hongkongen
Indices insights: Does integrating sustainability reduce opportunities for active investors?

Indices insights: Does integrating sustainability reduce opportunities for active investors?

12-04-2022 | Insight

In this Indices insights article, we show that incorporating sustainability does not constrain the potential for alpha. Indeed, active investors can still benefit from similar levels of market breadth, even after excluding stocks that contribute negatively to the UN SDGs.

  • Joop  Huij
    Joop
    Huij
    Head of Indices
  • Simon Lansdorp
    Simon
    Lansdorp
    Portfolio Manager

Speed read

  • SDG integration has minimal effects on the distribution of stock characteristics
  • Positive alignment with SDGs need not reduce market breadth
  • Thus, this leaves active investors with sufficient opportunities to add value

The potential to outperform market indices is the key advantage of active investment approaches, including popular styles such as growth or value. With investors increasingly seeking to integrate sustainability, active managers are tasked with generating alpha for their clients while simultaneously incorporating their sustainability preferences. The question is whether exclusions based on sustainability aspects can dilute the relative advantage of an active approach.

In the previous ‘Indices insights’ article, we looked at whether the integration of sustainability considerations has an impact on passive investors’ financial objectives. From our analysis, we demonstrated that it is possible for passive solutions to exhibit risk-return characteristics that are similar to those of the market even when high carbon emitters or companies that negatively impact the SDGs are excluded. We also saw that these sustainable passive solutions can enjoy the diversification benefits of market-cap weighted indices.

In this article, we will examine to what extent the integration of sustainability affects active investors. The application of sustainability screens reduces the size of the investment universe, which therefore could constrain the alpha potential of an active solution. Indeed, active investors have a greater chance of delivering alpha if the distribution of stock characteristics within an investment universe is more dispersed, i.e., reflecting higher market breadth.

Stay informed on Sustainable Investing with monthly mail updates
Stay informed on Sustainable Investing with monthly mail updates
Subscribe

Sustainability integration leaves investors with ample investment opportunities

To assess this, we analyzed the distribution of stock characteristics – including market capitalization, valuations, quality and risk – for two separate investment universes: one consisting of thousands of stocks globally (full universe), and the other comprising the full universe minus stocks with poor sustainability attributes (sustainable universe). More specifically, the sustainable universe excludes companies that contribute negatively to the SDGs, determined by Robeco’s proprietary SDG framework.

As shown in Figure 1, we found that the stock characteristics for the two universes were virtually identical. This is reflected by the blue ellipses (sustainable universe) almost completely overlapping the orange ellipses (full universe).

Figure 1 | Breadth and distribution of stock characteristics are similar for both full and sustainable universes

Source: Robeco, FactSet. Global stock characteristics as per 31 December 2021.

More specifically, the centers of the ellipses indicate the average size, value, quality or risk characteristics of the two universes. Therefore, how the ellipses are rotated around their centers provides an indication of the correlation between stock market caps and their corresponding valuation, quality or risk metrics. Given that each pair of ellipses is rotated in a similar angle, we can conclude that applying the sustainability filter – using the SDG criteria – does not result in concentrated exclusions within specific market segments, for example stocks with low valuations or high quality.

Finally, the similar-sized areas within the blue and orange ellipses as well as the dispersion of the blue and orange dots indicate that the breadth of the investment universe is similar after the sustainability screen is applied. Put differently, the opportunity set for active investors is not significantly impacted by excluding companies based on their negative contributions to the SDGs.

We also scrutinized how stocks are distributed across 3x3 groups sorted on size and value, size and quality, as well as size and risk. We observed that the distribution across the full and sustainable universes was markedly similar, as depicted in Table 1.

Table 1 | Highly similar distribution of stocks across 3x3 sorted pairs of stock characteristics

Source: Robeco, FactSet. Global stock characteristics as per 31 December 2021.

For instance, 2.2% and 2.5% of the stocks are large caps with low valuations in the full and sustainable universes, respectively. These similarities hold for all the other groups as the differences in distribution are typically very small. Although it is difficult to see, this is also reflected in Figure 1 by the distribution of the blue and orange dots within each of the nine blocks (groups) in the three separate charts.

Data and methodology

For our analysis, we based our investment universes on the constituents of the MSCI World Investable Market Index as at the end of December 2021. Regarding stock characteristics, we used the log of market caps for size, log of book-to-price ratios for value, gross profits-to-assets ratios for quality, and historical 36-month market betas for risk, all sourced from FactSet and rescaled to have a mean of zero and unit standard deviation. We excluded financials from our study when analyzing the size and quality traits.

To construct our sustainable universe, we applied a sustainability screen based on Robeco’s proprietary SDG framework. The framework provides a clear, objective, consistent and replicable approach to measuring the contributions that companies make to the 17 SDGs. More specifically, we excluded companies that contribute negatively to the SDGs. While our full universe consisted of roughly 6,000 stocks, our sustainable universe comprised approximately 4,700 names.

Similar to the Morningstar Style Box and Morningstar Ownership Zone analyses, we then produced scatterplots of the stocks in three dimensions based on their size and value, size and quality, as well as size and risk characteristics. We also added the breakpoints of the market cap and secondary characteristics to split the universes into 3x3 groups, using the 10th and 90th percentiles. These breakpoints are denoted by the vertical and horizontal lines in the plots. Additionally, we calculated ellipses for each pair of characteristics covering 95% of the stocks in the relevant universe that are closest to the average.1

Sustainable Indices
Sustainable Indices
Our expertise in sustainable and factor investing gives us the unique ability to offer investors more sustainable index solutions.
Read more

Conclusion

Based on our findings, we conclude that an SDG-based sustainability screen has virtually no effect on the dispersion and distribution of stock characteristics, when we analyze an investment universe in the context of several stock attributes that are typically deemed relevant for explaining differences within the cross-section of stock returns.

Furthermore, we find that the integration of sustainability leaves investors with ample investment opportunities. This is particularly important to active investors who aim to generate alpha for their clients and adhere to their sustainability preferences. In the next ‘Indices insights’ article, we will put this notion to the test within the context of factor investing, by analyzing the effect such sustainability screens have on expected factor premiums.

1 A universe which is less dispersed will have an ellipse covering a small area versus a universe which is more dispersed.


  Background to sustainability metrics

In defining sustainability, investors have a multitude of dimensions and metrics they could consider. For example:

  • Values-based exclusions
  • ESG integration
  • Impact investing

ESG scores typically put more focus on the operations of a business, whereas SDG scores also incorporate the impact that the business' products and/or services have on society.

We see client sustainability objectives increasingly moving towards avoiding controversial businesses (values-based exclusions) and including those that provide sustainable solutions (impact investing). In the first few articles of our Indices Insights series, we will empirically show how the different sustainability metrics (negative screening/exclusions, ESG, SDG) relate to the increasingly impact-oriented client sustainability objectives.

 

Important information

The contents of this document have not been reviewed by the Securities and Futures Commission ("SFC") in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. This document has been distributed by Robeco Hong Kong Limited (‘Robeco’). Robeco is regulated by the SFC in Hong Kong.
This document has been prepared on a confidential basis solely for the recipient and is for information purposes only. Any reproduction or distribution of this documentation, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited. By accepting this documentation, the recipient agrees to the foregoing
This document is intended to provide the reader with information on Robeco’s specific capabilities, but does not constitute a recommendation to buy or sell certain securities or investment products. Investment decisions should only be based on the relevant prospectus and on thorough financial, fiscal and legal advice. Please refer to the relevant offering documents for details including the risk factors before making any investment decisions.
The contents of this document are based upon sources of information believed to be reliable. This document is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.
Investment Involves risks. Historical returns are provided for illustrative purposes only and do not necessarily reflect Robeco’s expectations for the future. The value of your investments may fluctuate. Past performance is no indication of current or future performance.

Logo

Disclaimers

1. General
Please read this information carefully.

This website is prepared and issued by Robeco Hong Kong Limited ("Robeco"), which is a corporation licensed by the Securities and Futures Commission in Hong Kong to engage in Type 1 (dealing in securities); Type 4 (advising in securities) and Type 9 (asset management) regulated activities. The Company does not hold client assets and is subject to the licensing condition that it shall seek the SFC’s prior approval before extending services at retail level. This website has not been reviewed by the Securities and Futures Commission or any regulatory authority in Hong Kong.

2. Important risk disclosures
2. Important risk disclosures Robeco Capital Growth Funds (“the Funds”) are distinguished by their respective specific investment policies or any other specific features. Please read carefully for the risks of the Funds:

  • Some Funds are subject to investment, market, equities, liquidity, counterparty, securities lending and foreign currency risk and risk associated with investments in small and/or mid-capped companies.
  • Some Funds are subject to the risks of investing in emerging markets which include political, economic, legal, regulatory, market, settlement, execution, counterparty and currency risks.
  • Some Funds may invest in China A shares directly through the Qualified Foreign Institutional Investor (“QFII”) scheme and / or RMB Qualified Foreign Institutional Investor (“RQFII”) scheme and / or Stock Connect programmes which may entail additional clearing and settlement, regulatory, operational, counterparty and liquidity risk.
  • For distributing share classes, some Funds may pay out dividend distributions out of capital. Where distributions are paid out of capital, this amounts to a return or withdrawal of part of your original investment or capital gains attributable to that and may result in an immediate decrease in the net asset value of shares.
  • Some Funds’ investments maybe concentrated in one region / one country / one sector / around one theme and therefore the value of the Fund may be more volatile and may be subject to concentration risk.
  • The risk exists that the quantitative techniques used by some Funds may not work and the Funds’ value may be adversely affected.
  • In addition to investment, market, liquidity, counterparty, securities lending, (reverse) repurchase agreements and foreign currency risk, some Funds are subject to risk associated with fixed income investments like credit risk, interest rate risk, convertible bonds risk, ABS risk and the risk of investments in non-investment grade or unrated securities and the risk of investments made in non-investment grade sovereign securities.
  • Some Funds can use derivatives extensively. Robeco Global Consumer Trends Equities can use derivatives for hedging and efficient portfolio management. Derivatives exposure may involve higher counterparty, liquidity and valuation risks. In adverse situations, the Funds may suffer significant losses (even a total loss of the Funds’ assets) from its derivative usage.
  • Robeco European High Yield Bonds is subject to Eurozone risk.
  • Investors may suffer substantial losses of their investments in the Funds. Investor should not invest in the Funds solely based on the information provided in this document and should read the offering documents (including potential risks involved) for details.

3. Local legal and sales restrictions
The Website is to be accessed by “professional investors” only (as defined in the Securities and Futures Ordinance (Cap.571) and/or the Securities and Futures (Professional Investors) Rules (Cap.571D) under the laws of Hong Kong). The Website is not directed at any person in any jurisdiction where (by reason of that person’s nationality, residence or otherwise) the publication or availability of the Website is prohibited. Persons in respect of whom such prohibitions apply or persons other than those specified above must not access this Website. Persons accessing the Website need to be aware that they are responsible themselves for the compliance with all local rules and regulations. By accessing this Website and any of its pages, you acknowledge your agreement with understanding of the following terms of use and legal information. If you do not agree to the terms and conditions below, do not access this Website or any pages thereof.

The information contained in the Website is being provided for information purposes.

Neither information nor any opinion expressed on the Website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. The information contained in the Website does not constitute investment advice or a recommendation and was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. An investment in a Robeco product should only be made after reading the related legal documents such as management regulations, prospectuses, most recent annual and semi-annual reports, which can be all be obtained free of charge at www.robeco.com/hk/en and at the Robeco Hong Kong office.

4. Use of the Website
The information is based on certain assumptions, information and conditions applicable at a certain time and may be subject to change at any time without notice. Robeco aims to provide accurate, complete and up-to-date information, obtained from sources of information believed to be reliable. Persons accessing the Website are responsible for their choice and use of the information.

5. Investment performance
No assurance can be given that the investment objective of any investment products will be achieved. No representation or promise as to the performance of any investment products or the return on an investment is made. The value of your investments may fluctuate. The value of the assets of Robeco investment products may also fluctuate as a result of the investment policy and/or the developments on the financial markets. Results obtained in the past are no guarantee for the future. Past performance, projection, or forecast included in this Website should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Fund performance figures are based on the month-end trading prices and are calculated on a total return basis with dividends reinvested. Return figures versus the benchmark show the investment management result before management and/or performance fees; the fund returns are with dividends reinvested and based on net asset values with prices and exchange rates of the valuation moment of the benchmark.
Investments involve risks. Past performance is not a guide to future performance. Potential investors should read the terms and conditions contained in the relevant offering documents and in particular the investment policies and the risk factors before any investment decision is made. Investors should ensure they fully understand the risks associated with the fund and should also consider their own investment objective and risk tolerance level. Investors are reminded that the value and income (if any) from shares of the fund may be volatile and could change substantially within a short period of time, and investors may not get back the amount they have invested in the fund. If in doubt, please seek independent financial and professional advice.

6. Third party websites
This website includes material from third parties or links to websites maintained by third parties some of which is supplied by companies that are not affiliated to Robeco. Following links to any other off-site pages or websites of third parties shall be at the own risk of the person following such link. Robeco has not reviewed any of the websites linked to or referred to by the Website and does not endorse or accept any responsibility for their content nor the products, services or other items offered through them. Robeco shall have no liability for any losses or damages arising from the use of or reliance on the information contained on websites of third parties, including, without limitation, any loss of profit or any other direct or indirect damage. Third party off-site pages or websites are provided for informational purposes only.

7. Limitation of liability
Robeco as well as (possible) other suppliers of information to the Website accept no responsibility for the contents of the Website or the information or recommendations contained herein, which moreover may be changed without notice.
Robeco assumes no responsibility for ensuring, and makes no warranty, that the functioning of the Website will be uninterrupted or error-free. Robeco assumes no responsibility for the consequences of e-mail messages regarding a Robeco (transaction) service, which either cannot be received or sent, are damaged, received or sent incorrectly, or not received or sent on time.
Neither will Robeco be liable for any loss or damage that may result from access to and use of the Website.

8. Intellectual property
All copyrights, patents, intellectual and other property, and licenses regarding the information on the Website are held and obtained by Robeco. These rights will not be passed to persons accessing this information.

9. Privacy
Robeco guarantees that the data of persons accessing the Website will be treated confidentially in accordance with prevailing data protection regulations. Such data will not be made available to third parties without the approval of the persons accessing the Website, unless Robeco is legally obliged to do so. Please find more details in our Privacy and Cookie Policy.

10. Applicable law
The Website shall be governed by and construed in accordance with the laws of Hong Kong. All disputes arising out of or in connection with the Website shall be submitted to the exclusive jurisdiction of the courts of Hong Kong. 

Please click the “I agree” button if you have read and understood this page and agree to the Disclaimers above and the collection and use of your personal data by Robeco, for the purposes for which such data is collected and used as set out in the Privacy and Cookie Policy, including for the purpose of direct marketing of Robeco products or services. Otherwise, please click “I Disagree” to leave the website.

I Disagree