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‘We have a much better proposition than passive’

‘We have a much better proposition than passive’

18-12-2018 | インサイト

Robeco’s Enhanced Indexing Equity strategies have enjoyed renewed popularity in recent months. Inflows have totaled nearly EUR 4 billion over the past year, thanks to a series of major mandate wins. Wilma de Groot discusses the reasons for this success.

  • Wilma de Groot, PhD
    Wilma
    de Groot, PhD
    CFA, Executive Director, Head of Core Quant Equities

Speed read:

  • Passive strategies have undisputable merits
  • But there are also important pitfalls
  • Enhanced indexing emerges as a proven alternative

How do you explain the recent string of large mandate wins for Robeco’s Enhanced Indexing Equity strategies?

“I think this is because investors increasingly acknowledge the merits of this approach as a valid alternative to passive strategies. It shows that in the current massive shift away from traditional active management to seemingly cheap passive strategies, a growing number of investors are looking for better options. And in my view, they have good reasons for doing so.”

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Because despite its growing popularity among investors, passive investing is far from perfect, right?

“Passive strategies have their merits. I don’t dispute that. They offer attractive fees with portfolio return-risk characteristics that are close to the market portfolio. Furthermore, with passive strategies, you know what to expect. But at Robeco, we think investors can do much better than simply following a market-capitalization index. More specifically, we identify five major concerns associated with this kind of approach. These concerns have been extensively documented in the academic literature and investors should not overlook them.”

“The first concern is that passive investing inevitably lags the market index, due to management fees and transaction costs. Second, because they are fully transparent, passive strategies are prone to arbitrage by opportunistic investors who anticipate trades once changes in an index have been announced. Third, passive investing ignores decades of academic insights on market anomalies and factor premiums. As a result, replicating the market index implies investing a significant part of a portfolio in stocks with negative expected returns.”

“The fourth concern is that passive strategies do not take sustainability considerations into account. At best, they can apply very basic negative screening in the form of rigid exclusion lists. Finally, passive investors cannot engage efficiently with companies. Since passive strategies track the results of third-party indices based on variables such as market capitalization and liquidity, passive investors can’t do much to influence the management of the companies they own.”

For some of our recent mandate wins, we were competing directly with passive asset managers’

So, do the Robeco Enhanced Indexing strategies address all these concerns?

“Yes. Enhanced Indexing strategies address all the pitfalls I just mentioned and, at the same time, the portfolio’s characteristics are similar to those of the market portfolio. So, while we do not offer passive strategies, we think we have a much better proposition. Some of our recent mandate wins, where we were competing directly with passive asset managers, show that clients from around the world and with very different backgrounds are increasingly acknowledging this. Wholesale advisors are also realizing the added value of our proposition compared to basic passive strategies.”

“The idea behind Enhanced Indexing is to systematically capture the market return and benefit from factor premiums. Enhanced index portfolios take the selected capitalization-weighted market index as their starting point. They then give slightly more weight to stocks with attractive stock characteristics and slightly less to those with unattractive characteristics. This enables us to deliver stable outperformance after costs, with a low tracking error, as only slight deviations from the benchmark are allowed.”

“For more than 15 years now, our Enhanced Indexing strategies have actually proven their ability to consistently and significantly outperform their reference index, both in developed and emerging markets. Recently, we also launched a series of regional Enhanced Indexing strategies that focus on specific equity markets, such as Europe, the US or China. Carveouts based on the realized long-term performance of our existing strategies indicate that the concept of Enhanced Indexing not only works for broad global investment universes, a but also at a more local level. Even for the US market which is perceived to be very efficient, the strategy shows strong results.”

What about sustainability aspects? This has clearly become a major issue for investors in recent years…

“At Robeco we take sustainability very seriously. And within Enhanced Indexing portfolios, we incorporate ESG factors in the investment and decision-making process at every step of the investment process. First, sustainability scores are taken into account when determining the quality characteristics of companies in developed markets. Second, when building the Enhanced Indexing portfolio, we make sure that the weighted RobecoSAM sustainability score of the portfolio is always better than that of the index.”

“Finally, a direct link is created between the enhanced engagement program and the portfolio. No overweight positions are taken in companies that are placed under enhanced engagement. Should the enhanced engagement be closed unsuccessfully, the company may be excluded from the investable universe and any remaining positions in the portfolio will be sold. With this enhanced form of sustainability integration, we avoid the risk of overexposure to less sustainable companies.”

“In addition, we have advanced Sustainable Enhanced Indexing strategies available which even take sustainability integration several steps further. In those strategies we apply a broader exclusion list and we ensure that the weighted RobecoSAM sustainability score of the portfolio is 30% better than that of the index. On top of that, based on four different dimensions (e.g. greenhouse gas emissions), the environmental footprint is 20% lower than that of the index.”

This article was initially published in our Robeco Quarterly magazine.

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