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SMART SRI EQUITY INVESTING: COMBINING ESG CRITERIA WITH FACTOR INVESTINGKoen Van de Maele, CFA & Maxime Moro
WHITE PAPER
June 2017 2
Smart SRI Equity investing: Combining ESG criteria with factor investing
TABLE OF CONTENTS
1. INTRODUCTION 2
2. SRI SCREENING 3
3. PORTFOLIO CONSTRUCTION 6
3.1. Initial weighting based on fundamental criteria 6
3.2. Increaseddiversificationthroughanincreasedweightingofthelongtailofsmallercompanies 7
3.3. Factor biases: Value, Quality and Low Volatility 8
4. PUTTING IT ALL TOGETHER 11
4.1. Historical Performances 11
5. CONCLUSION 14
6. REFERENCES 15
1. INTRODUCTIONBoth Sustainable and Responsible Investing (SRI) and Factor Investing are increasingly gaining the investor’s attention. It is widelyrecognizedthattheseinvestmenttechniquescansubstantiallyaddvalue.SustainableandResponsibleInvestingintegrateslonger-termbusinessopportunitiesandrisks,which,hence,arerelevantfactorstointegrateintotheportfolio.Byexploitingsomebehaviouralbiasesorstructuralmarketsegmentations,FactorInvestingleadstosuperiorrisk-adjustedreturns.Thispaperpro-posesanequityportfolioconstructionmethodologythatcombinesbothelements.
Firstly,Candriam’sSRImethodologywillbedescribedanditseffectontheportfolioshown.Secondly,the3-stepportfoliocon-structionmethodologywillbeoutlined:afundamentalweightingoftheeligiblestocks,involvingreadjustmentofthelongtailofsmallstocksandtheimplementationofthefactortilts.Theeffectandaddedvalueofeachofthesestepswillbeillustrated.Third-ly,thedifferentstepsarecombinedinoneportfoliothatwillturnouttohavesuperiorrisk-adjustedreturns.Thelastsectionconcludesandadditionallyillustratestheout-of-sampleperformanceofthisindexmethodology.
Acrossthisdocument,theproposedindexmethodologywillalwaysbeappliedtofourdifferentgeographicalregionstotestitsrobustnessandavoidanyover-fitting.Thefourregionsare:Europe,EMU,JapanandtheUS.AllsimulationsstartinFebruary2006andendinDecember2015.Theout-of-samplereturncharacteristicssincethestartof2016areshowninthelastsection.
June 2017 3
Smart SRI Equity investing: Combining ESG criteria with factor investing
OVERVIEWOFCANDRIAM’SSRIAPPROACH
2. SRI SCREENINGCandriam’sSRImethodologyrankscompaniespersectorandpergeographicalregion(Europe,AsiaPacificandNorthAmerica)basedonMicroandMacroanalyses.TheMicroAnalysisprocedureassessesthecompany’smanagementofcustomers,employees,theenvironment,suppliers,investorsandthebroadsociety.TheMacroAnalysisproceduremeasuresthecompany’sexposuretoglobalsustainabilitytrendssuchasclimatechange,resourcedepletion,developingeconomies,demographicevolutions,health&wellnessandinterconnectivity.TheresultsoftheMacroandMicroanalysesarecombinedandthecompaniesrankedpersector.TheeligiblecompaniesarecomposedoftheTop70%ofstockswithintheirsectorintherespectiveuniverse.Additionally,anorms-basedanalysisbasedonanassessmentofhowcompaniescomplywiththetenprinciplesoftheUnitedNationsGlobalCompactandaverificationofcontroversialactivitiessuchasarmaments,gambling,tobaccoandnuclearactivitywilleliminateothercompanies.
MICRO ANALYSISStakeholdersmanagement
• Customers•Employees• Environment•Suppliers• Investors• Society
MACRO ANALYSISExposuretoGlobalSustainability Trends
• Climate Change•RessourceDepletion•DeveloppingEconomies•DemographicEvolutions• Health & Wellness• Interconnectivity
SECTOR STUDY
SRI UNIVERSE
COMPANY ANALYSIS
CONTIN
IOU
S D
IALO
GUEENG
AG
EMENT
NORM-BASED ANALYSISCONTROVERSIAL ACTIVITIES CHECK
June 2017 4
Smart SRI Equity investing: Combining ESG criteria with factor investing
FIGURE 1: Candriam SRI Universe – Cumulative Return
Sources: Candriam, Factset
0
21.81.61.41.2
10.8
0.40.6
0.2
EMU
■■ SRI_Included ■■ SRI_Excluded ■■ MSCI_EW
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
0
3
2.5
2
1.5
1
0.5
USA
■■ SRI_Included.3 ■■ SRI_Excluded.3 ■■ MSCI_EW.3
2006 2007 2008 2009 2010 2011 2012 2013 2014 20150
1.81.61.41.2
10.8
0.40.6
0.2
JAPAN
■■ SRI_Included.2 ■■ SRI_Excluded.2 ■■ MSCI_EW.2
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
0
2.5
2
1.5
1
0.5
EUROPE
■■ SRI_Included.1 ■■ SRI_Excluded.1 ■■ MSCI_EW.1
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
ToassessthefinancialimpactoftheSRIscreening,SRIuniversereturnsarecomparedwithnon-SRIuniversereturnsandwiththebroadstockuniverse(allportfoliosareequallyweightedandrebalancedonamonthlybasis).ThegraphsbelowillustratethattheaveragereturnoftheSRIcompaniesexceedsthatofthebroadmarketandofthenon-SRIcompanies,showing,too,thattheSharpeRatioimproveswhenSRIcompaniesaloneareinvestedin.
ThisSRIuniverseisthestartingpointfortheportfolioconstructionalgorithm,whichdeterminestheweightingsofthesestocks.Non-SRIcompaniesarenoteligiblefor theportfolio.More informationonCandriam’sSRImethodologycanbefoundonwww.candriam.com
June 2017 5
Smart SRI Equity investing: Combining ESG criteria with factor investing
TABLE 1: Return characteristics SRI universe: EMU,Europe,Japan,USA
EMU SRI_ Included
SRI_ Excluded
MSCI_ EW
Europe SRI_ Included
SRI_ Excluded
MSCI_ EW
Annualized Return 5.14 3.91 4.76 Annualized Return 6.15 4.46 5.62
Annualized Std Dev 16.82 16.92 16.86 Annualized Std Dev 15.81 16.71 16.07
AnnualizedSharpe(Rf=0%)
30.56 23.11 28.24 AnnualizedSharpe(Rf=0%)
38.9 26.72 34.96
MaximumDrawdown 52.01 54.23 53.39 MaximumDrawdown 51.95 55.1 53.42
Japan SRI_ Included
SRI_ Excluded
MSCI_ EW
USA SRI_ Included
SRI_ Excluded
MSCI_ EW
Annualized Return 5.38 3.61 4.92 Annualized Return 9.33 8.63 9.34
Annualized Std Dev 13.83 13.83 13.86 Annualized Std Dev 15 14.61 14.98
AnnualizedSharpe(Rf=0%)
38.9 26.09 35.53 AnnualizedSharpe(Rf=0%)
62.21 59.1 62.34
MaximumDrawdown 34.33 34.7 35.62 MaximumDrawdown 48.39 46.74 48.38
Sources: Candriam, Factset
June 2017 6
Smart SRI Equity investing: Combining ESG criteria with factor investing
TABLE 2: Illustration of fundamental weighting
INCOME STATEMENT
BALANCE SHEET
CASH FLOW STATEMENT
CompanyName
Average
Sales
Average Net
Earnings
Last Book Value
Average
OCF
Sales
Weighting
Net Earnings Weighting
Book Value
Weighting
OCF
Weighting
Fundamental
Weighting
Royal Dutch Shell Plc Class B 319,611.30 13,645.50 167,725.80 29,699.30 5.44% 3.93% 4.22% 3.67% 4.31%
HSBCHoldingsplc 74,877.60 11,543.40 153,191.10 17,787.00 1.27% 3.32% 3.86% 2.20% 2.66%
Banco Santander S.A. 78,541.40 4,729.80 88,610.00 39,062.80 1.34% 1.36% 2.23% 4.82% 2.44%
Total SA 162,028.40 7,839.40 88,199.30 20,152.70 2.76% 2.26% 2.22% 2.49% 2.43%
Allianz SE 98,271.00 5,309.40 67,744.00 21,642.40 1.67% 1.53% 1.71% 2.67% 1.89%
BNP Paribas SA Class A 93,898.20 4,584.20 89,540.00 15,963.80 1.60% 1.32% 2.25% 1.97% 1.79%
Nestle S.A. 75,562.20 9,006.50 51,746.50 11,737.50 1.29% 2.59% 1.30% 1.45% 1.66%
AXA SA 106,006.00 4,340.40 67,952.00 11,586.20 1.80% 1.25% 1.71% 1.43% 1.55%
VodafoneGroupPlc 52,734.30 4,719.00 77,476.70 14,327.30 0.90% 1.36% 1.95% 1.77% 1.49%
Novartis AG 42,792.60 7,045.10 64,503.00 10,485.70 0.73% 2.03% 1.62% 1.29% 1.42%
TOTAL OF UNIVERSE 5,879,931.20 347,306.90 3,971,125.60 810,236.70
Sources: Candriam, Factset
3. PORTFOLIO CONSTRUCTIONContrarytomostindices,individualstockweightingsarenotdeterminedbymarketcapitalization.Extensiveliteraturehasdemon-stratedthatmarket-capitalizationindicesarelessdiversifiedthanoftenassumedandskewedtowardsthemostexpensivestocks.Hencemarket-capitalizationportfolioconstructionmethodsarenotthemostoptimalmethodologies(asalsoindicatedinHaugen&Baker,1991).
Asanalternative,inthisdocumentindividualstockweightingsaredeterminedviaa3-stepprocess.First,afundamentalweightingforthecompanyisdeterminedthatreflectstheimportanceofthecompanybasedoncommoneconomicmeasures.Secondly,diversificationisfurtherincreasedbyaugmentingtheweightingofthelongtailofsmallercompanies.Lastly,stockweightingsaretiltedtoreflectValue,QualityandLowVolatilityfactors.Below,weoutlineeachofthesesteps,illustratingtheirimpactonrisksand returns.
3.1. Initial weighting based on fundamental criteria
Acompany’simportancewithintheeconomycanbemeasuredinmanydifferentways.Candriambelievesthatelementsofthebalancesheet,incomestatementandcashflowstatementshouldbeintegratedtohaveameaningfulassessmentofthesizeofacompany.Hencetheequallyweightedaverageofthesizeofthebalancesheet,thetotalrevenue,totalincomeandcashflowgenerationaretakentodetermineafairinitialweightingforallcompanies.Thetablebelowillustratesthismechanism.
Nestle Sales Weighting =Nestle Sales
=(75 562.20)
=1.29%Total Sales (5 879 931.2)
June 2017 7
Smart SRI Equity investing: Combining ESG criteria with factor investing
FIGURE 2: IndexConcentration
Sources: Candriam, Factset
0
1.2
1
0.8
0.6
0.4
0.2
EMU
■■ Equal Weighted ■■ Fundamental50 ■■ Fundamental ■■ Market Cap
0.00
0.07
0.14
0.21
0.28
0.35
0.42
0.49
0.56
0.63
0.70
0.77
0.84
0.91
0.98
0
1.2
1
0.8
0.6
0.4
0.2
EUROPE
■■ Equal Weighted ■■ Fundamental50 ■■ Fundamental ■■ Market Cap
0.00
0.06
0.12
0.18
0.23
0.29
0.35
0.41
0.47
0.53
0.58
0.64
0.70
0.76
0.82
0.88
0.93
0.99
0
1.2
1
0.8
0.6
0.4
0.2
JAPAN
■■ Equal Weighted ■■ Fundamental50 ■■ Fundamental ■■ Market Cap
0.00
0.06
0.13
0.19
0.26
0.32
0.38
0.45
0.51
0.57
0.64
0.70
0.77
0.83
0.89
0.96
0
1.2
1
0.8
0.6
0.4
0.2
USA
■■ Equal Weighted ■■ Fundamental50 ■■ Fundamental ■■ Market Cap
0.00
0.06
0.12
0.18
0.24
0.30
0.36
0.42
0.47
0.53
0.59
0.65
0.71
0.77
0.89
0.83
0.95
3.2.Increaseddiversificationthroughanincreasedweightingofthelongtailofsmallercompanies
Theaforementionedmeasuresstillresultinafairlyconcentratedportfolio,albeitonelessconcentratedthanaportfoliobasedpurelyonmarket-capitalization.Inordertofurtherdiversify,weightingsofthesmallestcompaniesareincreasedsothat50%oftheportfolioisallocatedtoacertainminimumweighting.AnadditionalbenefitofthistransformationisthattheSRIcharacteristicsofevenverysmallcompaniescanhaveameaningfulimpactontheperformanceofthetotalportfolio.
IllustratedbelowistheLorenzcurveforamarket-capitalizationportfolioagainstafundamentalportfolioandadiversifiedfundamentalportfolio(and,forillustrativepurposes,anequalweightingportfolio).ALorenzcurveplotsthecumulatedweightings(%)inaccordancewiththepercentileofthenumberofstocksthatareindexedinnon-decreasingorder.Theincreasedlevelofdiversificationofthissecondstepcanbeclearlyobservedintheportfolioconstructionprocess.
June 2017 8
Smart SRI Equity investing: Combining ESG criteria with factor investing
TABLE 3:AverageEffectiveNumberofstocks (from01/2006to12/2015)
EMU Europe Japan USA
MarketCapWeighted–SRIUniverse 58 80 58 80
FundamentalWeightedwith50%MinWi–SRIUniverse 106 164 85 137
MarketCapWeighted–MSCIIndices 85 129 96 144
Sources: Candriam, Factset, MSCI
TABLE 5: List of indicators to measure factors
Value Quality Low Volatility
Earnings Yield EBITDAToNetDebt(exFin) 6/12/24-monthVolatilityofweeklyreturns
OperatingCashFlowYield OCFTo(Capex+Dividend)(exFin)
SalesToEnterpriseValue OperatingMarginTrend*Stability(exFin)
Financing Cash Flow Yield ROCETrend*Stability
ROE
Sources: Candriam, Factset
TABLE 4:AverageNumberofstocks (from01/2006to12/2015)
EMU Europe Japan USA
SRI Universe 152 279 191 303
MSCIIndices 270 432 340 608
Sources: Candriam, Factset, MSCI
●● Valuecompanies–cheapestregardingEarningsYield,OperatingCashFlowYield,andSales-to-EnterpriseValue–obtain the highest score.
●● LowVolatilitycompanieswithhistoricallow-returnvolatilityobtainthehighestscore,basedonweeklyreturnsover6Months,1yearand2years.
●● Qualitycompanies(differentiatedbyFinancialsector)withlowleverageandthehighestprofitabilityobtainthehighestscore.MeasuredbyReturnonEquity,EBITDAtoNetDebt,TrendandStabilityofOperatingMarginandROCE.
Thetablebelowshowstheeffectivenumberofstocksofthedifferentmethodologies.Itturnsoutthatapplyingtheminimumweightingclearlyincreaseseffectivediversification.
Thistransformationobviouslyalsointroducesasizebiasintotheportfolio,i.e.,abiastowardsstockswithasmallercapitalization.
3.3. Factor biases: Value, Quality and Low Volatility
Factorinvesting(sometimescalledSmartBeta)hasgainedinpopularityinrecentyears.Inessence,thetechniqueisnotnew.FamaandFrenchlaidthefoundationsoffactorinvestingalreadyin1993.ButitgainedinpopularitywhenLowVolatilitywas“discovered”byHaugenandBakerin2012.Theyprovidedevidencethatinvestinginlow-volatilitystocksyieldedsuperiorrisk- adjustedreturns,contrarytoconventionalwisdom.Candriamalreadydiscussedthisso-calledanomalyinapreviouspaper,wherewecombineditwithaQualityscreening(VandeMaeleandJallet,2015).
MostexistingSmartBetaportfoliosarebasedononesinglefactor(eitherValue,Quality,Momentum,LowVolatilityorSize).How-ever,realdiversificationbenefitsexistwhendifferentfactorsarecombinedinoneportfolio.Inthisanalysis,wecombineValue,QualityandLowVolatility.ASizebiasisalreadyimplicitlypresentduetotheincreasedweightingofthelongtailofsmallercompanies(see3.2).SincetheMomentumfactorgeneratesarelativelyhighturnoverintheportfolio,itwasnotimplementedinthisanalysis.
ThetablebelowindicatesthemeasuresusedtodefineValue,QualityandLowVolatility.
June 2017 9
Smart SRI Equity investing: Combining ESG criteria with factor investing
FIGURE 3: Candriam factortilts–CumulativeExcessReturn
Sources: Candriam, Factset
-0.5
2
1.5
1
0.5
0
EUROPE
■■ Value ■■ Quality ■■ LowVolatility ■■ Combination
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
-0.4
1.2
1
0.8
0.6
0.4
0.2
-0.2
0
JAPAN
■■ Value ■■ Quality ■■ LowVolatility ■■ Combination
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015-0.2
1.4
1.2
1
0.8
0.6
0.4
0.2
0
USA
■■ Value ■■ Quality ■■ LowVolatility ■■ Combination
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
-0.4
1.81.61.41.2
10.8
0.40.6
0.20
-0.2
EMU
■■ Value ■■ Quality ■■ LowVolatility ■■ Combination
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Inordertoillustratetheaddedvalueofthe3aforementionedfactors,long/shortportfolioswerecreatedforeachoftheindividualfactors.Theseportfolioswerecreatedbyrankingeachstockwithinitsuniverseatfactorlevel.Stockswerethenclassifiedinquintiles,wheretheLong-Shortportfoliosinvestinthefirstquintileandshortthelastquintile(withanequalstockweightingineachquintile).
AcombinedLong/Shortportfoliowasalsocompiled,wheretherankingofthestockswasbasedonValue,QualityandLowVolatility(eachfactorequallyweighted).
ThegraphbelowshowsthecumulativereturnsoftheseLong-Shortportfolios.Itturnsoutthatthemulti-factorapproachundeniablyadds value in all regions.
June 2017 10
Smart SRI Equity investing: Combining ESG criteria with factor investing
-10
6
4
2
0
-2
-4
-6
-8
■■ EMU ■■ Europe ■■ Japan ■■ USA
Q1 Q2 Q3 Q4 Q5
4.8 4.623.01
1.54
4.92 4.24
-0.22
1.22
-0.060.15
-2.1-0.46
0.1
-0.71
-3.24-1.52
-7.6 -7.88
-2.99
-6,39
-0.4
1
0.8
0.6
0.4
0.2
0.2
0
■■ EMU ■■ Europe ■■ Japan ■■ USA
Q1 Q2 Q3 Q4 EWQ5
0.66
0.82
0.61
0.82
0.630.73
0.38
0.87
0.240.36
0.23
0.62
0.21 0.240.11
0.41
-0.15 -0.13
0.1 0.090.19
0.27 0.32
0.52
FIGURE 4: Factorscombination–AnnualizedExcessReturns
FIGURE 5: Factorscombination–AnnualizedSharpeRatio
Sources: Candriam, Factset
Sources: Candriam, Factset
Figure4showstheannualizedexcessreturnofthequintilesagainsttheequallyweighteduniverses.Q1representsstocksinthetop20%andQ5thoseinthebottom20%.Foreachregion,theexcessreturnsfollowaratherlinearfunction,whereperformancedecreases in accordance with the quintile.
TheSharpeRatio,too,ispresentedinFigure5,wheretheQ1/Q2SharpeRatioistwicethatoftheequallyweightedportfolio,andtheQ4/Q5negativeorlowerthanit.
June 2017 11
Smart SRI Equity investing: Combining ESG criteria with factor investing
TABLE 6: Quintiles Factor Weighting
Q1 Q2 Q3 Q4 Q5
EMU +0.40% +0.20% Neutral -0.20% -0.40%
Europe +0.20% +0.10% Neutral -0.10% -0.20%
Japan +0.40% +0.20% Neutral -0.20% -0.40%
US +0.20% +0.10% Neutral -0.10% -0.20%
Source: Candriam
FIGURE 6: CandriamSRIIndex–CumulativeExcessReturn
Sources: Candriam, Factset, MSCI
0
2
1.5
1
0.5
EMU
■■ Candriam.SRI.Index ■■ MSCI.Index
2006 2007 2008 2009 2010 2011 2012 2013 2014 20150
2
1.5
1
0.5
EUROPE
■■ Candriam.SRI.Index ■■ MSCI.Index
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
0
2
1.5
1
0.5
JAPAN
■■ Candriam.SRI.Index ■■ MSCI.Index
2006 2007 2008 2009 2010 2011 2012 2013 2014 20150
3
2
2.5
1
1.5
0.5
USA
■■ Candriam.SRI.Index ■■ MSCI.Index
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
4. PUTTING IT ALL TOGETHERThelaststepintheportfolioconstructionprocessinvolvesputtingallthesestepstogether.Inessence,thefactortiltsneedtobeappliedtothe‘modified’fundamentalweightings.Inordertodoso,thefollowingdriftsareappliedbyquintiletothe“modified”fundamentalweightingsandthenrebasedto100%.
Thesizeoftheimplementationisbasedonthelargenessoftheuniverse.VerylargeuniversessuchasEuropeandtheUSwillhavealowerimplementationsizethanuniverseswithamorelimitednumberofconstituents(suchasEMUandJapan).Thisbeingthecase,theactiverisksofthe3stepsintheport-folioconstructionprocessremain,tosomeextent,equivalent.
4.1. Historical Performances
Thefollowingchartsshowthecumulativereturnsofthefinalindicesfrom02/2006to12/2015.Foreachregion,the“SmartSRI”portfoliooutperformsitstraditionalmarketcapitalization-weightedindex.Asshowninfigure7,cumulativeexcessreturnsarerelatively stable and robust over time.
June 2017 12
Smart SRI Equity investing: Combining ESG criteria with factor investing
Sources: Candriam, Factset, MSCI
FIGURE 7: CandriamSRIIndex–CumulativeExcessReturn
-0.1
0.450.4
0.150.1
0.2
0.30.35
0.25
0-0.05
0.05
EMU
■■ Index
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015-0.05
0.4
0.150.1
0.2
0.30.35
0.25
00.05
EUROPE
■■ Index
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
-0.1
0.6
0.1
0
0.2
0.4
0.5
0.3
JAPAN
■■ Index
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015-0.05
0.35
0.15
0.1
0.2
0.3
0.25
0
0.05
USA
■■ Index
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
June 2017 13
Smart SRI Equity investing: Combining ESG criteria with factor investing
TABLE 7: SRI Indices – Statistical Table
SRIEurope MSCIEurope SRIEMU MSCIEMU SRIJapan MSCIJapan SRI USA MSCIUSA
Annualized Return 5.8% 3.73% 5.25% 2.44% 5.14% 1.39% 8.81% 7.53%
Annualized Std Dev 16.09% 15.35% 17.5% 17.73% 14.32% 15.13% 14.24% 13.87%
AnnualizedSharpe(Rf=0%) 0.3606 0.2427 0.3002 0.1374 0.3588 0.092 0.6189 0.5432
MaximumDrawdown 53.83% 54.1% 53.78% 56.21% 37.2% 48.91% 49.34% 47.34%
HistoricalVaR(95%) -8.28% -8.55% -8.47% -8.8% -6% -7.58% -6.2% -7.39%
Beta 1.0345 0.9771 0.9105 1.0036
Beta+ 1.1379 1.0619 0.9622 1.0664
Beta- 0.9886 0.9444 0.8468 1.0024
AnnualizedAlpha 1.94% 2.79% 3.8% 1.22%
TrackingError 2.58% 2.48% 4.12% 3.02%
Information Ratio 0.8025 1.1372 0.9095 0.4245
Sources: Candriam, Factset, MSCI
-30
40
30
20
10
-10
-20
0
■■ US ■■ Europe ■■ EMU ■■ Japan
Size Volatility Profit Leverage DivYld Value
FIGURE8:Styleexposure
Sources: Candriam, Factset, Bloomberg, Barra
ThenexttableshowsthedifferentstatisticsoneachSmartSRIIndexvsitsRegionalMarketCapIndex.EachSRIIndexhasahigherannualizedreturnandSharpeRatio,withanannualizedalphaof1.22%intheUS,around2%inEurope/EMUand3.8%inJapan.
Riskmeasuresindicatesimilarstandarddeviations,whereasthedownsideriskasmeasuredbyHistoricalVaRislower.TheTrackingErrorliesbetween2.48%and4.12%,whichisrelativelylowandhelpscreateanInformationRatiobetween0.42and1.14.Additionally,theupsidemarketcaptureisclearlyhigherthanthedownsidemarketcapture.
Obviously,giventheaforementionedportfolioconstructionprocess,theportfoliohascertainstylebiasessuchasValue,Quality,LowVolatilityandSize.Thegraphbelowillustratesthe average style bias of the indices since the end of 2015.
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Smart SRI Equity investing: Combining ESG criteria with factor investing
FIGURE 9: Candriam SRI Index–Liveperformance
Sources: Candriam, Factset, MSCI
0.8
1.2
1.1
1
0.9
Dec. 15
Jan. 16
Feb. 1
6Mar.
16Apr.
16May
16Jun
. 16Jul
. 16Aug.
16Sep.
16Oct.
16Nov.
16Dec.
16Jan
. 17Fe
b. 17
Mar. 17
Apr. 17
EMU
■■ Candriam.SRI.Index ■■ MSCI.Index
0.8
1.2
1.1
1
0.9
Dec. 15
Jan. 16
Feb. 1
6Mar.
16Apr.
16May
16Jun
. 16Jul
. 16Aug.
16Sep.
16Oct.
16Nov.
16Dec.
16Jan
. 17Fe
b. 17
Mar. 17
Apr. 17
EUROPE
■■ Candriam.SRI.Index ■■ MSCI.Index
0.8
1.2
1.1
1
0.9
Dec. 15
Jan. 16
Feb. 1
6Mar.
16Apr.
16May
16Jun
. 16Jul
. 16Aug.
16Sep.
16Oct.
16Nov.
16Dec.
16Jan
. 17Fe
b. 17
Mar. 17
Apr. 17
JAPAN
■■ Candriam.SRI.Index ■■ MSCI.Index
0.8
1.3
1.1
1.2
1
0.9
Dec. 15
Jan. 16
Feb. 1
6Mar.
16Apr.
16May
16Jun
. 16Jul
. 16Aug.
16Sep.
16Oct.
16Nov.
16Dec.
16Jan
. 17Fe
b. 17
Mar. 17
Apr. 17
USA
■■ Candriam.SRI.Index ■■ MSCI.Index
5. CONCLUSIONBasedontheaboveanalysis,Candriamisconvincedthatthisportfolioconstructionmethodologyishighlyvaluableforinvestorsseekingtomatchorevenoutperformthebroadequitymarkets,butwhocaresaboutSustainableandResponsibleInvesting.Itshowsthatbothobjectivesarenotmutuallyexclusive.
Also,themostrecent“live”performanceoftheindices(sincetheendof2015,whenthebacktestended)confirmstheexcellentrisk-returncharacteristics.Thegraphbelowshowstheperformanceoftheindexcomparedtothebroadmarketbasedonastandardmarket-capitalizationportfolioconstructionmethodology.
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Smart SRI Equity investing: Combining ESG criteria with factor investing
TABLE 8: SRI Indices – Statistical Table
Candriam SRIIndexEurope
MSCI Europe
Candriam SRIIndexEMU
MSCI EMU
Candriam SRIIndexJapan
MSCI Japan
Candriam SRIIndex
USAMSCI USA
Annualized Return 9.62% 7.38% 11.66% 10.01% 6.94% 6.62% 13.85% 12.96%
Annualized Std Dev 17.87% 17.36% 17.81% 18.28% 21.21% 21.21% 14.46% 14.66%
AnnualizedSharpe(Rf=0%) 0.5384 0.4252 0.6544 0.5478 0.3272 0.3122 0.9575 0.8839
MaximumDrawdown 16.93% 17.21% 16.72% 17.76% 20.58% 20.48% 13.40% 15.06%
HistoricalVaR(95%) -1.68% -1.65% -1.66% -1.78% -2.02% -1.91% -1.53% -1.53%
AnnualizedAlpha 1.97% 1.75% 0.35% 1.06%
TrackingError 1.83% 1.79% 2.42% 1.99%
Information Ratio 1.2237 0.9185 0.1308 0.4467
Sources: Candriam, Factset, MSCI
TheRiskandPerformanceMeasuresintable8alsoindicateasignificanthigherSharpeRatio,andastrongInformationRatiobetween0.51and2.21,whereasMaxDrawdownandHistoricalVaRareslightlylower.
6. REFERENCES●● Arnott,RobertD.,JasonC.Hsu,andPhilipMoore. 2005.
“Fundamental Indexation.” Financial Analysts Journal, 83–99.
●● Carhart, Mark M. 1997. “On Persistence in Mutual Fund Performance.” The Journal of Finance, 57–82.
●● Eugene Fama and Kenneth French. 1993. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 3–56.
●● Fama, Eugene, and Kenneth French. 2015. “A Five-Factor Asset Pricing Model.” Journal of Financial Economics, 1–22.
●● Grinold, Richard C. 1992. “Are Benchmark Portfolios Efficient ?” TheJournalofPortfolioManagement,34–40.
●● Haugen, Robert A., and Nardin L. Baker. 1991. “The Efficient Market Inefficiency of Capitalization-Weighted Stock Portfolios.” TheJournalofPortfolioManagement,35–40.
●● Robert A. Haugen and Nardin L. Baker. 2012. “Low Risk Stocks Outperform Within All Observable Markets of the World.” TheJournalofPortfolioManagement,35–40.
●● Koen Van de Maele and Sebastien Jallet. 2015. “A New Way to Invest in Stocks, Aiming for Lower Risk and Higher Quality.”
Smart SRI Equity investing: Combining ESG criteria with factor investing
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