Fund flies SRI flag
Many long-term investors view sustainable investments as a means of achieving profitable returns and at the same time as a way of stimulating companies to act in a sustainable and responsible way to develop economic growth.
We focus on the portfolio strategy and the portfolio construction of the Loyalis Global Sustainability Fund (LGSF), to which the ABP pension fund decided to transfer its SRI investments at the end of 2002. One of the main reasons for the transfer is the opportunity LGSF offers to other pension funds to participate and thereby strengthen the network of pension funds working in the SRI area.
Loyalis Financial Services, a 100% subsidiary of ABP Pension Fund, offers this opportunity.
The LGSF’s philosophy generates a well-diversified global portfolio and sustainability screening based on a ‘best-in class’ approach. This philosophy is an answer to the question as to how to implement an SRI policy whilst ensuring that it remains in the best interest of our clients and leads to the highest possible return within strict risk control parameters.
Recent research publications indicate that portfolios based on sustainability screening cannot only be managed without a cost (negative excess return) but also offer the possibility of delivering positive excess returns. For instance, see the survey ‘International evidence on ethical mutual fund performance and investment style’ conducted by Rob Bauer, head of research at ABP Investments, together with Koedijk and Otten for which they were awarded the prestigious Moskowitz Prize for Socially Responsible Investing.
Achieving positive excess returns is exactly what the LGSF aims to achieve; the investment objective of the LGSF is to outperform the MSCI World Index (total rate of return) by 100 bp on a 3-5 year rolling basis within strict risk parameters. We have chosen to apply a mainstream MSCI benchmark, because it clearly positions the SRI-portfolio as part of the risk/return profile of the total investment portfolio and it perfectly shows the excess return of the SRI-portfolio in comparison to the overall benchmark.
When constructing a portfolio, it is important that the induced tracking error (TE) and resulting alpha actually are attributable to the predetermined active factors. In the case of the LGSF, the strategy is based on two alpha-sources. Predominantly, alpha should come from stock selection based on the sustainability-factor. Additionally, a fundamental top down investment process (with an in-house proven track record), should further enhance alpha.
Our stock selection is based on Innovest ratings for sustainability. Innovest is an internationally recognised investment research and advisory firm in which ABP has an interest. It specialises in analysing companies’ performance on environmental, social, and strategic governance issues, with a particular focus on their impact on competitiveness, profitability, and share price performance. The firm’s proprietary ratings are a key element of the portfolio construction process of the LGSF.
Innovest provides two types of data input: sector ratings and company ratings. Sectors are assessed based on their degree of impact on environmental and social factors. At the company level, companies are rated on a scale of AAA (best) to CCC (worst) according to their performance on environmental, social and strategic governance issues. Company ratings are assigned on a best-in-class basis, thus companies are rated on their sustainability performance relative to sector peers. Companies are assessed against at least 120 different criteria, and the company ratings are continually monitored.
The LGSF invests in companies, listed on stock exchanges worldwide, whose strong financial potential is enhanced by a substantial emphasis on sustainable management practices. For the LGSF we identify all stocks from the MSCI world index (our benchmark) rated as AAA to BBB. In practice 400–450 names remain, equal to roughly 50% of the benchmark market cap. All MSCI-sectors will be represented in the final selection, because Innovest determines ratings using a ‘best-in-class-approach’. As an additional check, we use an in-house developed screening method for detecting stocks with unacceptable financial risks, which can result in additional deletions from the selection. We use an optimiser to create an efficient portfolio with the final selection of stocks, taking into account our top-down fundamental views.
To test for the value added of the sustainability factor, we back-tested this approach (without fundamental bets) and found an information ratio (IR) of 0.497 (based on monthly rebalancing, before costs), indicating that stock selection based on sustainability can add alpha, if we implement as described.
We are confident that the portfolio construction as described above ensures to a large extent that our alpha will be attributable to stock selection on the basis of sustainability and our fundamental top down views. Given the positive back test on sustainability and our successful fundamental overlay, we also feel confident about our current portfolio strategy.
More than just investing
LGSF, we believe, satisfies both the sustainability and investment objectives institutional investors seek. From a sustainability perspective the fund acts as a way of stimulating companies to act in a sustainable way to develop economic growth. It also provides institutional investors with a tool to implement a sustainable investment strategy as part of their long-term investment policy.
On the investment side it offers a way of achieving profitable returns with diversification in investment style. It also provides a well-diversified global equity portfolio.
Above and beyond that, the fund offers institutional investors the chance to participate in a network of long-term investors who all have a vested interest in solid and sustainable business practices in the long run.
Genio van der Schaft is managing director at Loyalis Financial Services and Ivan Moen is portfolio manager at the Loyalis Global Sustainability Fund, both based in Heerlen in the Netherlands