reinsurance, asset backed securities or aeroplane leasing – others can provide welcome diversification to plain vanilla portfolios. And in times of market stress, a diversified approach is much needed to help boost returns and smooth losses. In this guide NN Investment Partners discuss the value of factor investing, and how the best factor strategies have a sound economic underpinning without being over-engineered. We also hear from Natixis’ UK sales head, Darren Pilbeam, who discusses how alternative strategies can provide a different lens through which to view market volatility. Alternatives do carry with them associated complexity and a lower level of regulatory oversight. So they are not without their challenges. But in a world of lower growth, a good deal of uncertainty and the feeling that traditional investment options are under delivering, alternative investments may just be the answer.
I
t’s fair to say that alternative assets are now a central strand of most investment portfolios. While some assets are too niche for the private investor – such as catastrophe
SPOTLIGHT
RESPONSIBLE INVESTING
Alternatives today: providing value in the current market
Simple, intuitive and effective: avoiding the data mining trap
New adventures in alternatives
IN THIS ISSUE
A report by Investment Week
By NN Investment Partners
By Natixis Investment Managers
This document is for investment professionals only and should not be relied upon by private investors.
All investing involves risk, including the risk of capital loss. This material is provided for informational purposes only and should not be construed as investment advice. The analyses, opinions, and certain of the investment themes and processes referenced herein represent the views of Natixis Investment Managers as of March 2019. The views and opinions expressed may change based on market and other conditions. There can be no assurance that developments will transpire as forecast, and actual results may vary. Provided by Natixis Investment Managers UK Limited, authorised and regulated by the Financial Conduct Authority (register no. 190258). Registered Office: Natixis Investment Managers UK Limited, One Carter Lane, London, EC4V 5ER.
FOR INVESTMENT PROFESSIONALS ONLY.
NN INVESTMENT PARTNERS
NATIXIS INVESTMENT MANAGERS
For more information visit: www.incisiveworks.com
This digital experience is an Incisive Works product © 2020 Incisive Business Media (IP) Limited
SHARE THIS EXPERIENCE
scroll
Important information
This marketing material is issued by Pictet Asset Management (Europe) S.A. It is neither directed to, nor intended for distribution or use by, any person or entity who is a citizen or resident of, or domiciled or located in, any locality, state, country or jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation. Only the latest version of the fund’s prospectus, KIID (Key Investor Information Document), regulations, annual and semi-annual reports may be relied upon as the basis for investment decisions. These documents are available on assetmanagement.pictet or at Pictet Asset Management (Europe) S.A., 15, avenue J. F. Kennedy, L-1855 Luxembourg. The information and data presented in this document are not to be considered as an offer or solicitation to buy, sell or subscribe to any securities or financial instruments. Information, opinions and estimates contained in this document reflect a judgment at the original date of publication and are subject to change without notice. Pictet Asset Management (Europe) S.A. has not taken any steps to ensure that the securities referred to in this document are suitable for any particular investor and this document is not to be relied upon in substitution for the exercise of independent judgment. Tax treatment depends on the individual circumstances of each investor and may be subject to change in the future. Before making any investment decision, investors are recommended to ascertain if this investment is suitable for them in light of their financial knowledge and experience, investment goals and financial situation, or to obtain specific advice from an industry professional. The value and income of any of the securities or financial instruments mentioned in this document may fall as well as rise and, as a consequence, investors may receive back less than originally invested. Risk factors are listed in the fund’s prospectus and are not intended to be reproduced in full in this document. Past performance is not a guarantee or a reliable indicator of future performance. Performance data does not include the commissions and fees charged at the time of subscribing for or redeeming shares. This marketing material is not intended to be a substitute for the fund’s full documentation or any information which investors should obtain from their financial intermediaries acting in relation to their investment in the fund or funds mentioned in this document. This document is a marketing communication issued by Pictet Asset Management and is not in scope for any MiFID II/ MiFIR requirements specifically related to investment research. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any products or services offered or distributed by Pictet Asset Management. Due to a regulatory change and increasing importance of emerging markets in the global equity allocation, the reference index has been changed retrospectively from the MSCI World to the MSCI All Countries (ACWI) on the 1st of January 2020. The strategy is not constrained by MSCI ACWI which is shown for comparison purposes only. The index does not influence portfolio construction and the strategy’s investment universe extends beyond the components of the index. Alternative global equity indexes are equally appropriate.
IN PARTNERSHIP WITH
he start of 2020 has been dramatic, with a global pandemic sending the world’s economy into a spin. It has focused minds on how capitalism impacts the world, with many investors calling for a shift towards a more
T
Why it is time to consider investing in sustainable equities
“The long-term secular drivers for environmental investing are likely to strengthen”
sustainable, responsible approach to the global economy.
This has come at a time when society has already become increasingly concerned about the environment. More and more investors have sought to get more than just profits from their holdings: they want to know they are making a difference to the world too.
We hope you find this guide a thought-provoking look at how the global investment community is transforming itself towards a more sustainable future.
This is for investment professionals only and should not be relied upon by private investors.
In this guide, Pictet Asset Management outline the case for a more responsible form of capitalism, explain how to transform the sustainable investment marketplace, and reveal how they uncover the true guardians of the environment. We also introduce you to the team behind the Pictet Global Environmental Opportunities Fund, which is at the forefront of this increasingly important market.
meet the team
Luciano Diana Luciano joined Pictet Asset Management in 2009. He is a Senior Investment Manager in the Thematic Equities Team. Before joining Pictet, Luciano spent four years at Morgan Stanley, where he headed the London-based clean energy sell-side research team. He began his career in 1998 as an IT strategy consultant at Accenture. Luciano holds a Laurea in Telecommunications Engineering from the University of Padua in Italy. He was a Visiting Scholar at the University of California in Berkeley. He holds an MBA from INSEAD.
Gabriel Micheli Gabriel joined Pictet Asset Management in 2006 and is a Senior Investment Manager in the Thematic Equities Team. He co-managed the Pictet Clean Energy strategy from 2007 to 2010 and has been managing the Pictet Timber strategy since 2008. He has been co-managing the Global Environmental Opportunities strategy since 2014. Gabriel is a Chartered Financial Analyst (CFA) charterholder. He graduated with a degree in Economics from the University of St. Gallen.
Yi Du Yi joined Pictet Asset Management in 2018. He is an Investment Manager in the Thematics Equities Team, co-managing the Global Environmental Opportunities strategy. Before joining Pictet, Yi worked in the Global Equity Research team of JP Morgan in Hong Kong covering utilities and environmental sectors in Asia. Prior to that he worked in the Investment Banking team of Barclays in Hong Kong. Yi holds a BBA in Accounting and Finance with First Class Honors from Hong Kong Polytechnic University and an MSc in Financial Economics with Distinction from the University of Oxford.
Marc-Olivier Buffle Marc joined Pictet Asset Management in 2014 as a Senior Product Specialist in the Thematic Equities team. Before joining Pictet, Marc was at RobecoSAM where he was a senior analyst, then head of industrials and finally head of SI research. Prior to that he was responsible for business development at the Danaher Corporation. Marc started his career at Trojan Technologies in London Canada, where he led an R&D team focusing on water treatment technologies. Marc holds a MSc in engineering from the ETH in Zurich, and a PhD from EAWAG in Environmental Chemistry and is the author of patents, scientific articles, technical and financial publications.
Stephen Freedman Stephen joined Pictet Asset Management in 2019 as Senior Product Specialist in the Thematic Equities team. Before joining Pictet, Stephen was at UBS Wealth Management, where he most recently served as head of Sustainable Investing Solutions for the Americas. Prior to that he served in various Investment Strategy roles, including head of Thematic Investing Strategy and head of Tactical Asset Allocation. He started his career with UBS in 1998 as an economist and public policy analyst. Since 2019, he has been teaching environmental finance at New York University. Stephen holds a PhD and a Master in Economics from the University of St. Gallen.
NO LONGER NICHE
In 2016, 344 new alternative funds were launched, compared to 10 in 1997. And further growth is on the horizon: a 2018 report by data tracker Prequin, The Future of Alternatives, predicts that the alternative investment industry will reach AUM of $14 trillion by 2023 – up from $8.8 trillion at the end of 2017. Much of this has been driven by the quest for diversification in an evolving market environment. Equities and bonds are often characterised by an inverse relationship – meaning that when equity prices rise, bonds fall. However, this relationship can sometimes reverse, while factors such as regulatory changes and the impact of monetary policy have led to higher risks for both asset classes. This has the effect of increasing the appeal of alternatives, which typically have low correlation to traditional asset classes – and to different assets that fall under the ‘alternatives’ umbrella. At the same time, factors such as lower forward-looking return expectations and concerns about the prospect of a recession are contributing to interest in this sector. All of this means that alternatives have a role to play in most investment portfolios.
One of those important roles can be seen in the pensions landscape, which is constantly changing through new legislation, court decisions or alterations in practice. In a recent report by JLT Employee Benefits, they found that an allocation to professionally managed illiquid assets could increase defined contribution (DC) pensions by 10 percent. The firm suggested a 20 percent exposure to illiquid assets such as private equity, infrastructure or real estate, could enhance diversification and generate additional return. Maria Nazarova-Doyle, head of DC investment consulting at JLT Employee Benefits, said: “The focus on daily-dealt funds with near 100 percent liquidity is a fundamentally impatient approach to DC. Many default strategies are currently failing to adequately diversify investments, precluding savers from the valuable illiquidity premium that can be accessed through alternatives.” Commenting on the research, Gemma Siddle, chartered financial planner for Eldon Financial Planning, said: “Illiquid assets such as these need to be considered as a long-term investment and certainly not a short or medium term ‘bet’. It’s important that those investing in them understand the risks and potential benefits. However, carefully managed investment into these areas in other countries shows that such arrangements can be a success.”
BOOSTING PENSIONS
Targeted absolute return funds have enjoyed something of a surge in popularity over recent years, which should come as no surprise, since their main aim is to deliver positive performance regardless of market conditions. But this isn’t guaranteed and you may get back less than you put in. In a bid to deliver consistent positive returns, these funds can employ a number of different investing techniques, and at times complex financial instruments, to help them to profit from the markets’ ups and downs. They can invest in equities, bonds and even currencies as well as a mixture of all of these and more. One of the more common tactics they use to enable them to potentially make money even if markets are sliding is known as ‘short selling’ where the aim is to profit from falling share prices. But while demand for these funds tends to increase during periods of volatility, it’s vital to remember that there’s no guarantee that they can protect your capital – you may well lose money. Louis Tambe, a fund analyst at FE, says this is a sector that can provide useful exposures, “whatever your views on markets”, noting that with heightened volatility and larger spreads between the most expensive and cheapest stocks, “if momentum doesn’t break out either upwards or downwards then there could be more room for fundamental equity long/short managers to separate the winners from the losers.” However, he warns that there is also more risk of getting this wrong, “so manager selection is important.”
THE ABSOLUTE RETURN ADVANTAGE
Tambe says that another potentially interesting area is that of defined return investments – in other words, assets which are typically held to maturity to lock in a yield – and structured products that only pay out in extreme market movements, “but pay a good return should they trade in a range.” But if markets were to start trending downwards, and if a crisis were to be on the horizon, “then allocating to more defensive assets is wiser” – an outcome which he says could benefit equity market neutral or global macro managers, as well as absolute return fixed income managers playing on longer duration and widening credit spreads. Similar concerns have been expressed about alternatives as a whole. “The returns of alternative funds have not lived up to expectations,” comments Mattias Möttölä, Associate Director, Alternatives at Morningstar. “Many investors have bought them often to replace fixed-income investments, which yield very little, but the expected returns of alternatives have not materialised in many cases.” He notes that such funds do provide diversification benefits, and that a reasonably priced alternative fund with a strong manager and proven process can be a good fit to a portfolio – “but it’s important to understand the manager’s strategy to understand what you can realistically expect from the fund.”
It is clear that alternatives are not without their challenges, and the associated complexity and lower level of regulatory oversight is a concern for some. Consequently, it is particularly important to understand the performance of different asset classes and the implications of market developments. But despite this caution, alternatives continue to be widely used, with robust growth expected in the coming years. The Prequin report predicts that by 2023, 34,000 fund management firms will be active in this space – 21% more than in 2018. The alternative investment universe contains a huge range of investment options, from asset leasing to infrastructure projects and everything in-between. Researching and valuing some of the more esoteric sub-asset classes can be difficult. Given the wide variety of options available, which have the potential to be true diversifiers for investors? With so many unique characteristics to the different investments, it takes specialist research in order to find the best opportunities the market has to offer.
ROBUST GROWTH
Alternatives fundraising (global private capital)
Billions USD
Demand for alternatives to strengthen
% of respondents planning to allocate more or less capital
2
1
There are many definitions of alternatives but some of the main types include commodities, specialist property, infrastucture and asset leasing....
Defining alternatives
Could solar energy help multiply returns for alternatives investors?
Jared Murray on Unsplash
READ MORE
Sources: (1) Preqin (2) Preqin, HFRI, J.P. Morgan Asset Management. Fundraising categories are provided by Preqin, and represent their estimate of annual capital raised in closed-end funds. Hedge fund fundraising numbers are represented by net flows and come from HFRI.Data are as of December 31, 2018.
lternatives are often defined in terms of what they do rather than what they are. To be sure, it is an asset class that does a lot: from the
A
CLOSE
There are many definitions of alternatives but some of the main types include commodities, specialist property, infrastucture and asset leasing. Once considered to only available to large institutional investors, these assets have moved to the mainstream as smaller investors look to add more diversification to their more traditional investments like bonds and equities. A 2018 paper published by CAIA Association and the CFA Institute Research Foundation, Alternative Investments: A Primer for Investment Professionals, outlines three primary attributes of alternatives, any of which can lead an asset to be classified as ‘alternative’: 1. Returns are driven by exposures to underlying assets with non-traditional cash flows. 2. The returns of the investment are driven by complex trading strategies which result in “unusual risk exposures”. 3. Returns are structured to “generate non-traditional payouts”. The report notes that in all of these cases, specialised methods of analysis are needed as returns do not mimic the returns of traditional asset classes – i.e. stocks and bonds.
Invest less capital than in past 12 months
Invest more capital than in past 12 months
Home
Close
ALTERNATIVES
ince the creation of the UN Principles for Responsible Investment in 2006, responsible investment has evolved from a niche activity into a mainstream approach: the development of ESG ratings by Morningstar and investment
S
More recently, individual investors, family offices and foundations have embraced similar principles, showing a growing desire to invest in a more responsible form of capitalism. We believe that this phenomenon results from a number of unrelated trends.
• Corporate scandals are not new, but the problems that engulfed Enron, Worldcom, Parmalat and Petrobras continue to resonate with investors, many of whom are still counting the costs of these governance failures.
• Environmental problems such as poor air quality in large cities, water contamination and climate change pose a challenge from a social, economical and political point of view. This opens up new business opportunities for companies that provide concrete solutions to such problems.
The case for responsible investing
Laurent Ramsey argues that investors can better manage long-term risks and seize growth opportunities by integrating environmental social and governance criteria into their investment framework
Investors show desire to invest in a more responsible form of capitalism
sian markets appear to be in a contradictory state and I would characterise 2019 as having been a good year for regional
stock markets but a bad year for regional stocks. As we have seen in the US, market leadership has becomevery narrow with a relatively small number of large-cap growth-orientated stocks driving a large proportion of overall gains from the broader market.
A growing proportion of renewable energy no longer needs public support to be cost-competitive with fossil fuels
consultants are indicative of institutional investors’ desire to better understand how their money is invested and to share their convictions publicly.
• Shifting consumer preferences for cleaner and healthier products such as electric cars or organic food are reshaping the business models of firms traditionally perceived as safe havens.
• Public policy in areas such as climate change, corporate tax or soft drinks is slowly but surely denting the profitability of companies that tend to generate profits at the expense of society.
• Changing economics in sectors such as energy, where a growing proportion of renewables no longer need public support to be cost-competitive with fossil fuels, which still benefit from subsidies in many countries.
We see three basic options for investors to mitigate the risks and seize the investment opportunities arising from these trends. As a minimum, we believe that every investor should be better equipped for detecting ‘torpedoes’ in core portfolios.
When investing in listed companies, we suggest investors undertake a systematic analysis of corporate governance structures in order to uncover structural deficiencies, such as the use of short-term and accounting-based metrics for setting executive remuneration. Potential concerns should be raised by investors and voiced through proxy voting. Failure by management to address them could be a reason for investors to divest their stakes.
A second option is to focus on sustainable companies. Identifying sustainable businesses requires a good understanding of their fundamentals, business franchise, management quality and track record. Because such companies tend to be more resilient to the fluctuations of the economic cycle and prone to integrate disruptive trends in their development strategy, we believe that they are better positioned to generate steady returns over the long-term.
A third option is to target a concentrated universe of companies that specialise in providing specific solutions to environmental problems, such as water treatment technology, energy efficiency, renewables or low carbon energy sources. This is effectively a growth story, since these activities are set to develop faster than global GDP.
In all cases, time is of the essence. Investors constantly need to resist the pressure of short-termism or the temptation to treat companies like commodities. We also see a need for specific metrics to measure portfolios’ ESG characteristics such as their carbon footprint.
There is no one size fits all, but the longer the time horizon, the greater the likelihood that responsible capitalism represents the best way for investors to achieve long-term success.
MENU
HIDE X
*Source: https://bloom.bg/2DydHka
Absolute Return
…when you have the ability to adapt, regardless of the market environment
Benefits from perceived incorrect valuations; hence we go long undervalued assets and short overvalued assets.
Benefits from the tendency of instruments with higher yields to outperform those with lower yields; hence we go long the instruments with a high yield and short those with a low yield.
Performance tends to persist; hence we go long the winners and short the losers.
Markets are subject to predictable and excessive buying and selling pressures in the short term; hence we go long excessive supply and short excessive demand.
Implied volatilities are generally higher than realised volatilities because implied volatility is a compensation, not an expectation, of volatility. We pay realised volatility and receive implied volatility.
Value
Carry
Momentum
Flow
Volatility
Factors applied with NN IP
Cumulative performance since inception (I Cap USD), Net of fees (2)
Past performance is not a reliable indicator of future results. Currency movements can affect your investment returns. For more detailed information about the NN (L) Multi Asset Factor Opportunities fund, please refer to the prospectus and Key Investor Information Document available at www.nnip.com.
Introducing NN (L) Multi Asset Factor Opportunities
Source: (2) NN IP Performance Measurement. Data as of end March 2019. Fund was launched on 23 March 2016.
SECTOR REVIEW
The best factor investing strategies have a sound economic underpinning without being over-engineered. In this interview lead portfolio managers from NN Investment Partners’ Factor Investing team Willem van Dommelen and Stan Verhoeven discuss the benefits of a multi factor investment approach and the importance of “cutting out all the noise”
stress, such as in February 2018, when both asset classes declined sharply in unison. Meanwhile, the second half of 2018 saw a shift from synchronized global growth to an unsynchronized slowdown across regions. The fourth quarter of 2018, in particular, saw global equities fall by almost 13% – the Nasdaq was technically in bear market territory on 24 December, down 23% from its end-August peak. December was the worst month for US equities in 50 years. With interest rates rising, central banks reducing their stimulus and market volatility increasing, 2019 is shaping up to be a complex and challenging investment landscape. Traditional asset classes like equities and bonds certainly still have their place in portfolios, but there’s an increasing need to think outside the box and look at the alternatives.
Willem: Well, investors have broadly embraced the concept of factor investing and the value it brings. In the last few years in particular, we have seen an increasing demand for factor-based strategies that go beyond single stock equities and extend into other asset classes, and that target an absolute return. This is a logical and valuable step because the drivers of factor returns, like behavioural biases, are present in all asset classes. By taking a multi asset class approach and combining long and short exposures, investors can further benefit from the added value that factors can bring, namely attractive and diversified returns.
We have seen factor investing assets grow signifcantly over the past decade. What do you see as the main developments within this space?
Factor investing is an investment style that selects securities based on shared characteristics, or factors, that have proven to be persistent drivers of risk and returns...
What is factor investing?
Factor investing is an investment style that selects securities based on shared characteristics, or factors, that have proven to be persistent drivers of risk and returns. The existence of factors has been extensively documented by academics and can be explained by three distinct drivers: 1. Compensation for risks that other investors want or need to transfer 2. Behavioural biases of investors causing assets to be “mispriced” 3. Compensation for providing liquidity in case of a supply and demand imbalance As these drivers are generic, factors are present across all asset classes and markets and can be employed “bottom-up” (for individual security selection) and “top-down” (for market allocation). Given their return potential and diversification benefits, factors can be considered suitable building blocks to create “all-weather” portfolios.”
We’ve seen exponential growth in the number of factors. How do you manage the risk of investing in spurious factors?
Stan: This is clearly a risk. Harvey and Zhu(1) named this phenomenon the “factor zoo” as a reflection of the significant increase in the number of factors documented in academic literature. Most of these so-called factors are the result of data-mining, and will probably be unable to deliver excess returns out of sample. Even though academic literature will continue to provide us with research insights, we believe it is vitally important for managers to research the factors themselves before deciding which ones to adopt. More importantly, as also suggested in the Harvey and Zhu study, a clear economic rationale should be driving the research to help eliminate the risk of spurious factors. At NN IP we make sure our factors are as simple as possible in order to control the risk of data-mining. Before any data analysis takes place, we extensively review the economic underpinning and the expected behaviour and performance of a factor strategy. Only if the factor behaves according to our economic rationale – and if it is robust and profitable after accounting for transaction costs and other forms of slippage – will it be included in our portfolio.
The last few years have been turbulent, with QE, Brexit and other geo-political events. How did this impact your factor strategy?
Willem: Yes, we’ve had QE in the market for over a decade but QE is not the first time the central banks stepped in. The value investing approach has been shown to be profitable for almost a century, and during that time central banks have taken many more actions than QE. When it comes to factor investing it is crucial to maintain a long-term view and not be distracted too much by shorter-term dynamics that make people believe that this time it’s different. We therefore rely on a very disciplined research and investment process, where we do not apply discretionary overlays to avoid falling into such typical pitfalls. We have been managing our NN (L) Multi Asset Factor Opportunities fund since 2016. Since then we have been confronted not only with QE, but also with the EU referendum, US elections and a sharp drop in equities in December 2018. During this period our strategy has generated strong returns, which confirms our view that a broadly diversified factor portfolio can deliver an attractive return in all market environments.
Some factors are spurious. For example, in 2017 a Bloomberg writer designed her own factor model based on back testing US companies with “cat” in their names...
The cat factor
Some factors are spurious. For example, in 2017 a Bloomberg writer designed her own factor model based on back testing US companies with “cat” in their names.* The model bought any US company whose name had “cat” in it, like “CATerpillar”, or “CommuniCATion”. What resulted was an 850,000% return six years to date. Willem van Dommelen says: “The performance was largely due to the rallying of an untradeable penny stock. So the return could not have been achieved in real life. Moreover, it lacked any form of economic underpinning and was therefore likely not to deliver excess return out of sample. What happened was this: when the article was published the index dropped again. This shows the importance of a thorough research process, and the ability to efficiently implement the factors that come out of it.
Where do you focus on in your research process? New factors?
Stan: It’s very unlikely that new factors will suddenly pop up but we do continuously research ways to create a more robust definition of a factor that adheres to our principle of simplicity. Doing things simply and cutting out the noise involves a lot of hard work and a critical mind. Next, we put significant effort in controlling transaction costs. Factors can generate a significant turnover, so there is a clear gain to be made there. Last, we extensively test how factors interact with each other to make sure they do not load on traditional investments like equities or on other factors. We also want investors to clearly see our offering as diversified building blocks for their portfolio. Therefore we focus on ensuring they offer true diversification to other building blocks such as equities and fixed income. In this way, our research is geared to make sure that we deliver what we promise: attractive, diversified returns.
Factor investing is often considered as a complex “black box”. How do you see this?
Willem: We disagree on the “black box” point. Factor investing is rule-based so all investment decisions can be disclosed and are consistent, or repeatable, through time. We provide detailed information to our clients, which include showing factor definitions, how we combine factors and how these have led to the overall positioning and performance of the fund. Our multi asset, multi factor approach is very transparent and quite the opposite of a “black box”. This is also what drives the success of factor investing. Clients understand what is under the bonnet and they subscribe to the benefits. The approach of a non-systematic / discretionary manager is certainly more “black box” than what we do. This is because one can never look into the brain of such a manager to determine what drives his or her investment decisions, let alone whether those decisions have been consistent through time. The more difficult element here is complexity, as that is a subjective matter. What is simple for one can be considered complex by others. We aim to overcome this challenge by keeping our factors as simple as possible with a clear economic underpinning.
To what extent is factor investing commoditised?
Willem: Factor investing within equities has matured but we clearly see this isn’t the case for multi asset, multi factor absolute return offerings. Within that spectrum of factor investing we have seen consistent inflow. We see this asset growth coming mostly from investors who were initially invested in hedge funds, that applied similar strategies but in a more expensive and less transparent way, and were disappointed about performances in combination with a substantial cost base. With the growing popularity of factors we do see a lot of offerings appear that use more complex approaches. We believe one should be wary of such complex and less transparent strategies as these are more subject to data-mining risk and thereby often show inferior performance out of sample.
What if a factor stops working?
Stan: The existence of factors has been extensively researched, proven by academics and applied by practitioners. Behavioural biases are one of the drivers behind the existence of factors and we know that a bias doesn’t shift easily. Because investors have different objectives, this creates structural opportunities that can be captured using a factor-based approach.
Source: (1) Harvey, C.R., Y. Liu, H. Zhu, 2015, …and the Cross-Section of Expected Returns, Review of Financial Studies:5-68
Willem: First, build a strong understanding of why factors exist and why they deliver attractive diversifying returns. Then, see how they are put into practice. Is there a disciplined research and execution process? How does one control the risk of data-mining or p-hacking? How robust, efficient and scalable is the platform used to perform the research and implement the strategies? And do not simply select based on superior back-test results. The combination of simplicity, transparency in terms of process and infrastructure, and “live” performance are the important elements to assess.
Transforming sustainable investment
Thanks to the emergence of a thriving environmental products industry investing to safeguard the planet no longer means sacrificing returns
how to spend it: Growth in China's environmental spending(3)
Planetary Boundaries(12)
Click on each icon for information
Safe operating space
Current economic intensity
Freshwater use
Land-system change
Chemical pollution
Climate change
Ozone depletion
Ocean acidification
Biodiversity
Aerosols
Nitrogen & phosphorous cycle
Ozone depleting substances destroy the stratospheric ozone layer, often after complex photochemical processes with heavy consequences for human health and other plant and animal organisms
Quantification not yet possible, but already heavy loading with airborne particles already impacting human health, climate and ecosystem
Ever increasing GHG emissions accelerate global warming that threatens to change global precipitation patterns, cause sea levels to rise and increase the severity of storms
Loss of species several order of magnitude higher than natural background rate; gravely endangering our natural “life support systems”
Human fixation of atmospheric N has reached an unprecedented scale with serious detrimental consequences (health impacts, eutrophication, global warming and ozone layer)
Planetary boundary not yet quantifiable, but consensus that level of pollution is already too high and disruptive to health and ecosystems
Conversion of forests & other natural habitats for intensive agricultural or industrial production releases GHG and degrades ecosystems
Water is overused and heavily polluted in many regions of this world with dire consequences on ecosystems, human health and economic production
Deposition of acidic compounds into the oceans deplete their buffer capacity for CO2, and impacts heavily on shell-forming organisms, and thus the entire marine food web
It was at once a joyful occasion and a reminder of the challenges posed by ever more people competing for finite resources. In less than 30 years’ time, the planet will be home to nine billion human beings, a larger proportion of which are likely to be part of the urban middle class.
This is certain to put even more pressure on the environment, testing it to breaking point. Investors are increasingly alert to these challenges. Many now recognise that, as stewards of capital, they have a crucial role to play in placing the economy on a more sustainable footing. But for them to become part of the solution, investors need to resolve a paradox.
Xi Jinping has named environmental degradation as one of the three main battles the country has to fight along with political and financial risks and poverty alleviation
People power has, in turn, brought about a change in government priorities. China is a striking example of this trend. In the run-up to the 2008 Olympics, the US embassy in Beijing started tweeting hourly air quality data from its roof-top monitor. This was the first time the public had access to live data on airborne particles known as PM2.5, which kill more than 4 million people worldwide a year.
Sources. (1) The Lancet Commission on pollution and health, 19.10.2017. (2) Pictet Asset Management. (3) National Bureau of Statistics of China, Pictet Asset Management. (4) According to the Chinese Academy of Social Sciences/South China Morning Post, as many as half of public protests in China involving at least 10,000 participants in 2000-2013 stemmed from concerns about pollution. (5) WIPO Database, data as of 31.10.2019. (6) USDA, bit.ly/2y1F3Qo. (7) Bloomberg. (8) Bloomberg New Energy Finance. (9) bit.ly/2A6e078 (10) The Global Commission of the Economy and Climate. (11) Lancet Commission on pollution and health, 19.10.2017. (12) Stockholm Resilience Centre, Pictet Asset Management, data as of 31.03.2020. (13) Butz, C., Liechti, J., Bodin, J. et al. Towards defining an environmental investment universe within planetary boundaries. Sustain Sci 13, 1031–1044 (2018). bit.ly/2zAIBt4. (14) We use Carnegie Mellon University’s Economic Input-Output Life Cycle Assessment (EIO-LCA) database to quantify the environmental impact of 150-plus corporate sub-industries, defined by Bloomberg with its Global Industry Classification Standard methodology. For more, see www.eiolca.net/ and bit.ly/3fLlhcU. (15) We remove companies that are on our “black list” – consisting of companies commercialising controversial weapons, such as anti-personnel mines, chemical or cluster munitions from the investment universe. (16) The portfolio has an average purity score of at least 60 per cent. (17) Pictet Asset Management.
How can they become responsible guardians of the environment and simultaneously secure an attractive return on their investments? We believe the solution to that conundrum has already begun to take shape. With governments and businesses responding to growing public pressure to reverse ecological degradation, a distinct and attractive group of environmental equity investments has emerged.
Once a niche activity, environmental investing is now moving firmly into the mainstream. There are several reasons for that. To begin with, society’s attitudes towards protecting the planet have changed considerably in recent years. That's partly because a growing proportion of the population has personal experience of the damage ecological degradation can cause. In 2015, pollution killed nine million people – three times more than AIDS, tuberculosis and malaria combined.(2) Floods and droughts have brought untold misery to millions more.
A burgeoning environmental products industry
Social media has also helped shape world opinion. Thanks to platforms such as Twitter and Facebook, people can now voice and share their concerns about pollution and sustainability in a way they couldn’t before.
Environmental industry in numbers(1)
The size of the environmental industry today
USD 2.5trn
Expected annual growth
6-7%
Stars aligned for environmental industry
The combination of people power, government policies and economics has given rise to a thriving – and eminently investable – industry for environmental products and services. China's generously-funded anti-pollution drive, for example, is likely to boost the prospects of firms that develop environmental technologies such as filters for engines and industrial applications for pollution control.
More broadly, as corporations worldwide embrace sustainable business practices, publicly-listed firms specialising in the development of a broad range of environmental technologies have mushroomed, while the number of patents filed for environmental products over the past decade has more than tripled.
The economic benefits – and investment potential – manifest themselves in several ways:
In the decade since the ground-breaking model was published, the PB framework has transformed our approach to the environment.
Crucially, it highlights the threats humans pose to ecosystems, beyond the highly publicised aspect of climate change. Partnering with the Stockholm Resilience Centre, we have developed a proprietary model that reveals how companies are operating with respect to the thresholds defined by the PB framework.
Using the proprietary screening tool based on the Planetary Boundaries, we define an opportunity set of around 3,500 companies.(15)
The second phase of the process involves taking a deeper look at the core business of each company that is identified in step one. Here, our goal is to determine which firms are developing products and services that make a real difference in reversing environmental degradation.
Making a demonstrable impact
The Global Environmental Opportunities portfolio achieves a significantly more positive environmental impact than that of a typical global equity strategy across all nine dimensions, particularly in climate change (see Key Facts).
For example, carbon dioxide emissions of companies in our portfolio stand at 454 tonnes of CO2 equivalent per million dollar of annual revenue (tCO2 eq/mn$), compared with 1,948 tonnes for the MSCI AC World index.
Previous
Next
anica May Camacho was born on October 30, 2011, to the sort of fanfare rarely seen in Manila’s crowded public hospitals. That’s because she represented a global milestone – her birth brought the world’s population to seven billion.
D
These are companies that combine strong environmental credentials with innovative products and services designed to safeguard the world’s natural resources. Such firms form the core of our Global Environmental Opportunities (GEO) portfolio.
As a result, local residents began voicing their concerns about air quality, eventually taking to the streets to stage large public demonstrations.(4)
In response to growing social discontent, China’s leadership unveiled a ground-breaking action plan in 213 to tackle “Airpocalypse” with investments worth hundreds of billions of dollars and a slew of regulations.
China's Premier Xi Jinping has named environmental degradation as one of the three main battles the country has to fight along with political and financial risks and poverty alleviation, adding that: "We will never again seek economic growth at the cost of the environment." China’s investment in the environment has in fact risen seven-fold since the early 2000s (see chart above).
But this is unlikely to be the end of its spending boom. Beijing has promised to invest even more heavily in advanced environmental science and technology.
Also giving sustainable investing a shot in the arm is a sharp drop in the cost of technologies such as renewable energy, water recycling and agri-tech. In the US, wind power is now cheaper than any other form of energy, having seen a 40 per cent drop in production costs over the past decade. The costs of producing utility-scale solar power have declined by more than 60 per cent over the same period.
becoming innovative: Environmental technology patent publications by filing country(5)
• Precision agriculture
A GPS guidance system can save a farm of 1,000 acres about USD13,000 in variable costs annually, paying for itself within one year. Even if only 10 per cent of US farmers use GPS for planting seeds, it could save 16 million gallons of fuel, four million pounds of insecticide, and two million quarts of herbicide per year.(6)
• renewable energy
Renewable energy usage has been growing rapidly thanks to falling production costs. Being bid at less than USD0.02 per kilowatt hour, solar power will soon be cheaper than any form of fossil fuel-based power generation.(7) The cost of electricity from offshore wind farms, once one of the most expensive forms of green energy, is expected to drop by some 70 per cent over the next two decades.(8)
• smart cities
Installing a suite of connected infrastructure such as water, electricity and waste, or upgrading ageing systems should cut bills and improve resource management. Barcelona, for example, saves USD58 million annually with smart water technology that uses connected sensors and cloud servers to monitor irrigation and water levels.(9)
• Energy efficiency
Investing in electric public transport, using more renewable energy and increasing efficiency in commercial buildings and municipal waste management could cut energy costs by about USD17 trillion worldwide by 2050.(10)
• pollution control
Pollution mitigation and prevention can yield large net gains for the economy. In the US, an estimated USD30 in benefits has been returned to the economy for every dollar invested in air pollution control since 1970.(11) More specifically, we see strong growth for companies developing technologies such as filters for engines and industrial applications for pollution control.
Overall, we estimate that the environmental products industry is already worth some USD2.5 trillion, and can grow by about 6-7 per cent per year.
That should matter to investors: sales growth of companies operating in this sector should outpace that of firms in the MSCI All-Country World equity index.
When it comes to investing in rapidly-evolving area of environmental solutions, identifying the most promising opportunities isn’t straightforward.
A process to unlock the potential of environmental investments
That is why investment managers of our GEO strategy have developed a process that deploys both a scientific, rule-based framework and traditional company-by-company research to build their portfolio. Central to the investment process is a ground-breaking scientific framework called Planetary Boundaries (PB).
This is a model developed in 2009 by a team of leading scientists at the Stockholm Resilience Centre and other leading organisations.
The PB framework identifies the nine most critical environmental dimensions - including carbon emissions (climate change), fresh water, land use and biodiversity - that are essential to maintain a stable biosphere required for human development and prosperity. It then quantifies the safe operating space within which human activities should take place.
Breach any of these thresholds, the model says, and the risk of triggering abrupt or irreversible damage to the Earth’s biophysical systems increases significantly. Already, four of the nine boundaries have been transgressed (see chart below).
Specifically, the model defines resource use and emission limits for every industry in the global economy – expressed per USD1 million of annual revenue.(13)
This model analyses every activity in the production of a good or service: the extraction of raw materials, manufacturing processes, distribution and transport, product use, and disposal and recycling.(14)
Take biodiversity as an example. The loss of animal and plant species is as serious a threat as climate change. Our PB model quantifies that, for changes in biodiversity to remain at natural levels, the annual extinction rate must be less than 1.3 x 0.0000001 extinctions per million species for every USD1 million of annual revenue generated.
Applying this framework to the constituents of MSCI All-Country World Index, we can identify industries that make positive contribution to biodiversity. Our analysis shows that the biodiversity footprint of industries such as environmental engineering and consulting, as well as water sewage networks, are negative - meaning that products and services provided by these groups of companies help restore biodiversity.
Identifying environmental specialists
What is more, we only choose companies whose products or services make a positive impact on at least one environmental dimension in the Planetary Boundaries model. For each company we assign a proprietary “thematic purity” value, which indicates what proportion of a firm’s enterprise value (EV), revenue or EBITDA is derived from environmental products and services.
For a company to qualify for inclusion in the portfolio, its purity value must be at least 20 per cent.(16)
These filters narrow down our investment universe to about 400 companies. In the next step, we conduct detailed company-by-company research to identify firms with the most attractive risk-return characteristics.
The result is a concentrated portfolio of around 50 stocks - each investment combining an attractive risk-return profile with a small ecological footprint. But our investment process does not end there.
Our aim is to be an active owner of the companies we invest in. For this, we exercise voting rights through a proxy voting platform and engage with the companies to ensure they have the best possible governance structure in place.
Our goal is to determine which firms are developing products and services that make a real difference
This is one of the many positive impacts investors can make with this strategy to protect the planet. As stewards of global capital, investors matter. And in two ways.
On one hand, investors can provide vital funding to the companies developing products and services that can reverse ecological damage. On the other, they alone have the power to withhold or withdraw capital from businesses that fail to take their environmental responsibilities seriously.
For investors, the opportunity to bring about change has never been greater. Many investors have long appreciated the need to protect the planet. But they have not always been convinced sustainable investment was financially viable.
Thanks to the emergence of thriving environmental products industry, the calculus is now changing. Investing to safeguard the natural world does not mean sacrificing returns. It can enhance them.
Case study: Analysing industries' impact on biodiversity
Our model, based on the Planetary Boundaries (PB) framework, shows that the threshold for biodiversity loss for any industry, across its entire production chain, is 1.3 x 0.0000001 extinctions per one million species per year (MSY) per USD1 million of annual revenue.
Environmental engineering and consulting
The PB model shows that business activity of companies which provide specialised consulting and technical services in environmental and resource management actually improves biodiversity. The industry’s biodiversity footprint stands at a negative 1.27 x 0.000001 extinctions/MSY per USD1 million of annual revenue. This means products and services provided by this group of companies help restore biodiversity. In fact, the environmental engineering industry has a positive environmental footprint across all the nine PB dimensions, particularly in terms of promoting biodiversity and combatting global warming.
Companies operating in this industry provide specialised technologies and utility services on water sewage networks. The PB model shows the industry’s biodiversity footprint stands at minus 1.11 x 0.000001 extinctions/MSY per USD1 million of annual revenue. The water sewage networks industry has positive PB scores across the nine boundaries, with the exception of global warming.
Water sewage networks
actively engaging: Example of how we've engaged with a UK-based environmental utility company(17)
2016
2017
Initiated calls with the company's CFO to understand the governance issues on accounting including the use of exotic financial instruments
Held three separate discussions with the CFO to raise the issue repeatedly
Issues become incorporated into sell-side industry research
The company exited exotic and risky financial instruments. Share price rose afterwards
01 / 03
PREV
NEXT
02 / 03
03 / 03
Key facts – Pictet Global Environmental Equities
An unconstrained global equity strategy focusing on innovative businesses providing solutions to environmental challenges facing our planet
Sources. (1) Pictet Asset Management, NEOSIS, 31.03.2020. The strategy is not constrained by MSCI ACWI which is shown for comparison purposes only. The index does not influence portfolio construction and the strategy’s investment universe extends beyond the components of the index. Alternative global equity indexes are equally appropriate. (2) Pictet Asset Management as ot 30.04.2020. Due to a regulatory change and increasing importance of emerging markets in the global equity allocation, the reference index has been changed retrospectively from the MSCI World to the MSCI All Countries (ACWI) on the 1st of January 2020. The strategy is not constrained by MSCI ACWI which is shown for comparison purposes only. The index does not influence portfolio construction and the strategy’s investment universe extends beyond the components of the index. Alternative global equity indexes are equally appropriate. (3) Pictet Asset Management. All data as at 30.04.2020, in Sterling, net of fees for the I-dy GBP share class. The reference index is MSCI AC World GBP.
Performance that does not have to cost the planet(3)
performance history: PICTET Global Environmental Opportunities - I dy GBP
Periods over 1 year are annualised
Past performance is not a guarantee or a reliable indicator of future performance.
With our Global Environmental Opportunities strategy, investors can help safeguard the planet while retaining the prospect of long-term outperformance.
-1.77%
8.65%
5.35%
11.46%
8.57%
Global Environmental Opportunities - I dy GBP
MSCI AC World (GBP)
Investing for impact(2)
Our strategy invests exclusively in the environmental products and services industry. Already a USD2.5 trillion market, we expect this dynamic sector to grow 6 per cent per year.
More than just a climate change strategY
The fund is an actively managed unconstrained global equity strategy and seeks to invest in companies with the strongest environmental credentials that also specialise in the development of products or services which help reverse ecological damage and increse resource efficiency. At the centre of the investment process is the Planetary Boundaries scientific framework, which identifies nine of the most damaging environmental challenges, such as climate change, water use and biodiversity. We use this framework to identify firms with the strongest environmental credentials across their entire value chain from the extraction of raw materials to manufacturing processes, distribution and transport, product use, and disposal and recycling.
Demonstrable impact...
Using the Planetary Boundaries framework to compare Pictet Global Environmental Opportunities strategy versus MSCI World Index (1)
MSCI World Index
Global Environmental Opportunities
As the charts show, the final Global Environmental Opportunities portfolio achieves a significantly more positive environmental impact than that of a typical global equity strategy across all nine dimensions, particularly in climate change. For example, as shown in the top left chart, carbon dioxide emissions of companies in our portfolio stand at 454 tonnes of CO2 equivalent per million dollar of annual revenue (tCO2 eq/mn$), compared with 1,948 tonnes for the MSCI World index.
We invest in specialised companies that provide solutions to the planet’s environmental challenges
5.80%
Investment philosophy
We invest in specialised companies that provide solutions to the planet’s environmental challenges, as well as using resources efficiently, minimising their waste and limiting other adverse impacts on the environment. We believe these companies will outperform the global equity market over the long run.
Investment process
• The investment managers use a proprietary screening tool, based on the Planetary Boundaries, to identify companies with a low environmental footprint across nine dimensions: climate change, oceanic acidification, ozone depletion eutrophication, fresh water, land use, biodiversity, aerosols and chemical pollution.
• They then conduct in-depth fundamental analysis to isolate those providing specialised products and services designed to reverse ecological degradation and help others improve their environmental footprint. They pay close attention to valuation, business franchise, and management quality criteria. ESG scoring using in-house analysis is embedded.
• The result is a concentrated portfolio of around 50 stocks - each investment combining an attractive risk-return profile with strong environmental credentials.
Sources. (1) Pictet Asset Management, as of 31.12.2019. The strategy is not constrained by MSCI ACWI which is shown for comparison purposes only. The index does not influence portfolio construction and the strategy’s investment universe extends beyond the components of the index. Alternative global equity indexes are equally appropriate. (2) Pictet Asset Management. Data as of 31.12.2019. Please note that the strategy is benchmark agnostic; the MSCI World is not a benchmark but a reference index which serves as a proxy for global equities (other proxies such as MSCI ACWI are appropriate). (3) Pictet Asset Management. All data as at end of February 2020, in Sterling, net of fees for the I-dy GBP share class. The reference index is MSCI AC World GBP. Performance is for the I dy GBP share class, net of fees. Past performance is not a guide to future performance.
Leading the environmental pack
Pictet’s Luciano Diana, manager of the Pictet-Global Environmental Opportunities fund, explains the fund’s approach to selecting environmental stocks
We are interested in the indirect exposure to emerging markets. We know that is where most of the environmental problems are
The strategy, which has been in place since October 2014, sees the manager invest in companies with business models that provide a solution for one of two types of issues: either natural resource efficiency, or environmental quality and pollution control.
The manager said: “It is not enough to be good citizens, it is not enough to have a good ESG profile, so to speak. These companies also need to offer solutions to environmental challenges and that is why we operate from a relatively narrow investment universe.”
The fund has returned 5.8% over one year to 30 April 2020, versus the MSCI AC World index losses of -1.77%. The fund has outperformed its benchmark MSCI AC World index over three and five years.
t is not enough for portfolio holdings to simply be “good citizens” to be considered for inclusion in the £1.6bn Pictet Global Environmental Opportunities fund, according to its manager Luciano Diana.
Indirect exposure to emerging markets
The fund's largest exposure by geography is the US, which accounts for approximately 60%, a percentage that “has been quite high throughout the history of the fund”, followed by Europe. Diana added: “What we are interested in is the indirect exposure to emerging markets. We know that is where most of the environmental problems are. Instead of investing directly, we prefer to find those American or European companies that have a sizeable business in China, or southeast Asia.”
He cited US-based holding Agilent as an example, which specialises in environmental monitoring and has more than 25% of its sales in China. “Because China needs a lot of their equipment to first understand what kind of issues they have in terms of environmental clean-up before they can act on that,” added Diana.
How has investors’ interest in responsible investment changed over the last few years?
Q&A with Luciano Diana, Senior Investment Manager, Pictet-Global Environmental Opportunities Fund
Society’s attitudes towards protecting the planet have changed considerably in recent years. That's partly because a growing proportion of the population has personal experience of the damage ecological degradation can cause.
Social media has also helped shape world opinion. Thanks to platforms such as Twitter and Facebook, people can now voice and share their concerns about pollution and sustainability in a way they couldn’t before. The combination of people power, government policies and economics has given rise to a growing demand to incorporate sustainability principles in investments.
The base of assets incorporating sustainability criteria grew by 34% between 2016 and 2018 according to the Global Sustainable Investment Alliance and Morningstar estimates that the flows into US Sustainable funds quadrupled to over USD 20bn relative to the prior year. In particular, thematic investment strategies that target publicly-listed firms specialising in the development of a broad range of environmental technologies have mushroomed in recent years.
The Pictet-Global Environmental Opportunities strategy was launched in 2014. Were you ahead of the game in this regard, considering so many other funds have launched in the last couple of years?
We launched our first ‘best-in-class’ ESG strategy in the late 1990s, focusing on Swiss equities. We then expanded our regional scope, first applying the strategy to the European equity market in 2004 and to the emerging equity market in 2006.
For the last two decades, we have been active in the area of environmental strategies, an area that we pioneered. We launched the first Water fund in the industry in 2000. This was followed by additional environmentally-focused thematic strategies, including Clean Energy, Timber, Nutrition and Global Environmental Opportunities themes.
Such broad-based experience has allowed us to continuously innovate by incorporating scientific insights into our investment process. In particular, for each strategy we are able to draw on the expertise of Advisory Boards consisting of academics and industry veterans that provide a unique perspective to our investment teams.
Tell me about the team and your track record.
The fund is managed by three investment managers, but also draws on ideas from the rest of Pictet’s thematic team, which can provide a deeper perspective into individual segments such as Water, Clean Energy or Timber. An independent advisory board provides an insight into the latest environmental developments.
Pictet Global Environmental Opportunities Fund vs MSCI AC World (GBP)*
*Current index: MSCI AC World (GBP) valid from 12/07/2011. Source: Pictet Asset Management as of 10/03/2020. The value and income of any of your investments may fluctuate in accordance with market conditions and you may lose some or all of the money you invested.
While the manager does not apply any exclusions to countries or regions, he currently has no exposure to India in the fund, noting “we would like to, but we struggle to find direct and indirect plays on that country”.
Diana said software companies had contributed to performance. “These businesses are extremely robust, with very high margins, very high returns on capital, they are growing and, therefore, these stocks have done extremely well over the last few years and they have also explained quite a lot of the performance of our fund,” he said.
He added an important change “has been that early definitions of what was environmental were too narrow”, and recalled that ten to 15 years ago it was “just about renewable energy”. Diana explained: “From a performance standpoint, sometimes having those narrow definitions would lead to a lot of volatility and also sometimes not necessarily strong business models.”
MSCI AC World GBP
People power, government policies and economics has given rise to a growing demand to incorporate sustainability principles in investments
