Our research shows that multi-factor credits and high yield strategies can be aligned with the SDGs. This follows the pioneering work that Robeco has done in developing SDG-screened investment strategies in credit and equity markets.
We explore here a multi-factor credits strategy that makes a clear contribution to the SDGs, while adhering to its primary objective: to offer exposure to proven factors and providing better risk-adjusted returns than the market index over a full credit cycle.
The Sustainable Development Goals (SDGs) are 17 goals with 169 underlying objectives for improving human society, environmental sustainability and quality of life, published by the United Nations in 2015. They cover a broad spectrum of sustainability topics, ranging from eliminating hunger and combating climate change, to promoting responsible consumption and making cities more sustainable.
There are many, often quite intuitive reasons why it is essential to incorporate SDG considerations into investment strategies. In an increasingly renewables-powered global economy, it is easy to foresee that the business models of companies such as coal miners, oil producers, fossil fuel-based electricity generators, and even car manufacturers that do not adapt quickly enough to a world of electric vehicles, will come under severe pressure. On the other hand, those companies that offer solutions to help achieve the SDGs may well be the winners of the future, as well as attractive investment candidates.
With 17 goals and 169 targets, the SDGs address a very broad range of issues. Robeco has developed a comprehensive proprietary SDG measurement framework to assess to what extent companies contribute to the SDGs. Based on these SDG assessments, which are translated into SDG scores for companies, Robeco can screen the investment universe of its multi-factor credits and high yield strategies for companies that contribute positively to the SDGs, and can exclude companies that detract from them.
To evaluate whether multi-factor credits and high yield strategies could be aligned with the SDGs, we assessed the performance impact of screening out (i.e. excluding) companies in sectors that contribute negatively to the SDGs on our global multi-factor credits and global multi-factor high yield strategies, over a 1994-2019 research period. In other words, we simulate the multi-factor credits strategy over this historical period and make assumptions about the companies that are included and excluded from the investible universe on the basis of their contribution to the SDGs.
We find that excluding companies that contribute negatively to the SDGs has a negative impact on the simulated performance.1 This means the strategy would have performed better if the SDG-related exclusion had not taken place. From a risk-adjusted perspective, the impact is more limited, though, as not only the return decreases but also the volatility.
There are two likely explanations for the drop in performance. First, our SDG screening assumptions reduce the investable universe by about 20%, which effectively reduces the selection power of the multi-factor model; less breadth means less expected outperformance as per the Fundamental Law of Active Management.2 Second, in the earlier parts of the simulation period, there was less attention paid to the impact that companies had on sustainability and the quality of our lives. Some of the excluded companies may have in fact benefitted from engaging in actions that nowadays would be deemed negative from an SDG point of view.
Simulating the performance impact of SDG screening since the introduction of the SDGs in 2015 provides interesting findings. Significantly, risk-adjusted performance has improved over this period, mainly because of a more significant drop in volatility. Although the period is only five years, this suggests that achieving attractive risk-adjusted returns and aligning our strategies with the SDGs are not necessarily conflicting objectives.
Our research shows that screening out companies in sectors that contribute negatively to the SDGs is an effective way to increase the SDG score of the portfolio. The impact on historical performance depends on how far back you look. At the start of the research period, there was no clear risk-return benefit to tilting investments away from companies in sectors with negative SDG scores; in the more recent period, however, such an approach did improve the risk-adjusted performance of the multi-factor strategies.
For clients who would like to ensure that their credit investments make a contribution to the SDGs, we can implement our multi-factor credits and multi-factor high yield strategies on an SDG-screened investment universe. In our analyses, we have chosen to use sector-level SDG scores, because of the lack of historical company-level SDG scores. However, if we were to implement SDG screening in practice, we would use company scores instead, because they more accurately measure a company’s alignment with the SDGs, allowing us to more effectively reduce the exposure to SDG-related risks in a portfolio.
1 See the full report for the data and analysis.
2 Grinold & Kahn, 1995, Active Portfolio Management: Quantitative Theory and Applications.