Quantitative investing for the sustainability set

(Bloomberg Brief) – Arabesque Asset Management, which manages about $50 million in assets, has been running a “ESG Quant” strategy since 2014 to apply quantitative investment models to sustainable investing. Andreas Feiner, head of ESG research at Arabesque, spoke with Bloomberg Brief Sustainable Finance Editor Emily Chasan about the strategy and the underlying ESG data quality. Comments have been edited and condensed.

Q: Arabesque has its roots in Barclays Plc. Tell us about how your firm got its start.

A: I started my career in equity research and equity asset management. I was at Barclays, and started work on a strategic projects team, which is how we started Arabesque in 2010. I remember a big client said to us at the time, that you probably can’t combine values investing with performance. Intuitively, I think it’s completely the other way around. Companies that are managed well perform well. If you run a company and take into consideration more than your short-term shareholders in your decision-making, your company should be more resilient. It should be less risky and make more money.  But it was really difficult to find a product that does that, so we came up with a specific plan, got the board of Barclays and investment bank on board and it was eventually made part of Barclays’ asset management business. In 2012, we asked to buy it off of them.

Q: People often think of sustainable investing as more qualitative than quantitative. So what is a “ESG Quant” strategy?

A: The major purpose of ESG quant is to take qualitative ESG information, make it quantifiable and integrate it into a rules-based investment process. We use ESG as a supplement to fundamental analysis. We believe that ESG tells you about the DNA of the company —  is this company taking undo risks? You will never see 99 percent of the decisions a company makes as an investor, so it’s very important to understand how they behave.

Q: What are the challenges to building models for ESG performance?

A: Data quality is a challenge. I believe that the data quality of ESG is only at 10 percent of where it will be in the future. It’s just good enough in order to make money and pick better stocks, and support the security analysis.

I believe that the quality will increase over time with the efforts of Sustainability Accounting Standards Board and with the effect of what the European Commission has done by making CSR data mandatory. The Sustainable Stock Exchanges Initiative is another important one, and if you look at the pension funds, there are a huge amount of asset owners, who now have some form of sustainability in their investment process. Now, more and more companies report on sustainability. We are at the tipping point. Just imagine what will happen if regulators, investors and stock exchanges push companies to really disclose ESG.

It’s the same for accounting metrics, 50 years ago there was no standard at all. This is where we are now in sustainability.

Q: Are there places where it is easier to find high quality ESG data for your models?

A: There are obviously challenges in different parts of the world, which are less prone to give you the ESG information you would like. As a rule of thumb, you can say the quality of ESG data is best in Europe, and developed markets in general. The U.S. is the next place where we find a good performance impact of the data. We can use it to make money and pick better stocks for the investment portfolio. It’s challenging in emerging markets, challenging in Asia, and challenging the smaller the company gets.

Q: Are there particular metrics that you rely on as well?

A: We look at regulatory risk, carbon and water risks, where do you source your natural capital and how efficiently do you turn it over? What is your waste management process?

For social factors, we look at stakeholder relations, product liability, fines, and social opportunities for the company.

In governance, it’s really all about disclosure. If you don’t get enough data from the company it’s kind of a zero and we don’t want to have them in our portfolio because A, if they don’t disclose the data, they have something to hide, or B, they don’t think it is important.

We also look at competitive behavior. If you have a company that tries to build its business by pushing out other companies and limiting competition, these are companies that over the short term make a lot of money, but over the longer term they get bitten by regulators.

Q: How is your ESG strategy performing?

A: We believe that ESG is a source of alpha. There is a correlation between ESG and company investment performance and that has the indirect effect of channeling money into companies that are better run.   We want to make ESG more mainstream. In order to make it more mainstream you need to make it performance relevant and get the investors who are not yet on board with you. Then you can increase this effect with companies.