December 11, 2017 B A R R O N ’ S 23

to identify companies that demonstrate continued growthand increasing earnings, strong balance sheets and cashflow, and are incorporating the behavioral patterns of sell-side research analysts. Our strategy uses artificial intelli-gence. In the U.S., we have a Securities and ExchangeCommission-registered fund called Arabesque System-atic USA (ticker: ASUIX) and separately managed ac-counts. We also have Arabesque S-Ray, which collectsdata on sustainability.

How did you approach starting your firm?

I’ve been in banking for 20 years. In 2010, I began tothink finance and business would be significantly dis-rupted, partly because of the zero interest-rate environ-ment. Of the five asset classes—equities, rates, real estate,commodities, foreign exchange—60% is in rates andcredit, and we’ve had falling rates for over 25 years. InGermany, the unprecedented negative interest rates willaffect pension savings, insurance policies, everything. Eq-uities are the new fixed income.

Really? Stocks are the new bonds?

Real estate is regional and local, commodities are a func-tion of geopolitics, foreign exchange is dictated by thecentral banks. The only asset class that’s liquid, transpar-ent, and can be used globally for asset allocation is equity.That’s why we see all-time highs around the globe andwill probably see them for quite a while—with some cor-rections. If you don’t want to sell bonds, you are sittingon a pretty nasty position once rates start to rise.

How does this fit in with sustainability?

Investing in fixed income is risk-transfer, in equities it’srisk-sharing. Once invested in equities, you start thinkingdifferently about the company, which paves the way tosustainable investing.

And that’s one of the big “disruptions” the financial world is experiencing today. What else?

Another disruptor is something I call the “lifestyle feelingof finance.” Finance is opaque; the language is difficult tounderstand. That will change with millennials, the peoplewhom Georg Kell calls Generation S, who want sustain-ability, don’t want to contribute to climate change, and soforth. Another is the availability of Big Data and the abil-ity to put it through machine learning and artificial intelli-gence. Pushed by the regulatory environment, companiesnow have to provide more information. You know, 90% ofthe world’s data is only a couple of years old.

So the zero-rate environment, equities being the newfixed income, Big Data, and the lifestyle of finance will allchange how finance will work. In 10 years, the biggestbanks will be called Google, Apple, and Facebook.

What do you think of the stock market today?

My gut feeling is it will go higher, we’ll have a sharp cor-rection, and then it will continue up. Nobody knows wherethe market is going. I intend to be free of that. I want tolet the system choose what makes sense. When you buy a

car, you go on the website, pick your color and the leatherand the engine. You don’t look at how the valves open andclose. I want people to see what their money is doing andenjoy it, rather than seeing whether the P/E is too high ortoo low—which has nothing to do with investing, really.

What’s holding sustainable investing back?

In the past, impact investing gave up returns for somegreater good. We are doing our best to make sustainabilitycompetitive. Here’s an analogy: We had years of ugly elec-tric cars that didn’t go fast and weren’t cool. Then Tesla(TSLA) came along and made electric cars go like a rocketand made them cool. Tesla was the first electric car builtby people who love cars. Arabesque is a firm built by fi-nance people who love sustainability and want to use ourexpertise to generate performance and make alpha. Sus-tainability is still a luxury good. Our mission is to take itmainstream. Because we use machine learning, I can dothat in a way that is performance- and cost-efficient.

Why did you build S-Ray?

When we decided to build Arabesque, we needed to knowhow sustainable companies are, because we wanted to bea sustainable asset manager. We thought we would takethe service available from current data providers, but weweren’t too happy: The data were biased, delayed, incon-sistent. The big providers had a correlation of 0.2—it wasall over the place. So we built a vacuum cleaner thatsucked in everything we could find, including providerslike Transparency International, which supplies data onglobal corruption, or regional specialists like Thaipat In-stitute in Thailand and GoldenBee CSR in China. We builta machine-learning algorithm to cross-reference all thisinformation and come up with a score. That’s S-Ray. Peo-ple started to ask us about it, so we made it available. It’sbecome a big success. We cover 640 Japanese companies,and a Japan pension fund asked us to increase it to 2,000.Now, State Street, Deutsche Bank, and S&P Dow JonesIndices are using it.

Other data providers base their data on human analyti-cal work. Sustainalytics and MSCI built the pot we’re usingnow. I have the utmost respect for them; they are makingthe transition. I don’t have a single ESG researcher, justdata scientists and programmers. We are like Airbnb,which doesn’t have a single hotel room, but is still the big-gest provider of hotel accommodations in the world. Ma-chine learning thrives on Big Data. We are the only service

that refreshes daily; has 10 years of history; and becauseit’s quantifiable, I can see what contributes to alpha. Wecan switch every filter on and off and calculate the impact.

How do you define sustainability?

S-Ray scores companies based on their compliance withthe U.N. Global Compact principles on human rights, laborrights, the environment, and anticorruption. It then scorescompanies on [more specific] ESG factors. Lastly, it filtersinformation based on specific client preferences. We ex-clude companies that violate UNGC principles and thosewith ESG rankings in the bottom 25% of their industry, al-though we readmit them if they show an improvementover two quarters. We also exclude companies significantlyinvolved in producing weapons, tobacco, or gambling.

How do you narrow ESG down to what’s material to stock price performance?

Companies that are better in terms of sustainability gen-erally have better risk-adjusted returns. The most impor-tant component, the one that helps us generate alpha, isgovernance. S-Ray prevented us from investing in compa-nies such as Toshiba (6502.Japan), Volkswagen (VL-KAY), and Kobe Steel (5406.Japan), which had low rat-ings primarily because of governance issues. I believeESG is the fourth dimension of investing, giving investorsmore information about the DNA of a company—for ex-ample, how risk-embracing or risk-averse management is.We are at the start of the journey; ESG data is only about10% of what it will become in the next few years.

What are the limitations?

Data quality is better in developed countries and forlarger companies. We also need enough companies for agood statistical sample. Give me two companies to choosefrom, and I might get it wrong. Give me 100 companies,and I will get it right more often than I get it wrong.

Tell us about the mutual fund.

Our flagship European fund, Arabesque Systematic, hasused machine learning and has a three-year track recordthat outperformed its benchmark by two percentagepoints every year, with a quarter less volatility. It investsin 100 stocks, and the computer allocates among them. TheArabesque Systematic USA fund is similar, with a systemthat assesses market risk daily and, in times of crisis, willreduce equity exposure and increase cash. At the moment,the fund is mid-cap growth, but that could change: It looksfor companies with positive price momentum.

Next year, we’re bringing out in the U.S. a pure artifi-cial intelligence product that uses 32,000 investment mod-els to generate its own investment process. If we’re cook-ing, S-Ray defines the ingredients and what’s allowed tobe part of your meal. Our Systematic strategy is a recipewe’ve developed over the years with a good track record.But the AI piece is literally building the kitchen, designingits own recipes. That is the future of asset management.

Thanks, Omar.

“Tesla was the first electric car built by people who love cars. Arabesque is a firm built by finance people who love sustainability.” —Omar Selim

26 B A R R O N ’ S December 11, 2017

selloff—a 15% decline in February 2016—it seems a distantmemory. On Friday, the S&P 500 index ended at 2651.50.

Given synchronized global growth and rising corporateprofits, 2018 could be another good year for stocks, not-withstanding the bull’s advancing age. The S&P 500 couldgain about 7%, mirroring similar gains in corporate profits,according to the consensus forecast of 10 investmentstrategists at major U.S. investment banks and money-management firms surveyed by Barron’s each December.The group’s predictions range from 2675 to 3100, with amean estimate of about 2840.

The outlook isn’t entirely rosy: Interest rates are headedhigher, stocks are expensive, and a tax overhaul could stillstall or fail. But so long as corporate earnings keep climb-ing and the Federal Reserve raises rates in a measured

way, the strategists see more room for gains.“Rational exuberance is the stock market’s theme for

2018,” says David Kostin, Goldman Sachs’ chief U.S. equitystrategist, harking back to the well-known but ill-timed “irra-tional exuberance” comment made by Federal ReserveChairman Alan Greenspan in late 1996 about the rollickingbull market of that era. The market doubled after Green-span’s veiled critique, only to lose about 50% from its top inthe 2000 dot-com bust.

A rapidly expanding price/earnings ratio, or marketmultiple, drove the 1990s bull, but “it’s the earnings thistime,” says Kostin, whose view is shared by his peers.

Our prognosticators expect S&P 500 earnings to climbto $145 in 2018 from an expected $131.45 this year. Most

estimates assume that global growth will spur earningsgains, with an additional boost coming from U.S. tax cuts.Depending on the final tax bill, they figure that lower cor-porate taxes could be worth 5% to 10% of earningsgrowth, or anywhere from $7 to $14 a share. But in theunlikely event that no tax cuts are passed, the marketcould drop sharply.

Industry analysts forecast S&P earnings of $146.20 fornext year, not including tax cuts. If analysts revise theirestimates higher in coming months to account for the posi-tive impact of lower taxes, stocks could get a furtherboost.

Market strategists are divided on whether stocks’ P/Eratios will expand. The S&P 500 trades for 18 times thenext four quarters’ expected earnings, up from 17.1 times

S&P 500 2018 TARGET

S&P 500 EPS 2018**

U.S. GDP GROWTH 2018

10-YR TREASURY YIELD 2018

FAVORITE SECTORS

AVOID

WALL STREET FORECASTS: 2018

JohnPraveenPGIM

2925

$139.30

2.80%

3.00%

Financials, Industrials,Info Tech

Utilities,Consumer Staples

RobSharpsT. ROWE PRICE

2775

$150.00

2.50%

2.75%

Financials, Health Care

Energy

SavitaSubramanianBofA MERRILL LYNCH

2800

$139.00

2.40%

2.90%

Financials, Info Tech,Materials

Consumer Discretionary,Utilities, Real Estate

MikeWilsonMORGAN STANLEY

2750

$145.00

2.10%

1.95%

Industrials, Energy,Info Tech, Financials

Cons. Staples, Real Estate,Telecoms, Cons. Discretionary

Investment strategistsexpect U.S. stocks tohead higher next year,propelled by economicgrowth and earningsgains. They’re bullish onfinancials and tech, butcautious on consumerstaples and utilities.Their mean S&P 500forecast: 2840.

StephenAuthFEDERATED

3000

$150.00

2.90%

2.75%

Financials, Energy,Health Care

Consumer Staples,Utilities

JeffreyKnightCOLUMBIA THREADNEEDLE

2750

$144.00

2.75%

3.10%

Materials, Energy,

Health Care, Utilities

DavidKostinGOLDMAN SACHS

2850

$150.00

2.50%

3.00%

Financials, Industrials

Consumer Staples, Utilities,Real Estate, Cons.Discretionary

DubravkoLakos-BujasJPMORGAN

2800*

N/A

2.30%

2.70%

Financials, Industrials,Energy, Materials

Info Tech, Cons. Staples,Utilities, Real Estate

TobiasLevkovichCITI RESEARCH

2675

$141.00

2.70%

2.75%

Financials, Energy,Consumer Discretionery

Health Care, Cons. Staples,Telecom, Info Tech, Utilities

S&P 500 2018 TARGET

S&P 500 EPS 2018**

U.S. GDP GROWTH 2018

10-YR TREASURY YIELD 2018

FAVORITE SECTORS

AVOID

EdYardeniYARDENI RESEARCH

3100

$147.00

3.00%

2.75%

Industrials, Financials, InfoTech, Consumer Discretionary

Telecoms, Utilities,Consumer Staples

*2018 midyear forecast; **Some 2018 earnings estimates don’t reflect potential tax cuts; Note: Some GDP and yield estimates are from the firm’s economists and bond strategists N/A=Not Available

Ais

te S

tanc

ikai

te f

or B

arro

n’s

CYA

NM

AG

ENTA

YEL

LOW

BLA

CK

Com

posi

te

Com

positeC

M Y

KP

2BW

345000-0-W02300-1--------X

AC

L,CN

,CX

,DL,D

M,D

X,E

E,E

U,F

L,HO

,KC

,MW

,NC

,NE

,NY

,PH

,PN

,RM

,SA

,SC

,SL,S

W,T

U,W

B,W

EB

G,B

M,B

P,C

C,C

H,C

K,C

P,C

T,D

N,D

R,F

W,H

L,LA,LD

,LG,LK

,MI,M

L,PI,P

V,T

D,W

O

P2B

W34

5000

-0-W

0230

0-1-

----

---X

A