we will be bolstering our corporate engagement and advocacy work and will begin reporting on impact outcomes quarterly.

Forging a New Path to ESG and Impact 

As always, we remain 100% committed to being “impact first”. The relationships that we have time stakingly built with our impact partners and our advocates is a critical distinction for us. Not only has it allowed us to build a deep understanding of the real work of sustainability, but they have been extraordinarily helpful as we’ve struck out on the road to create a very unique experience incorporating both impact and ESG. No other investment firm has been able to cultivate relationships with our world’s most distinguished impact leaders. 

Nor should it be diminished that we are big believers in the idea that companies that are responsible stewards of our world’s most precious resources will perform better than those that are not. We believe that public companies should be considered public institutions and as such the interests of more than just shareholders should be considered when making corporate decisions. 

But it goes deeper than that. The most important thing that public companies can do today is to create sustainable value. Companies that embrace this philosophy and put into practice long term decision making, accumulate contingent assets. This focus normally results in a lower cost of capital and superior financial performance for these companies. 

As portfolio managers, we are in the business of understanding the nature of how companies accumulate contingent assets and liabilities, how they generate excess returns, and control risk. As a complement to impact, we work diligently to identify great businesses that not only generate an extraordinary amount of wealth for their stake-holders, but leave an imprint on the world and on their communities. Great businesses invest in the long-term interests of their customers, employees, and communities. Great businesses create contingent assets not reflected in typical financial metrics, and these market inefficiencies are driven by these excess factors. Extensive evaluation of these extra financial factors can reduce risks and uncover alternative sources of excess returns. The market most times under-appreciates the impact of these extra financial factors creating an inefficiency that we take advantage of. The point is that the way an organization discharges its practices, drives future returns before they become real financial factors. Once they become financial factors, they are already efficiently absorbed into stock prices. 

We are proud of the work that we pursue at Newday, of the coveted client and partner relationships that we have carefully built, and of the commitment that our employees and our clients have made to helping us build an organization that stands for something more important. Our commitment is to build a company that lasts in perpetuity, helping solve some of the world’s most challenging social and environmental issues by allowing for capital to be channeled to organizations and their leaders who have ambitions for a greater good. f

As a father of three children, I am always mindful of setting the right example. Like many parents, I am no stranger to Dr. Seuss, his writings, and the film cartoons that have been produced from his work. Every holiday season, I look forward to watching “How the Grinch Stole Christmas.” 

The messages are important ones. One of Seuss’ most famous works, The Lorax, was made into a full length motion picture. It is one I’ve read and seen now many times at the request of my children. Over the years, I’ve paid attention to its strong messages. While the opening paragraph infers a strong message of “doing what is right,” Seuss concludes with a message that perhaps is even more powerful.

“Now that you’re here, the word of the Lorax seems perfectly clear. Unless someone like you cares a whole awful lot, nothing is going to get better. Sad to say, but it’s not.” 

On behalf of our Newday team, our advocates, and all of the people that we touch through our impact relationships, thank you for caring!! I extend my very best for a happy, healthy, and prosperous New Year. It’s been a pleasure having you as a part of the Newday Impact community and we thank you for your support and advocacy. We look forward to an incredibly productive and rewarding year.

Sincerely,

Doug Heske

CAPITAL MARKETS COMMENTARY

“Global economic conditions remain good by historical standards and corporate-profit growth has been strong. However, the cycle is shifting. Moderating growth, the new Omicron variant and fading monetary stimulus have resulted in volatility in capital markets which likely continues in 2022”.

Summary: 

The global economy encounters a variety of headwinds 

A new coronavirus variant, Omicron, higher inflation, ongoing supply-chain challenges, and China’s economic slowdown are among the main headwinds facing the global economy in 2022. Moreover, policymakers are acknowledging the economic recovery is maturing, which allows for a gradual dialing back of monetary accommodation and less generous fiscal support. As the recovery progresses and economies reach their potential, it is natural for global growth to become less buoyant. We believe the recovery is still in decent shape and expect growth to persist in 2022, albeit at a slower pace relative to 2021. Amongst the headwinds, there are two key catalysts we see supporting the ongoing expansion. The first, is consumers are flush with cash, and they have much lower financial commitments, putting them in a better position to increase their spending. The second, is businesses have expressed a desire to rebuild inventories and boost capital expenditures. Weighing the positives and the negatives, we are expecting 3.5% global growth in 2022.

The coronavirus regains traction… again

The pandemic has become more challenging in recent months thanks to the Omicron variant. Infections are once again rising throughout the world. Colder weather, in the northern hemisphere, the reopening of schools and the relaxation of social restrictions have made it easier for the virus to spread. The impact is most obvious in Europe, including the U.K., but cases are also now ramping up in North America. The Omicron variant is proving to be more contagious (2x Delta) though perhaps less deadly, superior at resisting vaccines and better at re-infecting people. Vaccine makers are working diligently to adapt their formulas, but it might take several quarters before production ramps up sufficiently and distribution gets to the point where sizable portions of the global population are protected. 

Inflation continues to run hot 

The rate of inflation has increased further over the past quarter and now stands at levels not encountered in decades. Economic demand has snapped back faster than supply, causing higher commodity prices, a lack of workers, and shortages in a variety of goods. Inflation data has consistently remained hot. Supply-chain constraints are showing signs of receding and oil prices may come down, other inflation pressures can persist. Central banks worldwide have printed significant amounts of money and appear accepting of higher inflation over at least the next twelve months. Our view remains that even after distortions from the pandemic settle, we should see a return to a more normalized historic level of inflation. 

U.S. stocks are fully valued, so profit growth will be critical to sustaining the bull market in 2022 

Global equities extended gains from 2020 to record another strong year in 2021 resulting in equities reaching fully valued levels. At these valuation multiples, equities are pricing in a favorable outlook for both the economy and corporate profits. A key risk we will be focusing on, this year, is the demanding valuations for U.S. large cap growth equities. Disappointing sales and/or profit growth will not be treated kindly by investors. Continued strong gains in corporate profits will be critical to supporting higher equity prices overall and U.S. large cap growth equities in particular. We believe an environment of still historically low interest rates, with inflation transitioning back to more normal levels can still allow for robust growth in corporate profits. Assuming our thesis plays out, the U.S. equity market could deliver mid-single-digit to low-double-digit gains during 2022.

U.S.: Nothing to worry about except… Fed policy, politics, inflation, and Omicron

On the monetary-policy front, the U.S. Federal Reserve (Fed) has started reducing stimulus, and policymakers have signaled that bond purchases related to quantitative easing will end by June this year. Recent 30-year highs in inflation have prompted investors to expect the Fed to begin raising interest rates as early as April. The Fed’s goal on achieving full employment may have been achieved, and it now seems convinced that last year’s inflation jump should ease, as supply-chain congestion is relieved, and demand shifts from goods to services. The path taken by the pandemic will have a lot to say about when and how fast the Fed raises interest rates. The Omicron variant could, potentially, prompt policymakers to pause tightening plans until the outlook becomes clearer. On the political front, Congress has a lot to do. We have been assuming little/to zero new fiscal stimulus for 2022. In large part due to the uncertainty of Democrat support for Biden’s Build Back Better plan. Senator Manchin clearly dealt a significant blow to President Biden’s plans in December. Our expectation is for the private sector, not Washington DC, to be the economic growth driver, via strong profits, job creation, and rising wages this year.

Even prior to the appearance of the Omicron variant, we had begun reducing exposure in our U.S. portfolios to “riskier” companies with higher valuations and beta. Data reflected the number of new COVID-19 cases began rising in most U.S. states during the last week of October, hospitalizations began rising over the last two weeks of November and this trend has continued into the New Year. Despite this, we have refrained from shifting to an overweight allocation in defensive stocks because, in our view, the U.S. economic backdrop remains constructive. The job market is improving, with first-time unemployment claims at a 50- year low and both wages and salaries growing at a double-digit rate. According to the Atlanta Fed, real GDP growth for the fourth quarter 2021 is forecast to exceed 8%. For 2022, economic growth is now forecast to slow to between 3% and 4% but based on our models this still translates into corporate revenue growth of 7% and earnings growth of 9% which would be positive for equity markets.

In the meantime, at Newday, we continue to maintain exposure to our long-term themes such as digitization, electrification, decarbonization, artificial intelligence and machine learning, and infrastructure improvement. Specifically, within these themes, we have been emphasizing companies with earnings growth and strong free-cash-flow. These are the companies we believe are likely to experience tailwinds for years to come.

China: Regulatory uncertainty needs to be resolved

Last year saw many areas of the Chinese economy come under increased regulatory pressures. In particular, we saw regulatory measures aimed at technology companies including banning unfair competition, restricting the use of personal data, and banning fake reviews and cash incentives to attract positive ratings. These moves have caused investors to question whether Chinese authorities will allow capitalism to flourish. Such fears may be overcome when consideration is given to the crucial role played by the economy’s private sector, which now accounts for at least 80% of new jobs. The private sector is also needed to help upgrade the economy in areas such as technology, semiconductors, automation, and renewable energy. It is difficult for us to predict how long the regulatory overhang will last. However, recent official criticism of internet companies has been less strident.

The other key issue we see hurting Chinese equities has been monetary and fiscal policies that have been relatively tight in contrast to what has occurred in the developed world since the onset of the pandemic almost two years ago. The growth rates of both Chinese money supply and bank lending have fallen to multi-year lows, and on the back of this so has GDP growth. Part of this weakening is due to recent efforts to reduce property companies’ debt burdens through adherence to tighter leverage rules as well as measures to cool speculation in property. These rules have led to the much-publicized financial stresses facing Evergrande, China’s most leveraged developer with debts exceeding over US$300 billion. The Evergrande situation has driven concerns that China may face a “Lehman moment” leading to a collapse in its debt markets. But unlike Lehman Brothers in 2008, China’s current debt crisis has been triggered by its authorities, and we think there is every reason to believe that Chinese policymakers can deal with the fallout through a managed liquidation thus preventing any crisis.

Based on historic actions, we believe the growth slowdown in China will prompt Beijing to introduce monetary and fiscal-easing measures to bolster its economy. These steps could include facilitating credit lines for manufacturing and small businesses, and greater fiscal spending financed in part by sales of government bonds. The government may also boost the domestic supply of coal and other fuels to ease power outages and related supply-chain disruptions. However, based on our research, assuming economic growth can remain around 7%, we expect Beijing continues its measures aimed at reducing carbon emissions as it strives to be a leader in clean energy.

We have maintained for some time the Chinese government’s priorities have shifted in recent years from an emphasis on economic growth to quality of economic growth. That being said, we believe it will be important to be cautious in areas that are vulnerable to government intrusion. Our preference is to be positioned in themes the government is likely to support, such as renewable energy, electric vehicles and technology that reduces the country’s dependence on foreign investment. Chinese companies that are truly innovative and can compete on the global stage should be good investments. This environment should favor high quality companies with strong earnings growth, transparent management teams and clear competitive advantages. These are the companies that could be candidates for Newday portfolios.

Europe: Watching Omicron and bond yields closely

2021 macroeconomic indicators were mostly positive, suggesting economic expansion, although coming into the New Year, they are no longer rising. Historically, a period in which these indicators have flattened often precedes investors to shift into less risky investments. This change is not necessarily a negative for equities, assuming positive macroeconomic indicators continue to support good corporate earnings growth. In 2022, we expect earnings growth to fall back to a more “normal” 7% to 9% from the extraordinary 45% pace that followed the recovery from the depths of the pandemic. We do not consider valuations particularly stretched especially relative to the U.S.

Despite this, we need to be mindful of today’s elevated levels of global inflation and its possible impact on bond yields. The inflation spike in Europe has been driven primarily by the coronavirus-related lockdowns and as global growth recovered, the increased demand for goods which outstripped supply. The global supply chain has been under huge strain, and we have seen industries struggle to obtain labor, component parts and goods in a timely fashion, which has exacerbated the situation. We are confident that the supply-chain issues will resolve themselves over the course of this year, but its continued impact may keep inflation higher for longer. The reaction of central banks and the bond market to inflation will have a significant impact on investor sentiment. Equity investors, historically, do not appreciate swift rises in bond yields. For this reason, we continue to keep a close eye on bond yields. In addition, we are closely monitoring the Omicron situation in Europe, where soaring case numbers and hospital admissions, have led to short-term lockdowns. The latest outbreaks may create further short-term equity volatility. Overall, we do not expect this to hurt the long-term investment case for the companies we own in our portfolios. In fact, as an active investor this may create investment opportunities.

Japan: What inflation…

Economic growth in Japan was starting to accelerate on vaccination progress, but another surge in cases, late in 2021, suggests that in the short-run, economic activity will slow. While the pandemic has pushed Japan back into overall deflation, on a positive note, elevated commodity prices have led to welcome price increases in some areas of the economy. We expect Prime Minister Fumio Kishida to follow a fiscal course of economic expansion, while the Bank of Japan (BOJ) extends its accommodative monetary policy. Business confidence and equity markets have been fueled by optimism in the increased near-term government spending program. While supply constraints have resulted in stagnant production, global demand remains solid, and the sharp increase in prices for raw materials along with intermediate goods suggests that demand will stay strong for finished goods. A slowing Chinese economy may cool sales of Japanese goods, and machinery. At Newday, we continue to advocate focusing on companies that can deliver earnings growth, and strong free cash flow. 

Asia Pacific ex Japan: Now seeing potential for growth in both domestic demand and exports

We expect Asian growth to continue rising gradually, and domestic demand to catch up to exports as a growth driver. Developed Asian countries have reached high COVID-19 vaccination rates and developing countries are starting to make progress, which in time should also lead to a surge in domestic consumption. Factors affecting inflation likely remain within central-bank targets. We expect most central banks, in the region, to shy away from rate increases to avoid jeopardizing growth except for those in South Korea and India, where economic growth has been more robust.

In Hong Kong, the pace of recovery likely remains constrained by the pandemic, higher energy prices, slowing Chinese growth and uncertainty over U.S.-China relations. While GDP growth for 2021, should come in at around 6.8%, the economy overall is slowing primarily because of China. A key measure we follow is retail sales which remain 25% below 2018 levels, reflecting a dearth of tourism activity, especially from mainland China. Border restrictions in Hong Kong continue to be among the toughest worldwide which suggests this metric is not changing anytime soon.

In South Korea, we expect GDP growth to continue making strides toward pre-pandemic levels, supporting further policy-rate increases by its central bank. Export growth remains strong, signaling a possible decoupling from slowing Chinese demand. South Korea is benefiting from exports of chemicals and other petroleum products as strong demand has enabled producers to raise prices to a degree. Another positive is personal consumption is gradually improving, boosted partly by fiscal stimulus.

Emerging Markets: China’s struggles have made a significant impact

Emerging-market equities have been negatively affected, primarily, by the weak performance of China, which accounts for approximately one-third of the emerging-market benchmark and has been the weakest-performing emerging-market country over the past 12 months. The decline in Chinese equities, since the start of 2021, was driven by regulatory uncertainty surrounding technology and relatively tight monetary policy. The impact of internet stocks has been particularly pronounced given its weighting in the Chinese benchmark peaked at almost 50% a year ago.

India’s economy has been expanding quickly since the country emerged from an especially bad surge in coronavirus cases during 2021. We view the economy remains strong and progress on vaccinations has been such that the biggest near-term issue is not demand but supply. While aggregate demand shows signs of fatigue, reflected in weaker auto sales and exports, we believe this decline reflects supply-side bottlenecks such as chip shortages. Other key economic indicators exceed pre-pandemic levels. India’s central bank has embarked on plans to tighten monetary policy by ending bond purchases. However, financial conditions still remain loose, and GDP growth is forecast to rise to 9.5% in the 2022 fiscal year from “only” 7.7% last year.

For the emerging market investor, stark valuation differences remain. As an active stock-picker, within our ESG and fundamental investment process we continue to favor the consumer, driven by catalysts such as rising incomes, attractive demographics, and positive employment trends. Among cyclical sectors, we prefer financials based on valuation, improving asset quality and the scope for growth in fintech business, customer acquisition numbers and expanded services.

2022 Outlook: Scotsman’s View

I wrote this outlook as I was watching a favorite Scottish movie of mine: Local Hero. I had the good fortune to have lunch, in Glasgow, with its Director Bill Forsyth. It is, in my humble opinion, a hidden gem of a film. Should you care to watch the movie (for U.S. readers) there is a great line that best ties to my 2022 outlook:

Mac MacIntyre: What’s the most amazing thing you’ve ever found?
Ben Knox: Impossible to say. You see, there’s something amazing every two or three weeks.”

This sums up my outlook for 2022. My base case is for the global economy to continue growing at a robust yet slowing rate as the cycle matures. Central banks will dial back monetary accommodation, meaning that the capital markets will be receiving less support. The northern hemisphere is seeing the worst impact from Omicron, but the virus will spread to every country worldwide. However, countries are doing a better job of testing and vaccinating, Omicron symptoms appear less severe than Delta and hopefully this becomes an ongoing illness like the cold or flu. Nothing more severe.

With this backdrop, we expect another challenging year for investors. Volatility will remain elevated as 2022 brings U.S. midterm elections which will be a further source of uncertainty. Both the economic and business cycle is advancing, valuations are elevated, and markets are vulnerable to correction. In our view, stocks still offer better return potential relative to fixed income and cash. But we also see catalysts for stocks to advance, including significant investor cash on the sidelines, U.S. companies continue to have good operating leverage and TINA (there is no alternative), especially with inflation north of 3%. Prospective returns for bonds are especially unappealing in this environment and any meaningful increase in yields would lead to low or negative returns in sovereign bonds. 

As an investor, one of the things that has always attracted me to capital markets is they indeed change, delivering something amazing not only every two or three weeks but every day. At Newday, we continue to redouble our efforts in managing portfolios to minimize exposure to unwanted factors and risks in the market, enabling us to maintain a good risk-return profile for our clients.

ESG RESEARCH COMMENTARY

ESG 2021 – A Year in Review 

If some thought ESG was a heterodox phenomenon over the last few years, 2021 proved them wrong. ESG and Sustainability topics became more widespread, and investors and businesses began to earnestly make progress towards instituting and transitioning ESG initiatives into their business model. Essentially, all of the largest companies across our globe now disseminate voluntary sustainability reports and have set forth a self-imposed discipline related to improvements to its climate and societal goals.

So, what were some key ESG topics and takeaways in 2021?  

Record growth in ESG investing

According to the latest Refinitive Lipper data, as of November 30th, $649 billion went into ESG-focused funds worldwide, nearly a 20% increase from 2020, which was on top of a 90% increase in 2019. This accounts for 10% of all global fund assets and shows no signs of abating.

Social issues prevailed and climate change remains at the forefront

We saw shareholder activists challenge boards on ESG issues and companies take a stand. Big Oil companies were pressured to change their board composition and improve GHG policies as they moved from their status quo. Some even pulling CAPX investments in new oil field exploration due to public sentiment. 

We also saw a shift in the conversation to a cleaner economy with renewable energy now the world’s cheapest energy source. At least six major automakers even stated they’ll stop selling gasoline and diesel-powered vehicles in the next 15-20 years.   

COP26, the UN’s most important climate change summit in Glasgow, Scotland, saw progress as countries made improved pledges to decarbonize and laid out a pathway to avert major catastrophic climate change by reducing emissions to net-zero by 2050 and halving emissions by 2030. Based on these pledges and backed by the International Energy Agency, we are on a pathway to 1.8 degrees which are close to being in line with the 1.5-degree target. However, some critics argue that the countries’ pledges actually put us on a pathway to 2.4 degrees, below the necessary goal to stop global warming and climate change. 

Increased talk of the importance of natural capital

Natural Capital is the most fundamental and arguably the most essential form of capital in our global economy. While the global economy has grown nearly fivefold in the past 50 years, it has done so at a massive cost to the global environment. Half of the world’s GDP is in some way connected to Nature. However, currently, there is no way to value the importance of Nature and the grave consequences of biodiversity loss and the erosion of natural habitats. The UN Secretary-General António Guterres said, “Nature’s resources still do not figure in countries’ calculations of wealth. The current system is weighted towards destruction, not preservation.” Because of this, the UN adopted a new framework that includes the contributions of Nature when measuring economic prosperity and human well-being and would go beyond just using GDP in economic reporting to ensure that natural capital is recognized as well. 

Europe is leading the way with non-financial transparency and disclosures of sustainability reporting

At COP26, the International Financial Reporting Standards Foundation (IFRS) announced the formation of the International Sustainability Standards Board (ISSB) to develop a global baseline of sustainability disclosures for the financial markets. This initiative will bring together the myriad of non-financial standards prevalent in the marketplace under one umbrella. 

The US is still behind in this, but the SEC has responded to pressure by making ESG disclosures a priority and commented that its focus includes corporate board diversity, climate change, human capital management, and cybersecurity risk governance. The SEC is also introducing new rules for the disclosure of ESG metrics by asset managers.

While 2021 was a watershed year where shareholders spoke and most companies listened, more needs to be done to move the ESG needle. But if the last two years indicate where we are going, investment returns will be accompanied by companies doing more for our environment and society. Moreover, the development and implementation of ESG regulations will likely drive the required standardization and clarity that investors want, which will result in continued ESG asset growth.

ESG RESEARCH COMMENTARY

Chinese property giant Evergrande declared in default

China Evergrande Group, one of the China’s biggest property developers, was declared in default by all three major credit rating firms earlier this month following its failure to pay over $80 million of interest payments on two sets of dollar bonds by the end of a 30-day grace period.  The conglomerate has roughly $300 billion in debt including around $20 billion in U.S. dollar bonds, and it has been struggling to meet its obligations since the summer.  The company announced hiring financial advisers in September, and recently requested assistance from the local government in its home province of Guangdong.  The company has since its founding in the late 90s exemplified China’s epic debt-fueled real estate boom.  The Chinese government has more recently tried to rein in the property sector highlighting “three red lines” of indebtedness for real-estate developers to avoid.  In each case Evergrande has been well beyond the governments acceptable thresholds severely limiting its ability to borrow.  Having difficulty raising cash it began turning to its own employees for loans.  The company announced property sales fell 39 percent last year compared with the previous year further exacerbating the company’s cash crunch. Most worrying for the Chinese government, which puts social stability as the top priority, the company has presold millions of apartments for which it no longer has the money to complete.  

Implications: What follows will be a long and complex restructuring process, and with protests already reported expect priority to be given to owners of unfinished apartments as well as domestic debtors over the claims of international investors.  With other developers in similarly precarious positions the challenge will be unwinding Evergrande without sparking further contagion.

Germany leaves the Merkel Era

Social Democrat Olaf Scholz has been sworn in as chancellor of Germany following the signing of the country’s first ever three-party coalition agreement.  The so-called “traffic light” coalition includes the center-left Social Democrats, the environmentalist Greens and the pro-business Free Democrats.  The leadership transition brings to an end the 16-year rule of Angela Merkel, and her center-right Christian Democrats will go into the opposition for only the third time since World War II.  Scholz served as finance minister and vice chancellor in Merkel’s last government, and he campaigned as her natural successor saying he would follow her pragmatic leadership style.  The coalition manifesto proposed a program of structural overhauls focused on climate change and digital infrastructure, but it doesn’t propose any major changes to the country’s economic policy framework.  The document also called for greater integration of the European Union and for the bloc’s fiscal rules to be simplified and made more flexible.

Implications: The new government’s plans don’t represent a dramatic departure from past policy.  However, many details are yet to be laid out, and it remains to be seen how the political differences among the coalition partner parties will play out in practice.  

Turkey continues costly push against economic convention

The unorthodox economic policies followed by Turkish President Recep Tayyip Erdogan have continued to wreak havoc on the Turkish economy.  Rather than reversing course he has doubled down on his insistence on lower interest rates despite surging inflation, and he has removed any officials that question his priorities.  He has fired three central bank governors in two years as well as a number of deputy governors and top officials.  Under pressure from Erdogan, the central bank has cut its policy rates by 500 basis points to 14% since September.  The predictable result is inflation at its highest level since 2002. Annual inflation according to official statistics was over 36% in December.  The independent Inflation Research Group, made up of academics and former government officials, put the yearly inflation rate at a staggering 83%.  The lira was the worst performing emerging market currency last year with a decline of more than 40% against the U.S. dollar.  The government last month announced a new deposit scheme meant to protect domestic savers against further currency depreciation, which instigated a dramatic rally in the lira.  However, the gains faded in the days following as it became clear that the rally was largely tied to central bank interventions rather than any shift in domestic sentiment.   

Implications:  The economic chaos has eroded confidence in Erdogan and his ruling Justice and Development Party.  Elections are scheduled to be held no later than mid-2023.  If the opposition is able to unite around a strong candidate they will stand a good chance in the polls, but there is concern that Erdogan could resort to anti-democratic steps to cling to power.  

Chile runoff elections won by leftist former student protest leader

Leftist Gabriel Boric won the run-off election to become Chile’s next president defeating his right-wing opponent, Jose Antonio Kast.  Kast had won the first-round vote held in November with 27% of the vote (Boric was in second place with 25%), but no one received a majority, necessitating this month’s second round vote.  Boric secured a strong mandate, winning by 11 percentage points with the highest voter turnout since voting became voluntary in 2012.  At 36 years old, he will also be Chile’s youngest president.  Boric rose to prominence as a student leader during 2011 protests, and he was elected to Congress in 2014.  He was the candidate of the leftist bloc, which includes the Communist Party as part of its coalition.  Upon securing the bloc’s nomination, Boric declared that Chile would be the “grave” of neoliberalism.  In the second round, however, Boric broadened his coalition, and he softened his rhetoric promising to be fiscally responsible.  The election took place while an assembly is rewriting Chile’s dictatorship-era constitution.  Boric has long been an advocate for a new constitution, which is expected to be voted on in a referendum in mid-2022.

Implications: Boric will be sworn in as President on March 11 having promised radical reforms to the country’s free-market economic model.  A narrowly divided congress, however, will likely be an obstacle to enacting his proposals.  Hopefully, the calls for reforms to ease stark inequality can be met without destroying the prosperity built over the past 30 years.