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Data Arabesque: how ESG investments can be driven by numbers

Data Arabesque: how ESG investments can be driven by numbers

This article first appeared in the Modern Investor magazine.

In December last year, the world reached a historic agreement. More than 190 nations pledged to limit the rise of global temperatures to less than two degrees in a deal widely believed to be crucial for creating a more sustainable world economy.

‘Something happened that has never happened before. All the big countries united. The US, India, China and Russia were all in agreement, which has never happened before,’ says Andreas Feiner, founding partner and head of environmental, social and governance (ESG) research and advisory at Anglo-German asset manager Arabesque.

Frankfurt-based Arabesque runs two ESG quant funds, which analyse hundreds of data points – the bulk of them ESG-related – to pinpoint the best financially performing and most environmentally and socially friendly companies. What is more, Feiner says ESG and the overall performance of any given company go hand in hand.

‘We believe the ESG information is more forward-looking. In other words, it tells you a bit more about the DNA of a company. Is a company managed in a good way? Are they taking too much risk? Do they consider other stakeholders in their decision-making process?’

Arabesque considers the answers to hundreds of these kinds of questions in its investment analysis. By quantifying qualitative information, it is able to go through each company with a fine-tooth comb and repeat the process each time new data becomes available.

The art of science

The company, developed over two years at Barclays before a full management buyout in 2013, runs two funds. These are the longonly smart beta Arabesque Prime fund and the balanced global equity Arabesque Systematic fund.

While Arabesque’s Prime strategy is always 100% invested and is designed for people who can manage the risk themselves, the Systematic strategy can reduce risk and hold more cash on a daily basis if the environment is bearish.

‘We have 77,000 stocks in our database – everything that is tradeable. From this, we create our investment universe, which covers about 1,200 stocks. Of that, our smart beta Arabesque Prime fund selects 300 stocks. The company’s alpha fund, Systematic, selects up to 100 stocks out of the 1,200, with 1% weight per stock. Both funds use cash or equity, nothing else.’

The fund manager’s data-heavy approach is signalled in its name. The word ‘arabesque’ reflects the firm’s quantitative approach, in which it plots hundreds of data points – a process that results in an intricate virtual arabesque of all the relevant information.

The algorithms analyse 1,600 technical indicators per stock to assess its performance and whether or not the equity should be included in the portfolio. ‘We don’t predict. We take what the system tells us,’ Feiner says.

Even so, there is some scope for human judgment. Arabesque has an investment committee which – in unusual circumstances – can overrule the system, which is unable to see such things as the Russian crisis.

Feiner, though, says that this kinds of events are rare. He adds that the systematic, algorithm-based approach to ESG has so far been successful.

‘Since we went live in August 2014, we outperformed the market. This is in line with our back tests. It is even better than we anticipated, because the quality of ESG data is improving by the day.’

Over the past year, the Arabesque Systematic fund, managed by Hans-Robert Arndt, returned 3% and ranked among the top 12% of the global equities sector, Citywire data shows. The Prime fund, run by Philipp Müller, lost 1.2% over the same time. This is better than the average of a 3.1% loss for all funds in the global equities sector.

Obsessed with data

If the bulk of the process is data-driven, what does the work of a manager of an Arabesque ESG quant fund entail? Feiner says it's mostly assessing the quality of the data. Fund managers must decide whether there is better data available. They must also help devise programming routines that can fix glitches in the data.

‘ESG works best in Europe’s developed markets because the quality of the data is the best. Second comes global developed markets and the US. After this comes Asia-Pacific and emerging markets. It works better with large caps than small caps simply because the latter provide less data.’

Given that the success of COP21 is likely to lead more firms to publish additional data on their ESG criteria, Arabesque will be poised to use that public information to its advantage.

‘We believe that ESG information is 10% the quality of what it will be in the future. It will improve over time, especially in Europe, owing to the European Union’s push towards better ESG practices.’

Generation S

Arabesque wants to appeal to people who belong to the so-called Generation S – as the company's vice Chairman Georg Kell called it in his Huffington Post op-ed, Together We Are Generation S, published to coincide with the COP21 agreement.

Kell, who is also the founder of the UN Global Compact – a UN initiative to encourage businesses to adopt ESG criteria – says that Generation S describes people from all walks of life who want to align their financial investments with personal values.

‘Evidence is growing of this societal shift towards sustainable finance. A report by the Judge Business School at University of Cambridge, in collaboration with BNY Mellon, showed that millennials would allocate 42% of their investment portfolio to “social finance”, given the choice,’ Kell wrote in his Huffington Post article.

Feiner says that Generation S is inclusive and that it is a description of people’s mind-sets, rather than anything else. ‘It is not about generation in terms of age. Everybody can be Generation S. It's about people who care about the impact of their investments and consuming decisions.’


Investor's comment

Rainer Königs
Deutsche Bundesstiftung Umwekt (German Federal Environmental Foundation)

For some time now, evidence has mounted showing that companies with sustainable business models deliver improved financial returns, and that investors taking sustainability into account can deliver improved investment performance. With material environmental, social and governance (ESG) data becoming ever more accessible, more investors are actively searching for strategies that can capitalise on this information.

ESG quant is a new style that is particularly interesting.

We believe it breaks new ground in sustainable investing. Quantitative models have traditionally been based exclusively on financial information. Until only recently, ESG information has been largely used for screening purposes in qualitative, ethical investing strategies. Where ESG quant differs is in how it merges the two. Materially relevant sustainable issues are treated as valuable intelligence which, when integrated with fundamental and technical information, can provide the investor with a more holistic understanding of a company’s potential.

As the quality, frequency and consistency of materially relevant sustainability data continues to improve, we see real potential in ESG quant-based products to deliver enhanced, risk-adjusted returns. Such funds can now demonstrate that this strategy outperforms both qualitative ESG and conventional equity funds. As an institution with a proud heritage of sustainable investment, we are paying close attention.

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