This week I want to talk about integrating ESG factors into quant strategies. Historically ESG integration was limited to fundamental (traditional) investing strategies. However, as ESG disclosure has increased and improved, funds with quantitative strategies have begun to look at ESG data too.
In a nutshell, quant strategies use mathematical models and rules to define the weight of a given stock in a portfolio. The key for these models is to have enough data (to make it statistically significant) out of which certain correlations can be drawn and investing rules can be created. As ESG data is becoming more prevalent (and there is more historic data to work with too), it is not difficult to imagine that the same process can be done including some ESG factors of choice (i.e., quant investors can consider as many ESG factors as they want within their models as long as there is enough data in the market to feed these models). It would be expected that quant funds with ESG integration could focus on some sort of materiality map (like SASB) to incorporate different ESG factors for different industries, considering how relevant each topic is for a given industry.
The success of ESG integration into quantitative strategies will have to do with the quality of data that can be found both from corporates and from independent data providers. Currently, many investors rely on ESG rating agencies to provide scores on different topics which they then use in their models. Over time, it is likely this will not be enough to generate alpha (if everyone were using the same datasets and the datasets were relatively small still), so we foresee the integration of more detailed data at some point.
As an example of growth in this arena, last week BBVA Mexico announced the launch of a new momentum driven ESG fund (BBVAESG). This fund will be managed by the quant team at BBVA, starting with a strategy anchored around some broad international ESG ETFs and using ESG data provided by a rating agency (considering the rating agency’s methodology and ESG data selection). This fund is not thematic (i.e., it is not pushing one specific topic within the sustainability world), but maybe over time the offering will grow towards that (BBVA in Spain already has several thematic investment vehicles).
Another important related topic is whether ESG-integrated quant funds will be active with stewardship, which we have discussed in the past is an especially important process in responsible investing. Traditionally quant funds have not been that active in engaging companies in their portfolios. Since the investment decisions only factor quantitative data, these funds do not spend a lot of time meeting with management teams or research analysts (which fundamental funds do). As quant teams move towards ESG integration we believe it is unlikely they will change their behavior. This means they probably will not dedicate a lot of time and resources to stewardship, unless of course they are part of a bigger institution which also has regular fundamental strategies with ESG integration (such as BBVA in our example, that does have a plan in place to be more active with stewardship activities in Mexico going forward, across their funds).
The question remains then if sending a message through an investment alone is enough for companies to listen to the message well enough (i.e., will quant funds who incorporate ESG data be able to positively influence corporates’ behavior?). Our view is that at first companies will only listen to investors who spend time with them going over the sustainability topics that are most relevant to their investment decisions. Over time though, if many quant funds start to use ESG data in their models, then perhaps this will start to become a concern for companies too (especially if the data comes from an index provider or rating agency, when the data providers will have the power to convey the messages to the companies).
ESG investing is set to continue growing at a fast pace in coming years. This growth is likely to come through all the different investment channels we know, quant funds being one of them. With this we expect to see increased demands for data as we have mentioned in our ESG thoughts many times before.
I hope you found this interesting. As usual, if there is anything we can help you with, please reach out.
CEO, Miranda ESG
P.S. If you want to read more about Quant ESG strategies, we recommend the following:
Contacts at Miranda Partners