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Solving the sustainable investment dilemma

Solving the sustainable investment dilemma

25-05-2020 | Interview

Combining quant and sustainable investing efficiently requires expertise. We talked with Jan de Koning and Georgi Kyosev, from our Quant Equities team, about the most recent trends in this area and what sets Robeco’s offering apart.

  • Jan de Koning
    Jan
    de Koning
    Portfolio Manager Core Quant Equities
  • Georgi Kyosev
    Georgi
    Kyosev
    Researcher

Speed read

  • Combining quant and sustainable investing is easier said than done 
  • Decarbonization and engagement have become crucial aspects
  • Being able to adjust sustainability criteria over time is also key

What are the main changes you see in the way clients are grasping sustainability?

Georgi Kyosev: “Just a few years ago, sustainability wasn’t really a conversation topic. It was all about the ‘factor’ side of our quant strategies. But now, sustainability is becoming increasingly prominent. Quite often, it’s first ESG and then factors.”

Jan de Koning: “And sustainable investing itself is changing rapidly. This is good news, but that also means that, as asset managers, we need to be fast and flexible. Ten years ago, most investors were happy with simple exclusions. Now, they increasingly ask for more and more improvements. One reason is that the definition of sustainability is not carved in stone. It is very personal and I’ve never met two clients with the same requirement. They have their own goals, different legislations, different pressure from trustees, and so on.”

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What is the focus right now, the thing that most people ask for?

J.D.K.: “Carbon footprint reduction. One reason is that ESG scores’ integration is more complex – which scores should you use? – and values-based exclusions are very personal. Meanwhile, you don’t have much discretion regarding what a 50% carbon footprint reduction means, and it is very easy to communicate about it. It is tangible. This is why carbon is very popular.”

G.K.: “Another reason why clients are moving away from exclusions is that many of them already hold passive products and want strategies that will not alter the risk-return profile of their portfolio. So, they are quickly disappointed with exclusions, as they often do not significantly improve sustainability and come with relatively high tracking error.”

So, they may want to do something simple, but simple is not that simple, right?

J.D.K.: “Yes and because clients know sustainability is not static and not their only goal, they also want to remain flexible. They want to be able to customize today and tomorrow. In all these aspects, active managers can make a difference relative to conventional index providers, and offer portfolios that avoid unwarranted factor exposures, high turnover, undesired country or sector biases, etc.”

Index providers often need to sacrifice ESG improvements to prevent tracking error from soaring

OK. But what about the sustainability improvements themselves? This is also an area where active managers may stand out…

G.K.: “Certainly. Index providers often need to sacrifice ESG improvements to prevent tracking error from soaring. Or they may be able to limit tracking error but have high turnover. We call these tradeoffs the sustainable investment dilemma. The good news is that it is possible to solve this with an innovative approach that provides high levels of sustainability, low tracking error and low turnover at the same time.”

J.D.K.: “Also, our 20-year expertise in both quant and sustainable investing, as well as our size and global reach, enable us to remain very agile. We have quants who focus on sustainability data and sustainably experts who know a lot about quant investing. This enables us to both shorten time-to-market and to make our latest modifications available even for small mandates.”

“For instance, when quants came with the idea of ‘decarbonizing’ value strategies, we were able to put this to work quickly and to share insights on how to assess corporate sustainability profiles with our sustainability experts. Index providers and asset managers that either have very large teams working in silos, or that use generic ESG scores, for example, have difficulty going this extra mile.”

Are there any other elements that really set Robeco’ quant offering apart from the competition?

G.K.: “Next to our quant expertise, we also have an experienced engagement team. This is something only very few asset managers can provide. This aspect used to be overlooked by clients, but today, we see it coming back in almost every meeting. And we are perhaps one of just a handful who can offer the combination of a sustainable index and engagement.”

J.D.K.: “Active ownership and engagement with companies are clearly one of the biggest dilemmas of our time. We have huge passive managers that basically pass the parcel to index providers, claiming that the result of engagement should be reflected in index design in order to be able to lower the index weight of a company that fails to listen and thereby improve its corporate behavior.

“Whereas index providers pass the parcel to either asset managers or the regulators as their job is not to engage but just create indices. So, as a sustainable investor, you’re caught in the middle of conflicting incentives of index builders and passive managers. Who is going to force companies to change for the better?”

How about delivery? Robeco offers not only traditional quant funds and mandates but also indices…

G.K.: “Different clients come with different needs. Indices are suitable for those requesting full transparency and those willing to split intellectual property from fulfilment. In that case, they can keep their existing asset management contracts in place and only change the index they track. Indices also allow us to partner with an investment bank and build more complex structured products.”

“For example, one of our most recent clients implements our sustainable factor index though a total return swap. In this case, our ability to deliver a strategy as an index is essential. This was also the case for a partnership with a global asset consultant, that for cost and transparency reasons wanted a solution managed in the form of an index for its pension clients.”

J.D.K.: “On the other hand, our quant equity strategies are most appealing to investors who are looking for a one-stop shop. Having experience as a quant equity investment manager for over 20 years gives us enormous credibility in the field and we are consistently seen as a thought leader.”

Many roads lead to sustainable Rome and these roads can change over time

On a final note, can the sustainability components of our indices be adjusted over time?

G.K.: “Yes. In fact, this is something that really sets us apart from most index providers. At Robeco, we like to say that we partner with our clients, not just with our prospects. When we are in talks with a prospect, we really strive to come up with a solution that meets  their needs in the best possible way. But our conversation doesn’t stop once they become a client.”

J.D.K.: “And because sustainability is so changing and personal, leaving the door open for potential future enhancements we believe gives investors a competitive advantage. Many roads lead to sustainable Rome and these roads can change over time.”

This article was initially published in our Quant Quarterly magazine. 

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