September 2022 NIC undergrad Review

Contents

Page 3 Quick Take on Iberian Markets

Page 4 Inflation-Linked Bonds

Page 7 Sustainable Finance and the Relevance of ESG

Page 10 NIC-UD Fund: Monthly Performance

Quick Take on Iberian Markets

The Portuguese government has approved a 4.5million-euro (4.5 million$) investment in the port of Sines by REN-Redes Energeticas Nacionais SGPS SA. The primary strategy is to increase capacity for receiving and shipping liquid natural gas to other locations. This investment was agreed upon due to the possibility of the Portuguese facility and pipeline serving as an intermediary for European countries seeking to reduce their reliance on Russian gas

S&P Global Ratings has upgraded Portugal's government bonds' rating. S&P increased the rating from BBB to BBB+. Since the rating was downgraded to BBB from A- in 2011, this rating has been the highest in the nation. This demonstrates great hopes for the nation's economic future, making Portugal more alluring to potential investors.

Portugal s inflation rate reaches a 30-year high and Spain is lower than expected. The annual inflation rate in Portugal is likely increased to 9.3 percent in September of 2022, the highest since October of 1992, compared to 8 9 percent in August, preliminary estimates showed. Energy prices surged 22 2 percent, while food costs jumped 16 9 percent Spain's consumer price inflation dropped to 9.0 percent year-on-year in September 2022, moving further away from a 38-year high of 10.8 percent hit in July and compared with market expectations of 10.1 percent, a preliminary estimate showed

Standard & Poor's upgraded the long-term debt ratings of BPI, Santander Totta and BCP, but kept the outlook at "stable". "Portuguese banks have made substantial progress in rebalancing their funding profiles, making them less risky," the rating agency said As for Santander Totta, Standard & Poor's raised "the long-term issuer credit rating by one level from 'BBB' to 'BBB+'" and reaffirmed "the short-term rating at 'A-2′" On BCP the agency signals that it has raised "the long-term issuer credit rating by one level from 'BBB' to 'BBB+' and reaffirmed "the short-term rating at 'B'," it reads Banco BPI, S.A. reports that the rating agency S&P Global Ratings has upgraded the long-term debt rating of Banco BPI from BBB to BBB+, which means an increase of 1 level on the grade scale

Spain s leftist government said it will cut the income tax on lower-income households. Spain's leftist government announced plans to reduce income taxes for lower-income households to assist hard-hit consumers in dealing with soaring inflation. The government will lower income taxes for people earning up to 20.000 Euros per year, or one in every two workers Simultaneously, the government will levy a new tax on residents with assets exceeding three million euros in 2023 and 2024 to help fund inflation-fighting measures. This so-called "solidarity" tax will affect approximately 23 000 people, or 0.1 percent of taxpayers, and will generate 1.5 billion euros for state coffers over a two-year period

The Portuguese government passes on September 22 a package to help businesses through the current energy and inflation crisis valued at 1.4 billion Euros. Prime Minister António Costa said in Lisbon that 600 million would be made available in state-backed loans. Measurements for tax deduction have also been passed Furthermore, at the beginning of the month, the Lisbon government passes a relief package for families valued at 2 4 billion Euros to help counter the economic effects unleashed by the war in Ukraine. The package included cutting the value-added tax on electricity to 6% from 13% in October up to the end of 2023 at least. There was also a payment of 125 Euros to everyone earning less than 2,700 Euros a month.

Spanish cut on natural gas taxes. Spain will temporarily slash sales tax on natural gas from 21% to 5% to help consumers face rising energy costs this winter as Russia has cut back gas exports to Europe amid the war in Ukraine Teresa Ribera, Spain’s minister charged with energy policy, said on Tuesday that the reduction in sales tax will last until 31 December but can be extended beyond that date if needed It also will apply to the sale of firewood and biomass pellets. She said rising energy prices that all of Europe is enduring are directly linked to the reduction in gas flow from Russia as it tries to pressure Europe into dropping its support for Ukraine.

Francisco Bragança

Sustainable Finance and the Relevance of ESG

Introduction

We focus on sustainability not because we’re environmentalists, but because we are capitalists and fiduciaries to our clients. With this statement, made in his annual letter to CEOs, Blackrock Chairman Larry Fink caught the investor's attention this year Blackrock, the world's largest asset manager, had just passed the historic mark of 10 trillion US dollars in assets under management. According to the company's own figures, the amount of sustainable assets has doubled to over 500 billion in 2021 In this context, Larry Fink's statement not only underscores the importance of sustainable finance but also highlights a fundamental shift in the relationship between sustainability and returns. While the decision to invest in sustainable assets has long been associated with foregoing returns, Larry Fink argues that sustainability and returns are no longer mutually exclusive; on the contrary, they are actually mutually dependent.

Sustainability risks are investment risks

The primary reason for this argumentation is the ongoing climate change and its associated risks. The increase in physical risks, in the form of floods and droughts, is having an increasingly strong impact on the economy For example, if a bank finances real estate on flood-prone riverbanks, its default risk on the loans increases in the wake of the increased risk of flooding. Therefore, sustainability risks affect and exacerbate existing types of risk. In addition to these short-term physical risks, long-term structural trends like rising sea levels also play an incremental role in investment and financing decisions Additionally, stakeholders need to factor transition risks into their decisions as they adapt to climate change. A bank that ignores the shift in consumer demand toward sustainable investment products runs the risk of becoming obsolete. Hence, physical and

transition risks affect all three financial statements through different channels: leading to a revaluation of existing assets, lowering earnings, and affecting the company's cash position.

Regulation is catching up: The EU Action Plan on Financing Sustainable Growth

Sustainability risks are therefore investment risks. The European Union has acknowledged this and responded in the spring of 2018 with its EU Action Plan on Financing Sustainable Growth (see Figure 1) The aim of the actions presented in this plan is to make the financial market and the financial system as a whole more resilient to sustainability risks The individual initiatives are aimed at redirecting capital flows toward sustainable investments, integrating sustainability aspects into risk management and promoting greater transparency and long-term thinking in the financial industry The core instrument of the EU Action Plan is the so-called EU Taxonomy, which is intended to create a classification of economic activities as sustainable on the basis of transparent criteria. It is the basis for sustainability-related disclosure requirements and the consideration of sustainability criteria in the provision of financial services. Clear and transparent terminology is intended to prevent "greenwashing"

Similarly, the European Banking Association (EBA) and the European Central Bank (ECB) have already launched a large number of regulations in the context of sustainable finance. This will have farreaching implications for the strategy, internal governance and risk management of companies operating in the financial industry Based on the EU taxonomy, these companies will, for instance, be obliged to report the so-called Green Asset Ratio (GAR) in the future The GAR discloses the proportion of the institution's total assets that are invested in and financed by taxonomy-compliant economic activities

How three letters refine the financial industry and the behavior of its players

Yannick Forschner

How to assess sustainability? The ESG framework

Nevertheless, in addition to classifying individual activities as sustainable, the question of how sustainable particular companies are as a whole is increasingly coming to the fore ESG ratings, which evaluate companies on the basis of ESG factors (short for Environment, Social and Governance), are predominantly used for this purpose. According to Investopedia, the ESG concept is a framework designed to be integrated into an organization's strategy to create enterprise value by expanding the organizational objectives to include the identification, assessment and management of sustainability-related risks and opportunities with respect to all organizational stakeholders and the environment. In order to facilitate the use of the abstract ESG framework, the different letters are grouped into different thematic blocks that relate to Environment, Social and Governance (see Figure 2) These thematic blocks can be subdivided into further and further subgroups until finally individual key performance indicators (KPIs) can be identified that allow ESG performance to be measured and continuously monitored. Examples of such KPIs are the CO2 emissions emitted by the company or the number of women in management positions Depending on the company, its goals and ambitions, the individual letters can be weighted

differently and different subgroups and KPIs can underlie Environment, Social and Governance

ESG ratings: Curse or blessing?

In contrast to credit ratings, ESG ratings do not aim to assess whether a borrower will meet its financial obligations in full and on time, but, instead check whether ESG aspects are taken into account comprehensively within the company Based on this ESG performance or the ESG rating score, steering impulses emerge as to whether, for example, a particular investment should be made Nevertheless, there is also increasing criticism of ESG ratings, as the ESG rating providers are not subject to any supervision As a result, the market of providers and their methods are not transparent Most heavily, however, is the fact that there is no uniform definition of what is meant by ESG and which ESG factors need to be considered and weighted in the ESG rating As a result, the ESG ratings of different providers are not comparable and ESG ratings for the same company often diverge significantly.

Carbon emissions provide stimulus to adjust portfolios

Alongside this so-called exposure method for assessing and evaluating ESG risks, companies within the financial industry are focusing more and 5

Figure 1: Visualization of actions contained in the EU Action Plan on Financing Sustainable Growth (illustration by European Commission)

more on the so-called portfolio alignment method

The aim is to align the portfolio with global or internal sustainability targets. This provides steering impulses to adjust the portfolio composition in such a way that global sustainability targets, for example limiting the temperature increase to below 2°C, are ensured Carbon accounting plays an important role in this context. Although at first glance a bank mainly emits CO2 emissions via its facilities and IT infrastructure, it also indirectly finances the emissions of other companies via its portfolio These financed emissions are determined using a defined standard as part of the Partnership Carbon Accounting Financials (PCAF). With the help of this data, the bank can subsequently assess the extent to which its portfolio meets the sustainability targets via the financed emissions and whether any adjustments need to be made

However, the methods presented to assess ESG risks show only a small fraction of the multitude of ways in which sustainability shapes and impacts the financial industry. Not only investing, but also financing is becoming more sustainable. For instance, more and more green bonds are being issued, with the proceeds going to finance specific projects that contribute to environmental goals As

a result, companies in the financial industry are playing a general transformation role, channeling capital into sustainable projects and companies in their function as capital raisers and investors This entails both enormous challenges for the traditional business model and unimagined opportunities for growth and value creation Only those who understand this duality and position themselves accordingly will be able to survive in the long term.

Figure 2: Themes and key issues subsumed under the respective ESG letters (here using the methodology of the ESG rating provider MSCI)

Inflation-Linked Bonds

How ILBs work and ways to use them to protect against inflation

Introduction

Bonds are a fixed-income instrument that represents a loan paid to a specific entity, and that entity´s obligation to repay that money, with interest. It is formed by a principal, the amount of money initially spent on the purchase of the bond, and a coupon, representing the annual interest to be paid to the loaner Inflation-Linked bonds, or ILBs, are securities designed to help protect investors from inflation Primarily issued by sovereign governments, such as the U S and the UK, they are indexed to inflation so that the principal and interest payments rise and fall with the rate of inflation. This contrasts with nominal bonds, where the principal and the interest are fixed for the lifetime of the bond The main aim of this analysis will be TIPS and I Bonds, which are the two main Inflation-linked bonds issued by the US Treasury.

TIPS

Firstly, looking deeper into Treasury Inflation-Protected Security, or TIPS for short, are a US Treasury bond that is indexed to an inflationary gauge to protect investors from the decline in the purchasing power of their money This mechanism works through the increase of the value of the bond’s principal as inflation rises (measured by the Consumer Price Index), while the interest rate remains

the same in percentage points of the principal, when it increases so does the percentage of the interest, in relation to the original price paid for the bond. Investors thus receive increased interest or coupon payments as inflation increases (they pay interest every six months based on a fixed rate determined at the bond's auction) TIPS are issued with maturities of 5, 10, and 30 years. Currently, the fixed rate for these bonds are 2 52%, 2.44% and 1.19%, respectively.

Advantages and disadvantages

It is worth noting some of the more impactful advantages and disadvantages of these types of bonds On one hand, TIPS can lessen the actual effects of inflation since Interest payments increase as inflation increases given that the rate is calculated based on the adjusted principal balance Furthermore, investor´s

will never be paid less than their original principal when TIPS mature, so, one can be sure that, even if the expected inflation doesn’t materialize, at least the nominal value of the principal will be assured, as it is impossible for the principal to become cheaper than the value for which it was bought. One final important aspect is that Even though they are traded less often than nominal bonds, TIPS can still be bought and sold in the secondary market, a feature not shared with I Bonds as will later be analyzed On the other hand, now looking at disadvantages, the most obvious one is that if inflation does not materialize while TIPS are held, their utility decreases in relation to nominal bonds Moreover, as would be expected, the interest rate offered is usually lower than most fixed-income bonds that do not have an inflation adjustment, given that some of the return is already factored

Francisco Baptista

Figure 1: TIPS

into the future possible increase in principal. Finally, it is also worth mentioning the investors might be subject to higher taxes on increased coupon payments than they would be on nominal bonds.

Advantages and Disadvantages

Similarly, to TIPS, it is important to analyse I Bonds’ most relevant advantages and disadvantages. On one hand, in times of higher inflation, I Bonds return significantly higher amounts than other low-risk savings vehicles like high-yield savings accounts, and they present as low of a risk as possible given that they are assured by the US Treasury Like in the case o TIPS it is also impossible to lose money on an I Bonds’ principal. Furthermore, a potential increase in the fixed interest rate raises returns higher than just the sum of the interest rates, as shown by the previous formula, and finally, these bonds are exempt from paying some types of taxes On the other hand, since they must be purchased only through the US Treasury, they are not available in ETFs or mutual funds and as stated before it is necessary to hold them for at least 5 years to not incur penalties.

When is an ILB better than nominal bonds?

I Bonds

Now looking further into I Bonds; they were created in 1998 and are securities issued by the U.S. Treasury. They work slightly differently from TIPS while still protecting the investor against inflation. For I Bonds the bond's principal remains fixed throughout its lifetime while the composite interest rate changes I Bonds have two different interest rates, which combined form the composite interest rate, one is fixed, and the other one varies according to inflation, it is called the semi-annual inflation rate and is altered every six months. The composite rate is found through the formula: ������������������ �������� = ���������� �������� +ሺ ሻ 2× �������������������� ������������������ �������� +ሺ������������������ × �������������������� ������������������ �������� Currently, the semiannual inflation rate stands at 4.81% while the fixed rate is at 0%, resulting in a composite interest rate of 9.62%. I Bonds can only be bought directly from the US Treasury and can't be sold through secondary markets They have a fixed maturity of 30 years, and while it is possible to sell them back to the US Government before, the seller will have penalties for selling them after any period shorter than 5 years, and it is impossible to sell them back after any period shorter than one year

Moving on to an important aspect of understanding ILBs, which is how to determine their relative value. This can be done by comparing ILBs with nominal government bonds, through the analysis of the difference between nominal yields and real yields - the breakeven inflation rate This difference indicates the inflation expectations priced into the market, it is the rate differential at which the expected returns of ILBs and nominal bonds are equal If the actual inflation rate over the life of the bond is higher than the breakeven inflation rate, investors would earn a higher return holding ILBs while having lower inflation risk. On the other hand, if it is lower, the returns would be better with a nominal bond. For example, if a 10year nominal bond is yielding 2 5% and a 10-year TIPS is yielding 0.25%, then the breakeven inflation rate is 2 25% If the expectation is that inflation will be higher than 2.25% for the next 10 years, then an Inflation-Linked Bond would be a more attractive investment.

Main differences between bonds

Transitioning on to the matter of how to purchase these ILBs, and how their price and interestrates 8

Figure 2: Explanation ofa bond functionality

are set, for the case of I Bonds, based on changes in the non-seasonally adjusted Consumer Price Index for all Urban Consumers, the inflation rate on I bonds is changed every six months (CPI-U). A specific I bond's fixed rate won't fluctuate over the course of its life, but the U.S. Treasury analyses the fixed rate for new I bonds every six months and may adjust. I Bonds are available only to individuals, and they have a $10000 maximum amount limit, which is why there are no I Bond funds and they're available with face values as low as $25 directly from the US Treasure. In the case of TIPS, their interest rates are based on a fixed rate determined at the bond's auction​, and they can be bought on secondary markets or directly from the government treasure, having a minimum amount of $100 Furthermore, shares of mutual funds and exchange-traded funds (ETFs) with various TIPS mixes are also available for purchase, such as the Schwab U.S. TIPS ETF.

To conclude with some final thoughts, inflationlinked bonds can help to hedge against inflation risk given that they increase in value during inflationary periods, while being less appealing options during the time of little to no price changes It is important to keep in mind that as with other investments, the price of ILBs can fluctuate, and if real yields rise, the market value of an ILB will fall. Just like nominal bonds, ILB prices will increase as real yields decline and decrease as real yields rise. If an economy went through

a period of deflation, the inflation-adjusted principal could decline below its par value, and subsequently, coupon payments would be based on this deflation-adjusted amount, although this only matters for the calculation of the interest rates, given that the investor will always receive at least the par value of the bond upon the bond’s maturity. With this in mind, ILBs seem like a solid, low-risk investment option for a period like the current one, where sustained inflation seems like an inescapable certainty

Figure 3: Comparison ofcumulative returns from TIPS and normal treasury bond

NIC-UD Fund: Monthly Performance

Markets took a toll after interest rate hikes stopped being a matter of speculation to a matter of anticipation.

Global Markets

September was yet another difficult month for global markets with persistently high inflation around the globe and central banks maintaining a hawkish stance to bring it under control. Economic data shows the global economy slowing down while central banks rise rates at an unprecedented scale, making the risk of a global recession increasingly likely Both equity and bond markets were down for the month as investors assess these unfavorable conditions and uncertainty remains elevated While it has been over seven months since the war in Ukraine broke out there is still no end in sight. As consumers struggle with inflation companies have been lowering guidance and earnings estimates for the indexes have fallen Inventories have been building up as sales have been lower than expected, with inventory increases of over 40% not being uncommon In the US, inflation rose 8 2% in September, coming higher than expected. Mortgage

Current Positions

Rui Coelho

rates have risen to levels not seen since 2008, contributing to much weaker demand for housing, however, housing prices still haven’t declined, making mortgage payments roughly 50% higher than one year ago In the UK, bond markets suffered their biggest loss since 1957 as Liz Truss’s policy to cut taxes for the top earners sent gilt yields soaring as the policy adds inflationary pressure and added borrowing in a dismal economic environment British pension fund’s liability driven investing strategies (LDIs) further contributed to the bond sell-off as they needed to meet margin calls, causing the Bank of England to intervene Europe is struggling with record inflation and an energy crisis, making it increasingly likely that there will be a severe recession. In China, the zero covid policy continues wreaking havoc on the economy While in August the government announced a 1 trillionyuan plan to boost the economy the response has been weak

Our portfolio remained mostly unchanged in September. We reduced our position in BAE systems as we see most opportunities priced into the stock. The worst performer for the month was Block with a -20.01% decline closely followed by WisdomTree Carbon ETF which lost -18.67% of its value. The top performer was Sibanye Stillwater with a 7.87% increase in share price.

NIC-UD Share Price (InceptionCumulative Returns)

Benchmark Analysis

In the month of September, most indexes were down as high inflation, energy costs and the prospect of further tightening in monetary policy made equities less attractive

Our fund’s share price dropped nearly 7%, having only beaten the FANG + and the PSI 20. The FANG + was down 10.73% as multiples contract to adjust to higher discount rates and earnings are revised lower due to a slowing economy Meta was the worst performer of the index as investors grow more skeptical of the prospects of the Metaverse

The FTSE 100 lost 5.11% of its value as the UK is hit by exorbitant energy prices. While it fared better than most indexes the British bond market suffered one of its worst months in history after the announcement of an inflationary tax policy

The Shanghai-Composite had another down month as China shows little signs of loosening its zero covid policy The Chinese economy is set for its worst performance in decades as GDP growth for the year is expected to fall well below targets

Corporate News

MonthlyPerformance – September2022

Portfolio vsBenchmarks

Warren Buffett’s Berkshire Hathaway increased its stake in Occidental Petroleum to 20.9% after buying more shares in late September. Berkshire currently owns 194.35 million shares plus warrants to buy 83 million shares at an exercise price of $59.62 a share, which would raise its total stake in the company to 26 8% if exercised In late August Berkshire received regulatory permission to purchase up to 50% of Occidental Petroleum, which suggests they might be interested in eventually acquiring the entire company. Porsche ($P911) went public on September 29 at a price of $82 50 per share, valuing the company at $72 billion Volkswagen priced the shares at the top end of the valuation range and was able to raise $19 5 billion. The company retains a 75% stake in Porsche and will distribute half the proceeds as a special dividend and use the remaining funds to invest in EVs, self-driving cars, and creating a battery business Lastly, Disney rejected a request from activist investor Dan Loeb to spin-off ESPN. The investor’s hedge fund bought a $1 billion stake in the company calling it to buy the rest of Hulu, spin off ESPN and refresh its board, but eventually changed its stance on ESPN seeing the business as valuable to reach a global audience.