In this ‘Indices insights’ article, we analyze the impact of sustainability integration on factor premiums. We demonstrate that Value, Momentum, Quality and Low-risk factor premiums remain largely unchanged after SDG integration or carbon footprint reduction.
Factor investing entails the exploitation of academically proven factor premiums such as value, momentum, quality and low-risk. To harvest the long-term premiums associated with this style of investing, sufficient exposure to these factors is required. As investors are increasingly taking sustainability considerations into account, a key question is whether integrating sustainability aspects interferes with a portfolio’s factor tilts, leading to reduced performance.
In the previous two ‘Indices insights’ articles,1 we first analyzed the impact of sustainability integration on a passive, market-cap-weighted investment approach, as well as how this affects the opportunity set for an active investor. We demonstrated that, even after filtering the investment universe on certain sustainability criteria, a passive investor can still enjoy risk-return characteristics similar to those of the market, and that the distribution of stock characteristics does not change materially for an active investor. In this article, we will look into how such sustainability screens influence expected factor premiums.
In our assessment, we investigated the effects of applying SDG integration or carbon footprint reductions on global value, momentum, quality and low-risk premiums historically. For this purpose, we simulated factor-based portfolios for different investment universes. Specifically, we constructed long-short value, momentum and quality portfolios as well as a long-only low-risk portfolio based on the large and mid-cap segments of the market.
We then built similar factor-based portfolios using an investment universe that either excludes companies that contribute negatively to the SDGs (determined by Robeco’s proprietary SDG framework), or firms that belong to sub-industries with the highest carbon footprints. We then compared the performance of the factor-based portfolios constructed using the unconstrained, full universe with portfolios built using the sustainable universes (which apply either the SDG or carbon screens).
As shown in Figure 1, we found that excluding stocks with negative SDG scores or with high carbon footprints does not have a significant impact on the long-term performance of value, momentum, quality and low-risk portfolios. Across the board, the factor premiums were broadly similar when using the full universe and the sustainable universes.
For instance, the average value premium for the full universe was 1.9% per annum over the sample period. This was similar to the SDG-aligned universe, which also led to an annualized average value premium of 1.9%. Meanwhile, for the low-carbon universe, the average value premium was somewhat lower at 1.5% on an annual basis. In terms of momentum, the low-carbon universe had a higher average premium compared to the full universe, while it was slightly lower for the SDG-aligned universe. Interestingly, the average quality premium was higher for both sustainable universes versus the full universe. Regarding low risk, the average premium was virtually identical for all three universes.
For our analysis, we used the monthly US dollar returns of FTSE World Developed Index constituents before January 2001, and of MSCI World Index constituents thereafter. The full sample period of our investigation spanned from January 1986 to December 2021. For each month, we constructed market-cap-weighted portfolios based on the value, momentum, quality and low-risk factors for three different universes: the full universe (unconstrained) and two sustainable universes (using either SDG or carbon screens to filter out stocks).
Robeco’s proprietary SDG framework is used to assign SDG scores to companies. The framework provides a clear, consistent and replicable approach to measuring the contributions that firms make to the 17 SDGs. To create historical proxies for these SDG scores, we allocated SDG scores to companies based on their sub-industries. Therefore, our method resulted in a baseline sub-industry assessment of the goods produced and/or services provided by a company and how these contribute to the SDGs.
Sub-industries that make a positive impact receive SDG scores of +1 to +3 (low positive to high positive), depending on the strength and quality of their contributions. For example, positive contributions can be related to healthcare, medicine and water. Similarly, sub-industries that have a negative impact attain SDG scores of -1 to -3 (low negative to high negative), depending on the severity of their adverse impact.
For instance, negative contributions can be linked to gambling, fast food and shale gas. In our analysis, we assumed the SDG scores are fixed over the full sample period. For the SDG-aligned universe, we excluded all companies with negative SDG scores, which resulted in a reduction of between 20% and 25% in terms of total market cap as well as the number of stocks over the entire sample period.
Similarly, we first ranked all sub-industries on their carbon footprints based on scope 1 and 2 emissions as at the end of our sample period. Thereafter, we excluded the companies that belong to the sub-industries with the highest carbon footprints when we constructed the low-carbon universe. We assumed that present-day high-carbon sub-industries were also high-carbon sub-industries historically. The carbon screen resulted in a reduction of roughly 20% of the total market cap as well as the number of names over time, and a carbon footprint reduction of more than 50% at the end of our sample period.2
Within these three universes, we constructed 5x5 factor portfolios sorted on market cap and book-to-price ratio (value); market cap and past 12-minus-1 month return (momentum); market cap and gross profits-to-assets ratio (quality) and market cap and past 36-month beta (low risk). To control for the size effect, we took the average across the different market-cap-sorted quintiles, resulting in five size-neutral portfolios for each of the four factors.
We constructed a long-short value factor portfolio by taking a long position in high book-to-price stocks and a short position in low book-to-price stocks; a long-short momentum factor portfolio by taking a long position in recent winners and a short position in recent losers; a long-short quality factor portfolio by taking a long position in high profitability stocks and a short position in low profitability stocks. Using these long-short portfolios, we then estimated the historical factor premiums by calculating the average annualized return.
For the low-risk factor premium, we took a slightly different approach and only considered the long leg consisting of low-beta stocks. We then determined the Jensen alpha versus the market-cap-weighted return of all stocks within the unconstrained, full universe.
Given our findings, we conclude that long-term expected factor premiums remain largely the same after sustainability integration (via SDG or carbon screens). As such, we are of the opinion that single-factor or multi-factor strategies that incorporate sustainability considerations (such as SDG integration and/or carbon footprint reduction) are an interesting proposition for investors who want to achieve market-beating returns while following a sustainable approach.
1 Sustainable Index Solutions Team, March 2022, “Can passive investors integrate sustainability without sacrificing returns or diversification?”, Robeco article; and Sustainable Index Solutions Team, April 2022, “Does integrating sustainability reduce opportunities for active investors?”, Robeco article.
2 Measured by TruCost Scope 1 and 2 emissions divided by EVIC.
This information is for informational purposes only and should not be construed as an offer to sell or an invitation to buy any securities or products, nor as investment advice or recommendation.
The contents of this document have not been reviewed by the Monetary Authority of Singapore (“MAS”). Robeco Singapore Private Limited holds a capital markets services license for fund management issued by the MAS and is subject to certain clientele restrictions under such license.
An investment will involve a high degree of risk, and you should consider carefully whether an investment is suitable for you.
Warning/Important note: This website contains information which is only available to qualified investors as defined below. If you are not a qualified investor, please click “I Disagree” to leave the website.
By clicking on "I agree", I declare that:
1 - This website may only be accessed directly or indirectly by the following persons in Singapore:
1) “institutional investor” under section 304 of the Securities and Futures Act (Cap.289)(“SFA”), which means:
(i) the Government; (ii) a statutory board as may be prescribed by regulations made under section 341 of the SFA; (iii) an entity that is wholly and beneficially owned, whether directly or indirectly, by a central government of a country and whose principal activity is (A) to manage its own funds; (B) to manage the funds of the central government of that country (which may include the reserves of that central government and any pension or provident fund of that country); or (C) to manage the funds (which may include the reserves of that central government and any pension or provident fund of that country) of another entity that is wholly and beneficially owned, whether directly or indirectly, by the central government of that country; (iv) any entity (A) that is wholly and beneficially owned, whether directly or indirectly, by the central government of a country; and (B) whose funds are managed by an entity mentioned in sub-paragraph (iii); (v) a central bank in a jurisdiction other than Singapore; (vi) a central government in a country other than Singapore; (vii) an agency (of a central government in a country other than Singapore) that is incorporated or established in a country other than Singapore; (viii) a multilateral agency, international organisation or supranational agency as may be prescribed by regulations made under section 341 of the SFA; (ix) a bank that is licensed under the Banking Act (Cap.19); (x) a merchant bank that is approved as a financial institution under section 28 of the Monetary Authority of Singapore Act (Cap.186); (xi) a finance company that is licensed under the Finance Companies Act (Cap.108); (xii) a company or co-operative society that is licensed under the Insurance Act (Cap.142) to carry on insurance business in Singapore; (xiii) a company licensed under the Trust Companies Act (Cap.336); (xiv) a holder of a capital markets services licence; (xv) an approved exchange; (xvi) a recognised market operator; (xvii) an approved clearing house; (xviii) a recognised clearing house; (xix) a licensed trade repository; (xx) a licensed foreign trade repository; (xxi) an approved holding company; (xxii) a Depository as defined in section 81SF of the SFA; (xxiii) an entity or a trust formed or incorporated in a jurisdiction other than Singapore, which is regulated for the carrying on of any financial activity in that jurisdiction by a public authority of that jurisdiction that exercises a function that corresponds to a regulatory function of the Authority under this Act, the Banking Act (Cap.19), the Finance Companies Act (Cap.108), the Monetary Authority of Singapore Act (Cap.186), the Insurance Act (Cap.142), the Trust Companies Act (Cap.336) or such other Act as may be prescribed by regulations made under section 341 of the SFA; (xxiv) a pension fund, or collective investment scheme, whether constituted in Singapore or elsewhere; (xxv) a person (other than an individual) who carries on the business of dealing in bonds with accredited investors or expert investors; (xxvi) the trustee of such trust as the Authority may prescribe, when acting in that capacity; or; (xxvii) such other person as the Authority may prescribe.
2) “relevant person” under section 305(1) of the SFA, which means:
(i) An accredited investor; (ii) a corporation the sole business of which is to hold investments and the entire share capital of which is owned by one or more individuals, each of whom is an accredited investor; (iii) a trustee of a trust the sole purpose of which is to hold investments and each beneficiary of which is an individual who is an accredited investor; (iv) an officer or equivalent person of the person making the offer (such person being an entity) or a spouse, parent, brother, sister, son or daughter of that officer or equivalent person; or (v) a spouse, parent, brother, sister, son or daughter of the person making the offer (such person being an individual).
3) any person who acquires the units [in a collective investment scheme] as principal if the offer is on terms that the units may only be required at a consideration of not less than $200,000 (or its equivalent in a foreign currency) for each transaction, whether such amount is to be paid for in cash or by exchange of units in a collective investment scheme, securities, securities-based derivatives contracts or other assets, and if the following condition is satisfied: (i) the offer is not accompanied by an advertisement making an offer or calling attention to the offer or intended offer; (ii) no selling or promotional expenses are paid or incurred in connection with the offer other than those incurred for administrative or professional services, or by way of commission or fee for services rendered by any of the persons specified in section 302B(1)(d)(i) to (vi) of the SFA; and (iii) no prospectus in respect of the offer has been registered by the Authority or, where a prospectus has been registered (A) the prospectus has eAccxpired pursuant to section 299 of the SFA; or (B) the person making the offer has before making the offer 1. informed the Authority by notice in writing of its intent to make the offer in reliance on the exemption under this subsection; and 2. taken reasonable steps to inform in writing the person to whom the offer is made that the offer is made in reliance on the exemption under this subsection.
4) Or otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA.
If you are not any of the types of persons described above, you are not authorized to enter this website and you should leave this website immediately.
2 Terms and Conditions
You acknowledge that you have read these Terms and Conditions (“Terms”) prior to accessing the website located at www.robeco.com/sg (“Website”) and you agree to be bound by the Terms. If you do not agree to all of the Terms, you are not an authorised user and you should not use the Website. The Website is owned by Robeco Singapore Private Limited (company registration number: UEN. 201541306Z), which is licensed by the Monetary Authority of Singapore (“MAS”) pursuant to the Securities and Futures Act (Cap.289) (“SFA”) of Singapore, and is managed by Robeco Singapore Private Limited and/or its affiliates (collectively, as “Robeco”). The Website is intended for and should be accessed by institutional investors or accredited investors (as defined under Section 4A of the SFA) of Singapore. The Website is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or which would subject the Robeco to any registration or licensing requirement within such jurisdiction. It is your responsibility to observe all applicable laws, rules and regulations of any relevant jurisdiction. The content contained in the Website is owned by Robeco and/or its information providers and is protected by applicable copyrights, trademarks, service marks, and/or other intellectual property rights. You may not copy, distribute, modify, post, frame or link the Website, including any text, graphics, video, audio, software code, user interface, design or logos. You may not distribute, modify, transmit, reuse, repost, or use the content of the Website for public or commercial use, including all text, images, audio and/or video. Robeco may terminate your access to the Website for any reason, without prior notice. Neither Robeco, nor any of its associates, nor any director, officer or employee accepts any liability whatsoever for any loss arising directly or indirectly from the access of the Website. You agree to indemnity and hold Robeco, its associates, directors, officers or employees harmless against any and all claims, losses, liability, costs and expenses arising from your use of the Website due to violation of the Terms. Robeco reserves the right to change, modify, add or remove any parts of the Terms at any time and for any reason. The Terms shall deemed to be effective immediately upon posting. The Terms shall be governed by, and shall be construed in accordance with, the law of Singapore.
The Website has not been reviewed by the MAS. Accordingly, the Website may not be accessed directly or indirectly to persons in Singapore other than (i) to an institutional investor under Section 304 of the SFA, (ii) to a relevant person pursuant to Section 305(1), or any person pursuant to Section 305(2), and in accordance with the conditions specified in Section 305, of the SFA, or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA.
Nothing in the Website constitutes tax, accounting, regulatory, legal or investment advice. The Website is for informational purposes only and should not be construed as an offer to sell or an invitation to buy any securities or products, nor as investment advice or recommendation or for the purpose of soliciting any action in relation to Robeco’s businesses, or solicitation by anyone in any jurisdiction in which such an offer or solicitation is not authorised or to any person to whom it is unlawful to make such an offer and solicitation. Any reproduction or distribution of information from the Website, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited. By accessing to the Website, you agree to the foregoing.
The funds referred to in the Website are for information only. It is not a recommendation or investment advice, nor does it mean the funds is suitable for all investors. The contents of the website is not reviewed by the MAS. Any decision to participate in the funds should be made only after reviewing the sections regarding investment considerations, conflicts of interest, risk factors and the relevant Singapore selling restrictions. You should consult your professional adviser if you are in doubt about the stringent restrictions applicable to the use of the Website, regulatory status of the funds, applicable regulatory protection, associated risks and suitability of the funds to your objectives.
Any decisions made based on the information contained in the Website are the sole responsibility of yours. Any investments made or to be made shall be with your independent analyses based on your financial situation and objectives. The investments and strategies contained in the Website may not be suitable for all investors and are not guaranteed by Robeco.
Investment involves risks and may lose value. 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. The Website may contain projections or other forward looking statements regarding future events or future financial performance of countries, markets or companies and such projection or forecast is not indicative of the future. The information contained in the Website, including any data, projections and underlying assumptions are based upon certain assumptions, management forecasts and analysis of information available on an “as is” basis and without warranties of any kind, whether express or implied, and reflects prevailing conditions and Robeco’s views as of the date published or indicated, and maybe superseded by subsequent events or for other reasons. The information contained in the Website are accordingly subject to change at any time without notice and Robeco are under no obligation to notify you of any of these changes. Robeco expressly disclaims all liability for errors and omissions in the information presented in the Website and for the use or interpretation by others of information contained in the Website.
Robeco Singapore Private Limited holds a capital markets services licence for fund management issued by the MAS and is subject to certain clientele restrictions under such licence. An investment will involve a high degree of risk, and you should consider carefully whether an investment is suitable for you.