We recently sat down with Andy Wright from the Active Quantitative Equity (“AQE”) team to talk about the Emerging Markets Enhanced SRI (or “EM Enhanced SRI”) strategy and how it can serve investors. The following is a transcript of that interview, whichhas been edited and condensed for clarity.
The editors: Tell us about the EM Enhanced SRI strategy. How does it extend the core EM Enhanced strategy we discussed last quarter?
Andy Wright: As an Enhanced strategy, we look to add a small, incremental amount of value over and above the benchmark return on a consistent basis, with tight active-risk control. We do that by taking small, relative index bets on stocks that we like, using the same proprietary stock-selection model that we use across all of our Active Quantitative Equity strategies.
Like the Emerging Markets Enhanced (or “EM Enhanced”) strategy, our reference benchmark is MSCI Emerging Markets Standard. The difference between the standard EM Enhanced strategy and its SRI, or “socially responsible investing,” counterpart is that we actually use a screening process for those stocks that might be more sensitive to negative ESG (“environmental, social and governance”) issues.
How does your screening process work?
We use a normative or negative screen approach to exclude securities that would normally be contained within our investment universe, based on three criteria.
First, we exclude companies that are complicit in breaches or violations of international norms and conventions in areas such as labor rights, human rights, environmental degradation, bribery and corruption. Second, we screen out companies that manufacture controversial weapons, such as cluster munitions, antipersonnel weapons, land mines, and nuclear, chemical and biological weapons. Finally, we exclude companies that manufacture tobacco products.
Where do you source the information that you use to apply this screen?
We use data from Sustainalytics, a firm with a very long track record in this space, to aid us in this screening process, which is updated on a quarterly basis. We also cross-reference that Sustainalytics data against the exclusion list of the Norwegian Ministry of Finance, as an additional check. Normally the difference between the two lists is very minor, but we’ve got that second check just in case.
What kinds of investors typically seek the EM Enhanced SRI strategy? Who might benefit from it?
Typically, investors seeking to apply negative screens are restricted by law from investing in companies that fail these criteria. These kinds of legal restrictions are common in Scandinavian countries, for example. Others have their own investment policies or mandates that they must adhere to.
Two years ago we integrated an ESG alpha signal in our stock-selection model, which doesn’t prevent us from holding a badly scoring ESG company, although it can reduce our exposure. But this doesn’t go far enough for some of our clients who, through their own principles or through country regulations, either can’t or don’t want to invest in companies that lack good ESG practices.
Over the last 10 or so years, companies have increasingly approached us with their own set of SRI restrictions. These are typically very similar, if not identical, to the sorts of restrictions that we have within this strategy. So we have built these products to be in compliance with existing restrictions that companies have in place.
In terms of opportunity or benefit: Overall, we believe these less-developed markets, whether it’s emerging or small cap, could provide great opportunity for adding value for a range of investors. We would certainly encourage investors to consider emerging markets over the long run. If you’re a value investor, we believe there could be opportunity for you.
How is corporate social responsibility and good ESG practice taking shape in emerging markets?
Emerging-market companies want to be attractive to investors. They want to be seen to be doing the right things. Adhering to higher standards does tend to increase their valuation and their appeal to international investors, as firms in developed markets are becoming increasingly aware of the effect their supply chains could have on their business and reputation.
When our team undertook the integrated ESG research project 2 years ago, we actually weren’t sure how well it would work within the emerging-market investment universe. We assumed that the available data wouldn’t be good enough. However, when we actually ran our simulations, we were surprised to find that the signal actually did appear to work in emerging markets.