(Pictured: Kathryn McDonald)
AXA Investment Managers, which has a long history of research into and usage of ESG factors for investment, has now developed the integration of these factors into its ‘smart beta’ strategies.
The work, explained in a white paper distributed in Australia last week, involves the application of both negative and positive ESG screens to the smart beta portfolios.
Kathryn McDonald, director of investment strategy at AXA Rosenberg, the quantitative investment arm of the global AXA IM group, says combining the two approaches may produce higher risk-adjusted returns than the cap-weighted market index.
“Smart beta and responsible investment are both garnering greater attention from investors,” she says. “They may seem unrelated, but both approaches reflect a move by investors away from the unintentional and often uncompensated risks associated with traditional index tracking and a greater willingness by investors to make their own determinations about desired exposures, risks and expected returns.”
The AXA IM study shows that ESG smart beta can offer investors a lower total risk and higher return than index investing, along with improved diversification and strong ESG performance.
For the purposes of the study and subsequent investment strategy, AXA IM took its smart beta equity strategy as an initial vanilla portfolio. This portfolio is formed by passing the global equity universe through four filters: earnings sustainability, volatility, speculation, and distress. The process reduces exposure to sources of uncompensated risk. The portfolio is then diversified to remove the problem of a high concentration in larger companies that can be present in traditional cap-weighted indices, while avoiding the liquidity risk you can get from some alternative-weighted processes.
The interesting thing about the AXA IM process is the use of both negative and positive ESG influences with a smart beta strategy. By definition, smart beta is basically an index fund with tilts. Some managers, including AXA IM, will have some active qualitative inputs in the fund but its basic premise is still to provide a systematic low-cost way to beat cap-weight indices.
AXA IM now can both underweight or exclude stocks with a low ESG score and overweight those with a better score within the same process for the global equity universe.
McDonald, who is based in the US but has spent several years in Australia with AXA Rosenberg previously, says that any investment strategy needs to be anchored in something that’s “real”. She says: “You have to make it a legitimately holistic investment strategy.”
The aim of an ESG and smart beta strategy, which AXA IM sells as a “stable core” to big pension funds around the world, is to match or beat the cap-weighted index with only 80 per cent of the volatility and a reduced drawdown. The strategy has garnered about US$2.5 billion from investors in the past 18 months.
Craig Hurt, the Sydney-based AXA IM director, said that the firm would next be testing the approach through its emerging markets strategies and against the ACWI (all countries) index.