Human led, research tested: Only our best investment ideas survive the rigor of our analysis.
When defensive equity positions become more appealing, stocks that exhibit lower-risk attributes, including low beta stocks and stocks in traditionally defensive sectors, can become expensive.
Many US pensions are engaged in a critical balancing act, as they seek to manage funded status volatility and close funding gaps on their glide path to fully hedged liabilities.
Can ESG-related considerations offer an information edge for alpha-seeking equity investors? Our research says yes. Chen He, a senior research analyst on the Active Quantitative Equity team, discusses how investors can harness the power of ESG related considerations to affirmatively boost returns while managing risk.
Join Kishore Karunakaran, Global Head of Active Quantitative Equity Portfolio Strategy, as he reviews the principles of portfolio optimization – a critical component of the AQE teams’ investment process.
We are active managers, focused on solving investment problems. Built by a team with decades of experience, the stock-selection model that informs all of our solutions contains our best investment insights — carefully scrutinized, extensively tested and grounded in a strong economic rationale.
Companies and investors are increasingly focused on the factors that influence sustainability. We, as investors, are seeking practical and effective ways to incorporate ESG (environmental, social, and governance) considerations into portfolios. Our investment intuition: that ESG could serve as a quality metric that would indicate management’s focus on long-term growth prospects and the company’s exposure to regulatory and public-relations risk.
A 10-person working group with a wide range of investment experience and expertise conducted a thorough analysis of the current data sources, external research, and academic literature on ESG to form a hypothesis: “Behaving in a sustainable way should lead to better long-term performance. Firms that rank poorly on ESG may be more prone to chronic organizational issues and may be more exposed to regulatory risk and to the prospect of public scandals. This, in turn, could adversely affect stock valuations.”
The group determined that tailoring their ESG analysis by industry would provide the greatest insight. The group consulted multiple experts to identify consistent ESG themes across industries. These insights were used to create a proprietary AQE “materiality map,” which identified the relevant ESG-related characteristics, by industry. Before testing the map, the team identified the important lenses through which to view its effectiveness. The time horizon for expected payoff was one such lens: To the extent that the map helped to predict performance, would it do so over, say, the next week? The next year? Longer? The team expected the map to help to predict outcomes over periods longer than one year.
To construct a model based on the AQE materiality map, the team sourced data from well-established, highly-respected vendors, analyzing its quality before making a final decision on data sources. The map was then applied across the different specific ESG indicators to generate ESG scores for every company in the investable universe. The team ran extensive tests using historical data to assess whether the results of the new model were consistent with their hypothesis and expectations. The team also tested the impact of incorporating ESG into our stock-selection model, which is employed by all AQE strategies.
Having demonstrated that inclusion of the ESG signal did, in fact, enhance our stock selection model, the team presented its findings to State Street Global Advisors’ Technical Committee and to its Investment Committee for rigorous evaluation and verification of research protocol. Following this intensive evaluation, the ESG signal was ready to be incorporated into the model. As a result, the team now proactively includes ESG-related information in evaluating the alpha potential of thousands of stocks globally
How does the AQE team convert their investment intuitions into an insight worthy of a place in their stock-selection model?
"Many people think equity investing is all about finding companies that offer the best returns. We’re focused on the best way to form equity portfolios to deliver the best risk-adjusted returns, in line with the investor’s specific return and risk objectives. Our experience is in applying our investment knowledge across as many companies as possible in a highly objective way."
Olivia Engel
Chief Investment Officer, Global AQE
"Quantitative approaches are relevant to investors who are interested in taking full advantage of the potential of very rich, very diverse universes of companies, such as emerging-markets (EM) small cap. Arguably some of the most attractive companies in emerging markets sit in the small-cap category. In addition, equity returns for EM small-cap firms have historically been less volatile compared with EM large-cap, because the small cap category is more diversified. A quantitative approach can give investors access to some of the smallest-cap companies in the category, expanding the universe of potential investments, which we believe improves our ability to generate risk-adjusted returns."
Gaurav Mallik
Chief Portfolio Strategist; global head of the equity-portfolio strategist team
"Markets are inherently inefficient, and we’re able to go wherever we believe we can take advantage of those inefficiencies. In our Global Defensive Equity strategy, for example, we don’t start off by limiting ourselves to a low-volatility, defensive universe, and then seek to pick the best stocks within that limited universe. In our mind, that’s not optimal. We’d rather consider investment opportunities across the entire universe so that no stone is left unturned."
Chee Ooi
Managing Director of State Street Global Advisors and a senior portfolio manager for the AQE team
"Confucius said that real knowledge is knowing the extent of one’s ignorance. 'Ignorance' is a strong word, but in our world of investing or active money management, there is an enormous amount of uncertainty where investors can be wrong a lot. For us in AQE, it’s about working to stack the odds in our favor, so that when we are wrong, we are wrong a little less often."
Kishore Karunakaran
Global Head of Portfolio Strategy, AQE
*As of 12/31/2018, 78 out of 100 strategies outperformed on a gross-of-fees basis over a five-year horizon. Strategies did not outperform for all periods. Past performance is not a guarantee of future results.
