By Gregory C. Beier, Susarb, Sustainability Arbitrage LLC.
- We believe that the biggest opportunity in the markets today is transparently pricing sustainability in real-time.
- Sustainability arbitrage (“Susarb”) will, we believe, become the key investment strategy in the 21st century.
- Susarb uses our Full Market Disclosure innovation to generate sustainability price discovery so we can end climate change, biodiversity crises, and poverty.
- This is implemented through Susarb driving global adoption of Full Market Disclosure. Please see our November 29, 2021 piece ESG Data is a Public Good. Let’s Open It Up on Impact Alpha for more details. The article was republished on the Chartered Alternative Investment Analyst Association’s blog and on GreenBiz.com.
Optimal Pricing (or “Time to Go Viral”) – please let me know which works best.
We are keen to share our strategy with asset owners and managers to quickly scale our ideas up, because the best way for sustainability price discovery to work is if we have tens of thousands of capable, professional, regulated asset owners and managers using it overnight.
We believe that the world is ready for new ideas as the status quo is not working. We welcome your use and learning about your adaptations of Susarb.
(We think it’s best to explain a completely new idea by being as concrete and specific as possible - it avoids confusing generalities. Earlier this year, we wrote a version of the Susarb strategy for trading US equities. This is presented below with light edits and additions. Experienced participants will easily see how they would adapt it to their strengths and investment style.)
Susarb is a long-short strategy that initially focuses on two types of trades in large-cap US equities:
- Reratings – profiting from the wild divergences between the various ESG ratings firms on the same company converging through a totally new activist approach to transparently pricing sustainability.
- Flows – profiting from the erratic flows of capital on stock and bond prices driven by ESG ratings, data, indices, and ideas eventually converging to an appropriate pricing of sustainability.
We will buy stocks in companies that our Sustainable Development Goals (“SDGs”) analysis (or you can use whatever method of stock selection that works for you) clearly indicates are good prospects (to limit downside risk and make an investment which we would expect would be profitable in and of itself), and then we will seek to add significantly more upside via clarifying its ESG rating, hence strengthening its investor base and lowering its funding cost, through:
- Ideally working with an investee’s CEO, we will call up the CEO, portfolio manager, and the head of ESG at the company’s 20 largest institutional investors, educate them about Full Market Disclosure (“FMD”), and ask them to make their entire ESG analysis of the company a public good.
- Once the company and the investors begin speaking to each other frankly about how the ESG analysis is being conducted (with a focus on hard, primary data), then genuine sustainability price discovery will start (which is the entire point of this exercise) and the company will be rerated, hopefully resulting in a profitable position. Futures, options, and equity short positions will be used to take market risk out, if needed.
- The ESG industry behaves as if the company is the bad actor that finance has to police. But in truth, as opaque ESG data and black box ESG calculations have killed the market signal that generates sustainability price discovery, finance is a bad actor too. We believe that good companies have the best incentives to get their ESG right to tap green bonds and sustainable finance and to create an ardent following of ESG investors.
- A trade example would be going long a water infrastructure stock with a wide range of ESG ratings based on the SDGs view that spending on water infrastructure will increase dramatically for a decade for a variety of factors. Working with the company’s CEO, we would reach out to the 20 largest institutional shareholders and explain the benefits of FMD and emphasize the benefits of sharing ESG analysis to really determine what the essential analysis is. After several iterations of updating ESG analyses and sharing it publicly, we believe that clear sustainability pricing will be positive for the stock and may at times lead to significant appreciation.
As markets orient themselves to a sustainable future, we’ll trade the impulsive tides of capital driven by ESG data and conventions through using SDGs analysis (or whatever analysis you currently use – totally up to you) to assess an appropriate sustainability level given current factors. We will also trade the rich second-order effects of Flows and Reratings ideas in this book too.
- To aid the transition to a sustainable future by limiting the unnecessary destruction of capital, and as a dutiful adherent to the FMD ethic, we believe that it is important to state that “Market X, under conditions Y, are at an inflection price of Z.” Perhaps one benefit of public statements is that one will attract more capital from institutional investors as they recognize the positive informational impact of one’s Susarb trades.
- In fact, hedge funds can become impact funds by generating useful information. We see an immediate future where hedge fund performance will be increasingly valued on their thought leadership. By the way, this is nothing new in the hedge fund world. George Soros used to regularly do this on macro issues.
- A trade example would be capital rushing into the solar panel sector following a change in government policy electing to extend tax credits for qualified middle- and low-income buyers. If the SDGs analysis strongly supported that this would be a one-off wave, we would get short the solar panel sector after the mania has had its run and issue a statement that we see this as a temporary blip and are short the market.
Scaling Up the Strategy
Susarb’s strategy expansion could include mid-cap and small-cap equities, equities in other developed and developing markets, the whole gamut of fixed income, currencies, commodities, and other instruments.
But more importantly than just markets, Susarb will evolve significantly such that firms will specialize in Susarbing specific kinds of industry and policy evolutions. As Marvin Minsky, founder of MIT’s AI lab, wrote in his seminal work “Society of Mind,” a complex agent-agency process will emerge.
Any Edge Can Be Used
We believe that this is where Susarb gets really exciting as a strategy.
There are literally thousands of legitimate permutations to the Susarb strategy, based on what is already working for you in the securities of the capital markets that you trade and invest in now.
We fully expect that as the information environment gets rich from a growing base of Full Market Disclosure investors, more granular specializations will develop as investors with exceptional expertise will focus on very narrow trades.
Because it hasn’t existed before, there is no track record or backtest of performance for Susarb as a strategy.
However, we believe that over time value and growth will accrue to companies and instruments that align with what is obviously sustainable for the long term. And those things which are NOT sustainable for the long-term will stop growing and will eventually collapse in value.
The Winning ESG Strategy
Given the widespread agreement about the urgency to deal with climate change risks, the ESG business has developed a lot of interest but has so far failed to meet its promise by implementing solutions that generate the volume of transactions necessary to deliver change at scale.
The primary reasons for this disappointing outcome are poor data and unclear terms and standards. This can be remedied as we wrote here on CAIA:
“Standards like the Task Force on Climate-related Financial Disclosure (TCFD), Sustainability Accounting Standards Board (SASB), U.N. Principles for Responsible Investment (UNPRI), etc. would become applications that the Full Market Disclosure environment automatically tests and refines. Full Market Disclosure is a funnel that can efficiently process all of these competing applications. The more, the better!
They won’t be debated or promulgated – they’d be organically ratified by (Susarb) use in real-world investing, self-evident over time.”
The COP27 in Egypt will likely follow the usual pattern of announcements, hurrahs, and disappointment, let’s use the incredible power of the markets to universally disclose and price sustainability in real time – making ESG a success.
Markets got us into this climate and biodiversity mess because they couldn’t price negative externalities – markets can get us out of it too with cutting-edge innovation made possible by the latest technology and forward-thinking alternative investment professionals.
Hedge funds now have a route via Susarb to become legitimate, value-added impact funds.
About the Author:
Gregory C. Beier is the CEO and Founder of Sustainability Arbitrage LLC, which specializes in the sustainability arbitrage strategy that uses their innovation of Full Market Disclosure to price sustainability in real-time for asset owners and asset managers.