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SMART SRI EQUITY INVESTING: COMBINING ESG CRITERIA WITH FACTOR INVESTING Koen Van de Maele, CFA & Maxime Moro WHITE PAPER

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Page 1: SMART SRI EQUITY INVESTING: COMBINING ESG CRITERIA … · 2019. 5. 9. · Smart SRI Equity investing: Combining ESG criteria with factor investing OVERVIEW OF CANDRIAM’S SRI APPROACH

SMART SRI EQUITY INVESTING: COMBINING ESG CRITERIA WITH FACTOR INVESTINGKoen Van de Maele, CFA & Maxime Moro

WHITE PAPER

Page 2: SMART SRI EQUITY INVESTING: COMBINING ESG CRITERIA … · 2019. 5. 9. · Smart SRI Equity investing: Combining ESG criteria with factor investing OVERVIEW OF CANDRIAM’S SRI APPROACH

June 2017 2

Smart SRI Equity investing: Combining ESG criteria with factor investing

TABLE OF CONTENTS

1. INTRODUCTION 2

2. SRI SCREENING 3

3. PORTFOLIO CONSTRUCTION 6

3.1. Initial weighting based on fundamental criteria 6

3.2. Increaseddiversificationthroughanincreasedweightingofthelongtailofsmallercompanies 7

3.3. Factor biases: Value, Quality and Low Volatility 8

4. PUTTING IT ALL TOGETHER 11

4.1. Historical Performances 11

5. CONCLUSION 14

6. REFERENCES 15

1. INTRODUCTIONBoth Sustainable and Responsible Investing (SRI) and Factor Investing are increasingly gaining the investor’s attention. It is widelyrecognizedthattheseinvestmenttechniquescansubstantiallyaddvalue.SustainableandResponsibleInvestingintegrateslonger-termbusinessopportunitiesandrisks,which,hence,arerelevantfactorstointegrateintotheportfolio.Byexploitingsomebehaviouralbiasesorstructuralmarketsegmentations,FactorInvestingleadstosuperiorrisk-adjustedreturns.Thispaperpro-posesanequityportfolioconstructionmethodologythatcombinesbothelements.

Firstly,Candriam’sSRImethodologywillbedescribedanditseffectontheportfolioshown.Secondly,the3-stepportfoliocon-structionmethodologywillbeoutlined:afundamentalweightingoftheeligiblestocks,involvingreadjustmentofthelongtailofsmallstocksandtheimplementationofthefactortilts.Theeffectandaddedvalueofeachofthesestepswillbeillustrated.Third-ly,thedifferentstepsarecombinedinoneportfoliothatwillturnouttohavesuperiorrisk-adjustedreturns.Thelastsectionconcludesandadditionallyillustratestheout-of-sampleperformanceofthisindexmethodology.

Acrossthisdocument,theproposedindexmethodologywillalwaysbeappliedtofourdifferentgeographicalregionstotestitsrobustnessandavoidanyover-fitting.Thefourregionsare:Europe,EMU,JapanandtheUS.AllsimulationsstartinFebruary2006andendinDecember2015.Theout-of-samplereturncharacteristicssincethestartof2016areshowninthelastsection.

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June 2017 3

Smart SRI Equity investing: Combining ESG criteria with factor investing

OVERVIEWOFCANDRIAM’SSRIAPPROACH

2. SRI SCREENINGCandriam’sSRImethodologyrankscompaniespersectorandpergeographicalregion(Europe,AsiaPacificandNorthAmerica)basedonMicroandMacroanalyses.TheMicroAnalysisprocedureassessesthecompany’smanagementofcustomers,employees,theenvironment,suppliers,investorsandthebroadsociety.TheMacroAnalysisproceduremeasuresthecompany’sexposuretoglobalsustainabilitytrendssuchasclimatechange,resourcedepletion,developingeconomies,demographicevolutions,health&wellnessandinterconnectivity.TheresultsoftheMacroandMicroanalysesarecombinedandthecompaniesrankedpersector.TheeligiblecompaniesarecomposedoftheTop70%ofstockswithintheirsectorintherespectiveuniverse.Additionally,anorms-basedanalysisbasedonanassessmentofhowcompaniescomplywiththetenprinciplesoftheUnitedNationsGlobalCompactandaverificationofcontroversialactivitiessuchasarmaments,gambling,tobaccoandnuclearactivitywilleliminateothercompanies.

MICRO ANALYSISStakeholdersmanagement

• Customers•Employees• Environment•Suppliers• Investors• Society

MACRO ANALYSISExposuretoGlobalSustainability Trends

• Climate Change•RessourceDepletion•DeveloppingEconomies•DemographicEvolutions• Health & Wellness• Interconnectivity

SECTOR STUDY

SRI UNIVERSE

COMPANY ANALYSIS

CONTIN

IOU

S D

IALO

GUEENG

AG

EMENT

NORM-BASED ANALYSISCONTROVERSIAL ACTIVITIES CHECK

Page 4: SMART SRI EQUITY INVESTING: COMBINING ESG CRITERIA … · 2019. 5. 9. · Smart SRI Equity investing: Combining ESG criteria with factor investing OVERVIEW OF CANDRIAM’S SRI APPROACH

June 2017 4

Smart SRI Equity investing: Combining ESG criteria with factor investing

FIGURE 1: Candriam SRI Universe – Cumulative Return

Sources: Candriam, Factset

0

21.81.61.41.2

10.8

0.40.6

0.2

EMU

■■ SRI_Included ■■ SRI_Excluded ■■ MSCI_EW

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

0

3

2.5

2

1.5

1

0.5

USA

■■ SRI_Included.3 ■■ SRI_Excluded.3 ■■ MSCI_EW.3

2006 2007 2008 2009 2010 2011 2012 2013 2014 20150

1.81.61.41.2

10.8

0.40.6

0.2

JAPAN

■■ SRI_Included.2 ■■ SRI_Excluded.2 ■■ MSCI_EW.2

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

0

2.5

2

1.5

1

0.5

EUROPE

■■ SRI_Included.1 ■■ SRI_Excluded.1 ■■ MSCI_EW.1

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

ToassessthefinancialimpactoftheSRIscreening,SRIuniversereturnsarecomparedwithnon-SRIuniversereturnsandwiththebroadstockuniverse(allportfoliosareequallyweightedandrebalancedonamonthlybasis).ThegraphsbelowillustratethattheaveragereturnoftheSRIcompaniesexceedsthatofthebroadmarketandofthenon-SRIcompanies,showing,too,thattheSharpeRatioimproveswhenSRIcompaniesaloneareinvestedin.

ThisSRIuniverseisthestartingpointfortheportfolioconstructionalgorithm,whichdeterminestheweightingsofthesestocks.Non-SRIcompaniesarenoteligiblefor theportfolio.More informationonCandriam’sSRImethodologycanbefoundonwww.candriam.com

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June 2017 5

Smart SRI Equity investing: Combining ESG criteria with factor investing

TABLE 1: Return characteristics SRI universe: EMU,Europe,Japan,USA

EMU SRI_ Included

SRI_ Excluded

MSCI_ EW

Europe SRI_ Included

SRI_ Excluded

MSCI_ EW

Annualized Return 5.14 3.91 4.76 Annualized Return 6.15 4.46 5.62

Annualized Std Dev 16.82 16.92 16.86 Annualized Std Dev 15.81 16.71 16.07

AnnualizedSharpe(Rf=0%)

30.56 23.11 28.24 AnnualizedSharpe(Rf=0%)

38.9 26.72 34.96

MaximumDrawdown 52.01 54.23 53.39 MaximumDrawdown 51.95 55.1 53.42

Japan SRI_ Included

SRI_ Excluded

MSCI_ EW

USA SRI_ Included

SRI_ Excluded

MSCI_ EW

Annualized Return 5.38 3.61 4.92 Annualized Return 9.33 8.63 9.34

Annualized Std Dev 13.83 13.83 13.86 Annualized Std Dev 15 14.61 14.98

AnnualizedSharpe(Rf=0%)

38.9 26.09 35.53 AnnualizedSharpe(Rf=0%)

62.21 59.1 62.34

MaximumDrawdown 34.33 34.7 35.62 MaximumDrawdown 48.39 46.74 48.38

Sources: Candriam, Factset

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Smart SRI Equity investing: Combining ESG criteria with factor investing

TABLE 2: Illustration of fundamental weighting

INCOME STATEMENT

BALANCE SHEET

CASH FLOW STATEMENT

CompanyName

Average

Sales

Average Net

Earnings

Last Book Value

Average

OCF

Sales

Weighting

Net Earnings Weighting

Book Value

Weighting

OCF

Weighting

Fundamental

Weighting

Royal Dutch Shell Plc Class B 319,611.30 13,645.50 167,725.80 29,699.30 5.44% 3.93% 4.22% 3.67% 4.31%

HSBCHoldingsplc 74,877.60 11,543.40 153,191.10 17,787.00 1.27% 3.32% 3.86% 2.20% 2.66%

Banco Santander S.A. 78,541.40 4,729.80 88,610.00 39,062.80 1.34% 1.36% 2.23% 4.82% 2.44%

Total SA 162,028.40 7,839.40 88,199.30 20,152.70 2.76% 2.26% 2.22% 2.49% 2.43%

Allianz SE 98,271.00 5,309.40 67,744.00 21,642.40 1.67% 1.53% 1.71% 2.67% 1.89%

BNP Paribas SA Class A 93,898.20 4,584.20 89,540.00 15,963.80 1.60% 1.32% 2.25% 1.97% 1.79%

Nestle S.A. 75,562.20 9,006.50 51,746.50 11,737.50 1.29% 2.59% 1.30% 1.45% 1.66%

AXA SA 106,006.00 4,340.40 67,952.00 11,586.20 1.80% 1.25% 1.71% 1.43% 1.55%

VodafoneGroupPlc 52,734.30 4,719.00 77,476.70 14,327.30 0.90% 1.36% 1.95% 1.77% 1.49%

Novartis AG 42,792.60 7,045.10 64,503.00 10,485.70 0.73% 2.03% 1.62% 1.29% 1.42%

TOTAL OF UNIVERSE 5,879,931.20 347,306.90 3,971,125.60 810,236.70

Sources: Candriam, Factset

3. PORTFOLIO CONSTRUCTIONContrarytomostindices,individualstockweightingsarenotdeterminedbymarketcapitalization.Extensiveliteraturehasdemon-stratedthatmarket-capitalizationindicesarelessdiversifiedthanoftenassumedandskewedtowardsthemostexpensivestocks.Hencemarket-capitalizationportfolioconstructionmethodsarenotthemostoptimalmethodologies(asalsoindicatedinHaugen&Baker,1991).

Asanalternative,inthisdocumentindividualstockweightingsaredeterminedviaa3-stepprocess.First,afundamentalweightingforthecompanyisdeterminedthatreflectstheimportanceofthecompanybasedoncommoneconomicmeasures.Secondly,diversificationisfurtherincreasedbyaugmentingtheweightingofthelongtailofsmallercompanies.Lastly,stockweightingsaretiltedtoreflectValue,QualityandLowVolatilityfactors.Below,weoutlineeachofthesesteps,illustratingtheirimpactonrisksand returns.

3.1. Initial weighting based on fundamental criteria

Acompany’simportancewithintheeconomycanbemeasuredinmanydifferentways.Candriambelievesthatelementsofthebalancesheet,incomestatementandcashflowstatementshouldbeintegratedtohaveameaningfulassessmentofthesizeofacompany.Hencetheequallyweightedaverageofthesizeofthebalancesheet,thetotalrevenue,totalincomeandcashflowgenerationaretakentodetermineafairinitialweightingforallcompanies.Thetablebelowillustratesthismechanism.

Nestle Sales Weighting =Nestle Sales

=(75 562.20)

=1.29%Total Sales (5 879 931.2)

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June 2017 7

Smart SRI Equity investing: Combining ESG criteria with factor investing

FIGURE 2: IndexConcentration

Sources: Candriam, Factset

0

1.2

1

0.8

0.6

0.4

0.2

EMU

■■ Equal Weighted ■■ Fundamental50 ■■ Fundamental ■■ Market Cap

0.00

0.07

0.14

0.21

0.28

0.35

0.42

0.49

0.56

0.63

0.70

0.77

0.84

0.91

0.98

0

1.2

1

0.8

0.6

0.4

0.2

EUROPE

■■ Equal Weighted ■■ Fundamental50 ■■ Fundamental ■■ Market Cap

0.00

0.06

0.12

0.18

0.23

0.29

0.35

0.41

0.47

0.53

0.58

0.64

0.70

0.76

0.82

0.88

0.93

0.99

0

1.2

1

0.8

0.6

0.4

0.2

JAPAN

■■ Equal Weighted ■■ Fundamental50 ■■ Fundamental ■■ Market Cap

0.00

0.06

0.13

0.19

0.26

0.32

0.38

0.45

0.51

0.57

0.64

0.70

0.77

0.83

0.89

0.96

0

1.2

1

0.8

0.6

0.4

0.2

USA

■■ Equal Weighted ■■ Fundamental50 ■■ Fundamental ■■ Market Cap

0.00

0.06

0.12

0.18

0.24

0.30

0.36

0.42

0.47

0.53

0.59

0.65

0.71

0.77

0.89

0.83

0.95

3.2.Increaseddiversificationthroughanincreasedweightingofthelongtailofsmallercompanies

Theaforementionedmeasuresstillresultinafairlyconcentratedportfolio,albeitonelessconcentratedthanaportfoliobasedpurelyonmarket-capitalization.Inordertofurtherdiversify,weightingsofthesmallestcompaniesareincreasedsothat50%oftheportfolioisallocatedtoacertainminimumweighting.AnadditionalbenefitofthistransformationisthattheSRIcharacteristicsofevenverysmallcompaniescanhaveameaningfulimpactontheperformanceofthetotalportfolio.

IllustratedbelowistheLorenzcurveforamarket-capitalizationportfolioagainstafundamentalportfolioandadiversifiedfundamentalportfolio(and,forillustrativepurposes,anequalweightingportfolio).ALorenzcurveplotsthecumulatedweightings(%)inaccordancewiththepercentileofthenumberofstocksthatareindexedinnon-decreasingorder.Theincreasedlevelofdiversificationofthissecondstepcanbeclearlyobservedintheportfolioconstructionprocess.

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Smart SRI Equity investing: Combining ESG criteria with factor investing

TABLE 3:AverageEffectiveNumberofstocks (from01/2006to12/2015)

EMU Europe Japan USA

MarketCapWeighted–SRIUniverse 58 80 58 80

FundamentalWeightedwith50%MinWi–SRIUniverse 106 164 85 137

MarketCapWeighted–MSCIIndices 85 129 96 144

Sources: Candriam, Factset, MSCI

TABLE 5: List of indicators to measure factors

Value Quality Low Volatility

Earnings Yield EBITDAToNetDebt(exFin) 6/12/24-monthVolatilityofweeklyreturns

OperatingCashFlowYield OCFTo(Capex+Dividend)(exFin)

SalesToEnterpriseValue OperatingMarginTrend*Stability(exFin)

Financing Cash Flow Yield ROCETrend*Stability

ROE

Sources: Candriam, Factset

TABLE 4:AverageNumberofstocks (from01/2006to12/2015)

EMU Europe Japan USA

SRI Universe 152 279 191 303

MSCIIndices 270 432 340 608

Sources: Candriam, Factset, MSCI

●● Valuecompanies–cheapestregardingEarningsYield,OperatingCashFlowYield,andSales-to-EnterpriseValue–obtain the highest score.

●● LowVolatilitycompanieswithhistoricallow-returnvolatilityobtainthehighestscore,basedonweeklyreturnsover6Months,1yearand2years.

●● Qualitycompanies(differentiatedbyFinancialsector)withlowleverageandthehighestprofitabilityobtainthehighestscore.MeasuredbyReturnonEquity,EBITDAtoNetDebt,TrendandStabilityofOperatingMarginandROCE.

Thetablebelowshowstheeffectivenumberofstocksofthedifferentmethodologies.Itturnsoutthatapplyingtheminimumweightingclearlyincreaseseffectivediversification.

Thistransformationobviouslyalsointroducesasizebiasintotheportfolio,i.e.,abiastowardsstockswithasmallercapitalization.

3.3. Factor biases: Value, Quality and Low Volatility

Factorinvesting(sometimescalledSmartBeta)hasgainedinpopularityinrecentyears.Inessence,thetechniqueisnotnew.FamaandFrenchlaidthefoundationsoffactorinvestingalreadyin1993.ButitgainedinpopularitywhenLowVolatilitywas“discovered”byHaugenandBakerin2012.Theyprovidedevidencethatinvestinginlow-volatilitystocksyieldedsuperiorrisk- adjustedreturns,contrarytoconventionalwisdom.Candriamalreadydiscussedthisso-calledanomalyinapreviouspaper,wherewecombineditwithaQualityscreening(VandeMaeleandJallet,2015).

MostexistingSmartBetaportfoliosarebasedononesinglefactor(eitherValue,Quality,Momentum,LowVolatilityorSize).How-ever,realdiversificationbenefitsexistwhendifferentfactorsarecombinedinoneportfolio.Inthisanalysis,wecombineValue,QualityandLowVolatility.ASizebiasisalreadyimplicitlypresentduetotheincreasedweightingofthelongtailofsmallercompanies(see3.2).SincetheMomentumfactorgeneratesarelativelyhighturnoverintheportfolio,itwasnotimplementedinthisanalysis.

ThetablebelowindicatesthemeasuresusedtodefineValue,QualityandLowVolatility.

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June 2017 9

Smart SRI Equity investing: Combining ESG criteria with factor investing

FIGURE 3: Candriam factortilts–CumulativeExcessReturn

Sources: Candriam, Factset

-0.5

2

1.5

1

0.5

0

EUROPE

■■ Value ■■ Quality ■■ LowVolatility ■■ Combination

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

-0.4

1.2

1

0.8

0.6

0.4

0.2

-0.2

0

JAPAN

■■ Value ■■ Quality ■■ LowVolatility ■■ Combination

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015-0.2

1.4

1.2

1

0.8

0.6

0.4

0.2

0

USA

■■ Value ■■ Quality ■■ LowVolatility ■■ Combination

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

-0.4

1.81.61.41.2

10.8

0.40.6

0.20

-0.2

EMU

■■ Value ■■ Quality ■■ LowVolatility ■■ Combination

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Inordertoillustratetheaddedvalueofthe3aforementionedfactors,long/shortportfolioswerecreatedforeachoftheindividualfactors.Theseportfolioswerecreatedbyrankingeachstockwithinitsuniverseatfactorlevel.Stockswerethenclassifiedinquintiles,wheretheLong-Shortportfoliosinvestinthefirstquintileandshortthelastquintile(withanequalstockweightingineachquintile).

AcombinedLong/Shortportfoliowasalsocompiled,wheretherankingofthestockswasbasedonValue,QualityandLowVolatility(eachfactorequallyweighted).

ThegraphbelowshowsthecumulativereturnsoftheseLong-Shortportfolios.Itturnsoutthatthemulti-factorapproachundeniablyadds value in all regions.

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Smart SRI Equity investing: Combining ESG criteria with factor investing

-10

6

4

2

0

-2

-4

-6

-8

■■ EMU ■■ Europe ■■ Japan ■■ USA

Q1 Q2 Q3 Q4 Q5

4.8 4.623.01

1.54

4.92 4.24

-0.22

1.22

-0.060.15

-2.1-0.46

0.1

-0.71

-3.24-1.52

-7.6 -7.88

-2.99

-6,39

-0.4

1

0.8

0.6

0.4

0.2

0.2

0

■■ EMU ■■ Europe ■■ Japan ■■ USA

Q1 Q2 Q3 Q4 EWQ5

0.66

0.82

0.61

0.82

0.630.73

0.38

0.87

0.240.36

0.23

0.62

0.21 0.240.11

0.41

-0.15 -0.13

0.1 0.090.19

0.27 0.32

0.52

FIGURE 4: Factorscombination–AnnualizedExcessReturns

FIGURE 5: Factorscombination–AnnualizedSharpeRatio

Sources: Candriam, Factset

Sources: Candriam, Factset

Figure4showstheannualizedexcessreturnofthequintilesagainsttheequallyweighteduniverses.Q1representsstocksinthetop20%andQ5thoseinthebottom20%.Foreachregion,theexcessreturnsfollowaratherlinearfunction,whereperformancedecreases in accordance with the quintile.

TheSharpeRatio,too,ispresentedinFigure5,wheretheQ1/Q2SharpeRatioistwicethatoftheequallyweightedportfolio,andtheQ4/Q5negativeorlowerthanit.

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June 2017 11

Smart SRI Equity investing: Combining ESG criteria with factor investing

TABLE 6: Quintiles Factor Weighting

Q1 Q2 Q3 Q4 Q5

EMU +0.40% +0.20% Neutral -0.20% -0.40%

Europe +0.20% +0.10% Neutral -0.10% -0.20%

Japan +0.40% +0.20% Neutral -0.20% -0.40%

US +0.20% +0.10% Neutral -0.10% -0.20%

Source: Candriam

FIGURE 6: CandriamSRIIndex–CumulativeExcessReturn

Sources: Candriam, Factset, MSCI

0

2

1.5

1

0.5

EMU

■■ Candriam.SRI.Index ■■ MSCI.Index

2006 2007 2008 2009 2010 2011 2012 2013 2014 20150

2

1.5

1

0.5

EUROPE

■■ Candriam.SRI.Index ■■ MSCI.Index

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

0

2

1.5

1

0.5

JAPAN

■■ Candriam.SRI.Index ■■ MSCI.Index

2006 2007 2008 2009 2010 2011 2012 2013 2014 20150

3

2

2.5

1

1.5

0.5

USA

■■ Candriam.SRI.Index ■■ MSCI.Index

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

4. PUTTING IT ALL TOGETHERThelaststepintheportfolioconstructionprocessinvolvesputtingallthesestepstogether.Inessence,thefactortiltsneedtobeappliedtothe‘modified’fundamentalweightings.Inordertodoso,thefollowingdriftsareappliedbyquintiletothe“modified”fundamentalweightingsandthenrebasedto100%.

Thesizeoftheimplementationisbasedonthelargenessoftheuniverse.VerylargeuniversessuchasEuropeandtheUSwillhavealowerimplementationsizethanuniverseswithamorelimitednumberofconstituents(suchasEMUandJapan).Thisbeingthecase,theactiverisksofthe3stepsintheport-folioconstructionprocessremain,tosomeextent,equivalent.

4.1. Historical Performances

Thefollowingchartsshowthecumulativereturnsofthefinalindicesfrom02/2006to12/2015.Foreachregion,the“SmartSRI”portfoliooutperformsitstraditionalmarketcapitalization-weightedindex.Asshowninfigure7,cumulativeexcessreturnsarerelatively stable and robust over time.

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Smart SRI Equity investing: Combining ESG criteria with factor investing

Sources: Candriam, Factset, MSCI

FIGURE 7: CandriamSRIIndex–CumulativeExcessReturn

-0.1

0.450.4

0.150.1

0.2

0.30.35

0.25

0-0.05

0.05

EMU

■■ Index

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015-0.05

0.4

0.150.1

0.2

0.30.35

0.25

00.05

EUROPE

■■ Index

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

-0.1

0.6

0.1

0

0.2

0.4

0.5

0.3

JAPAN

■■ Index

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015-0.05

0.35

0.15

0.1

0.2

0.3

0.25

0

0.05

USA

■■ Index

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

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Smart SRI Equity investing: Combining ESG criteria with factor investing

TABLE 7: SRI Indices – Statistical Table

SRIEurope MSCIEurope SRIEMU MSCIEMU SRIJapan MSCIJapan SRI USA MSCIUSA

Annualized Return 5.8% 3.73% 5.25% 2.44% 5.14% 1.39% 8.81% 7.53%

Annualized Std Dev 16.09% 15.35% 17.5% 17.73% 14.32% 15.13% 14.24% 13.87%

AnnualizedSharpe(Rf=0%) 0.3606 0.2427 0.3002 0.1374 0.3588 0.092 0.6189 0.5432

MaximumDrawdown 53.83% 54.1% 53.78% 56.21% 37.2% 48.91% 49.34% 47.34%

HistoricalVaR(95%) -8.28% -8.55% -8.47% -8.8% -6% -7.58% -6.2% -7.39%

Beta 1.0345 0.9771 0.9105 1.0036

Beta+ 1.1379 1.0619 0.9622 1.0664

Beta- 0.9886 0.9444 0.8468 1.0024

AnnualizedAlpha 1.94% 2.79% 3.8% 1.22%

TrackingError 2.58% 2.48% 4.12% 3.02%

Information Ratio 0.8025 1.1372 0.9095 0.4245

Sources: Candriam, Factset, MSCI

-30

40

30

20

10

-10

-20

0

■■ US ■■ Europe ■■ EMU ■■ Japan

Size Volatility Profit Leverage DivYld Value

FIGURE8:Styleexposure

Sources: Candriam, Factset, Bloomberg, Barra

ThenexttableshowsthedifferentstatisticsoneachSmartSRIIndexvsitsRegionalMarketCapIndex.EachSRIIndexhasahigherannualizedreturnandSharpeRatio,withanannualizedalphaof1.22%intheUS,around2%inEurope/EMUand3.8%inJapan.

Riskmeasuresindicatesimilarstandarddeviations,whereasthedownsideriskasmeasuredbyHistoricalVaRislower.TheTrackingErrorliesbetween2.48%and4.12%,whichisrelativelylowandhelpscreateanInformationRatiobetween0.42and1.14.Additionally,theupsidemarketcaptureisclearlyhigherthanthedownsidemarketcapture.

Obviously,giventheaforementionedportfolioconstructionprocess,theportfoliohascertainstylebiasessuchasValue,Quality,LowVolatilityandSize.Thegraphbelowillustratesthe average style bias of the indices since the end of 2015.

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June 2017 14

Smart SRI Equity investing: Combining ESG criteria with factor investing

FIGURE 9: Candriam SRI Index–Liveperformance

Sources: Candriam, Factset, MSCI

0.8

1.2

1.1

1

0.9

Dec. 15

Jan. 16

Feb. 1

6Mar.

16Apr.

16May

16Jun

. 16Jul

. 16Aug.

16Sep.

16Oct.

16Nov.

16Dec.

16Jan

. 17Fe

b. 17

Mar. 17

Apr. 17

EMU

■■ Candriam.SRI.Index ■■ MSCI.Index

0.8

1.2

1.1

1

0.9

Dec. 15

Jan. 16

Feb. 1

6Mar.

16Apr.

16May

16Jun

. 16Jul

. 16Aug.

16Sep.

16Oct.

16Nov.

16Dec.

16Jan

. 17Fe

b. 17

Mar. 17

Apr. 17

EUROPE

■■ Candriam.SRI.Index ■■ MSCI.Index

0.8

1.2

1.1

1

0.9

Dec. 15

Jan. 16

Feb. 1

6Mar.

16Apr.

16May

16Jun

. 16Jul

. 16Aug.

16Sep.

16Oct.

16Nov.

16Dec.

16Jan

. 17Fe

b. 17

Mar. 17

Apr. 17

JAPAN

■■ Candriam.SRI.Index ■■ MSCI.Index

0.8

1.3

1.1

1.2

1

0.9

Dec. 15

Jan. 16

Feb. 1

6Mar.

16Apr.

16May

16Jun

. 16Jul

. 16Aug.

16Sep.

16Oct.

16Nov.

16Dec.

16Jan

. 17Fe

b. 17

Mar. 17

Apr. 17

USA

■■ Candriam.SRI.Index ■■ MSCI.Index

5. CONCLUSIONBasedontheaboveanalysis,Candriamisconvincedthatthisportfolioconstructionmethodologyishighlyvaluableforinvestorsseekingtomatchorevenoutperformthebroadequitymarkets,butwhocaresaboutSustainableandResponsibleInvesting.Itshowsthatbothobjectivesarenotmutuallyexclusive.

Also,themostrecent“live”performanceoftheindices(sincetheendof2015,whenthebacktestended)confirmstheexcellentrisk-returncharacteristics.Thegraphbelowshowstheperformanceoftheindexcomparedtothebroadmarketbasedonastandardmarket-capitalizationportfolioconstructionmethodology.

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Smart SRI Equity investing: Combining ESG criteria with factor investing

TABLE 8: SRI Indices – Statistical Table

Candriam SRIIndexEurope

MSCI Europe

Candriam SRIIndexEMU

MSCI EMU

Candriam SRIIndexJapan

MSCI Japan

Candriam SRIIndex

USAMSCI USA

Annualized Return 9.62% 7.38% 11.66% 10.01% 6.94% 6.62% 13.85% 12.96%

Annualized Std Dev 17.87% 17.36% 17.81% 18.28% 21.21% 21.21% 14.46% 14.66%

AnnualizedSharpe(Rf=0%) 0.5384 0.4252 0.6544 0.5478 0.3272 0.3122 0.9575 0.8839

MaximumDrawdown 16.93% 17.21% 16.72% 17.76% 20.58% 20.48% 13.40% 15.06%

HistoricalVaR(95%) -1.68% -1.65% -1.66% -1.78% -2.02% -1.91% -1.53% -1.53%

AnnualizedAlpha 1.97% 1.75% 0.35% 1.06%

TrackingError 1.83% 1.79% 2.42% 1.99%

Information Ratio 1.2237 0.9185 0.1308 0.4467

Sources: Candriam, Factset, MSCI

TheRiskandPerformanceMeasuresintable8alsoindicateasignificanthigherSharpeRatio,andastrongInformationRatiobetween0.51and2.21,whereasMaxDrawdownandHistoricalVaRareslightlylower.

6. REFERENCES●● Arnott,RobertD.,JasonC.Hsu,andPhilipMoore. 2005.

“Fundamental Indexation.” Financial Analysts Journal, 83–99.

●● Carhart, Mark M. 1997. “On Persistence in Mutual Fund Performance.” The Journal of Finance, 57–82.

●● Eugene Fama and Kenneth French. 1993. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 3–56.

●● Fama, Eugene, and Kenneth French. 2015. “A Five-Factor Asset Pricing Model.” Journal of Financial Economics, 1–22.

●● Grinold, Richard C. 1992. “Are Benchmark Portfolios Efficient ?” TheJournalofPortfolioManagement,34–40.

●● Haugen, Robert A., and Nardin L. Baker. 1991. “The Efficient Market Inefficiency of Capitalization-Weighted Stock Portfolios.” TheJournalofPortfolioManagement,35–40.

●● Robert A. Haugen and Nardin L. Baker. 2012. “Low Risk Stocks Outperform Within All Observable Markets of the World.” TheJournalofPortfolioManagement,35–40.

●● Koen Van de Maele and Sebastien Jallet. 2015. “A New Way to Invest in Stocks, Aiming for Lower Risk and Higher Quality.”

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Smart SRI Equity investing: Combining ESG criteria with factor investing

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