Coupling a quantitative approach with SRI/ESG factors can provide a path to identifying relevant alpha for investors in emerging markets, according to Robeco, the Dutch manager that is owned by Japan’s Orix Corporation.
Robeco has long pursued the use of quantitative analysis to help identify investment opportunities. It has also been applying SRI/ESG for some time – the RobecoSAM arm was set up specifically to develop sustainability investing. However, where the manager is looking now to apply its quantitative/SRI/ESG approach more broadly is in emerging markets, which it suggests are starting to generate the required amount of data to make possible investments this way.
Wilma de Groot (pictured) senior portfolio manager within Robeco’s Quantitative Equities team, and responsible for managing and developing quantitative emerging market strategies, says the work being done is leading to new ways of managing stock selection.
“Last year we set up a research project to see how we can bring SRI/ESG to the next level,” she says.
“The aim was for consistent implementation across a range of equity products, and ensure a consistent approach to SRI implementation. What you regularly see in the quants space is exclusion policy; the least popular stocks according to a filter are being excluded. But the more you exclude, the less opportunities you have to generate return or impact return.”
“Another way would be to use it as an alpha factor, to use ESG as an alpha factor. But there’s been no consensus in academic literature on using ESG as an alpha factor. What we find difficult there is how to use this in EM. In DM there is enough of a history to decide whether to apply ESG as an alpha factor. But in EM, while coverage has increased in recent years, a decade ago coverage was poor relatively speaking.”
Key to any development of using quants and SRI/ESG for identifying emerging market opportunities is to have enough data.
In Robeco’s case, the relevant data comes via RobecoSAM, the sustainability manager that has been gathering data from questionnaires sent to companies since 1999. These cover some 3,000 companies so far and has resulted in a proprietary database that is not publicly available.
The answers to the questionnaires are translated into ‘scores’, with total scores of companies consisting of the aggregate of answers to environmental, social and governance questions.
Discrete granular ESG scores can be viewed, but the focus tends to be on having a broad view of companies, de Groot says.
“If you really want to test the relation between alpha and stock returns, you may have the danger that one particular factor has positive correlation, but others not.”
“So the more you go into underlying scores data, into E, S, G, for example, into sub scores of the environmental scores, you may find relationships to returns, but it is unsure if those relationships hold going forward. That is why we prefer to look at the overall ESG score.”
The RobecoSAM data is useful also because of the breadth of coverage of the relevant investable universe: de Groot says that some 75% of the MSCI EM index is covered, representing some 90% of the index’s market cap.
From the portfolio manager’s perspective, de Groot says it less concerning to have some companies in the portfolio that score mediocre on ESG factors but it is important to avoid a portfolio that scores below its benchmark in terms of the scores. This is why portfolios are rebalanced monthly: if the overall portfolio measure is worse than the benchmark, then the manager is in a position to buy those companies that score better, or sell those that score worse.
This in turn leads to a different way of looking at SRI/ESG in terms of portfolio construction, because it means managers can do more than just apply negative screening, and avoid exclusion by also applying positive screening.
De Groot argues that the approach is benefitting investors. Return is not given up to ensure the portfolio is more sustainable than the benchmark, and the data also suggests that the 20% most attractive stocks before and after implementing the rules tend to be very similar.
Another way to look at it is to say that being positive exposed to ESG will not guarantee additional return, but to not be exposed to ESG brings with it certain other risks. This suits the quantitative approach, which is looking to avoid risks that will not bring additional return, she says.