Scott: How easy is it to explain that to trustees? If you have not been able to achieve something because you do not have the liquidity or a particular stock is not available, that is fundamental to the performance you achieve. You are in the same situation as everyone else, but you have under-achieved because of that premise. Leeuwen: It’s researching factors and how you implement them. Once you have realistic simulations and compare them to what you do in real life you can see that there are a lot of similarities. That is how you build trust. There’s a good economic rationale and you can show that it works, but it takes time for people to understand it. Scott: The other thing is quarterly reporting. In meetings you have maybe 20 minutes to explain it and you are one of four managers. There are all these things that stop the message getting fully through to the trustee board so that they can understand it. I understand where you are coming from, but the prob- lem is often explaining it to the trustee board in a way that they can understand it. With all these different types of investing, such as LDI, the explanation and understanding are the most challenging.
PI: How does ESG fit into factor investing? Leeuwen: RobecoSAM, our daughter company, provides an ESG score on every company in our uni- verse. We want to make sure that the portfolios we create have at least as good an ESG score as the average universe. Our strategies are 90% rules-based, 10% fundamental. We believe in our models, but we still ask an analyst to review the names that pop up which includes a look at ESG risks. We use quantitative analysis as well as fundamental screening to make sure that we have a good ESG profile in portfolios.
PI: Is ESG something that clients are asking for generally, not just in factor investing? Scott: It’s becoming huge for trustees. The regulator is demanding that you put it in your statements, so everyone’s talking about it and having to comply. It used to be a small statement in reports saying that we don’t have any views on this, and we leave it to the managers. That is no longer good enough and is where factor investing can shape a portfolio to be more ESG compliant. So it could be a big driver for factor investing. Peach: Factor investing in its purest form is not trying to do anything in an ESG-friendly way per se. The first problem is defining what ESG is. It can be strongly driven by clients’ beliefs and everyone’s beliefs are different, so trying to make that into a single all-encompassing product is difficult. So it would not necessarily pass the test of being a factor because it is not robust enough as a definition. One of the more objective bits of available data is around carbon emissions. There is something that can be done around carbon that is less subjective and can be incorporated into a factor product. It is not a factor in itself but it can be incorporated without diluting the strength of the factors or negatively impacting expected returns.
When it comes to ESG, you can do something on the ‘E’ with a carbon screen. For the ‘G’ you could argue that you are getting good governance within the quality companies that you are buying. However, the ‘S’ is a little harder to define. Barron: That’s the direction of travel. Nine out of 10 meetings are now ESG focused and the tenth ends up being ESG focused. It is the trend that we are seeing. We have a whole host of multi-factor products where clients are asking what is the ESG score of this? What’s the carbon footprint of this? The big question is could you do it without derogating your factor intensity.
ESG-plus factors in the index space work well because factors are going to drive performance, that’s why you allocated them, or at least for the diversification benefit. Anything else, highly concentrated ESG leaders, the top 50, that’s a big leap of faith and you must have a lot of trust in the vendor of that ESG data to want to concentrate a portfolio just on ESG. Factors help you determine if the stock is valuable and you can screen it with ESG but index-only or cap
18 September 2019 portfolio institutional roundtable: Factor investing
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