“I am not an environmentalist; I don’t really understand a lot of this stuff. I just have a passionate love for nature”. This is how Omar Selim, CEO of ESG quant fund manager Arabesque Partners, humbly describes himself as he shares his plans to disrupt the asset management industry with The Crowd Forum. “I have a bit of understanding of finance”, says a man who managed a multi-billion-dollar revenue budget and over a thousand staff, “but zero passion for it. So I try to combine the two to create sustainable finance”. It’s an intriguing starting point.
The story of Arabesque
The Arabesque story began at Barclays in late 2008 when Barclays had a 5-year of non-compete agreement with BlackRock following a sale of its asset management division. Selim and his team used this time to “reinvent asset management”, asking what would finance would look like in 10-20 years’ time. A time frame that is generally not associated with the finance community.
His language is also different. “Arabesque stands for the art based on geometry”, explains Selim. “In fact, it represents the beauty of mathematics. You try to understand the beauty of patterns, the information of patterns and to integrate that into the investment process.” He believes the connection between information needs to be introduced into contemporary asset management.
“Arabesque is built on two legs – one is sustainability research” (they process over a hundred billion of data points) and the second is “quantative models that extract the information out of the data through the pattern recognition”, using machine learning.
Like Tesla and a new generation of in-vogue “mission-driven” companies, Arabesque has a clear societal purpose. It seeks to mainstream sustainable investment, with a particular focus on retail investors, making it easy for you and I to invest as little as a £100 in high sustainability companies. Its key premise is that millennial investors care more about sustainability issues, but have limited access to the market.
The founder of Arabesque is convinced that people are increasingly interested not just in returns and volatility, but also how the return has been generated. If it comes at the expense of child labour, corruption or pollution, they would rather seek a return elsewhere. He even has a name for these enlightened minds – “Generation S”, with the “S” being sustainability. He adds “it’s not a function of your age, it’s a function of your mindset”.
“If you care about sustainability, you care about money. And you want your money to be invested in the right way”, Selim concludes. Arabesque’s model speaks to Generation S by offering a quant fund that uses big data and artificial intelligence to identify high sustainability companies. And with a strong track record, they’re meeting Generation S’ financial and sustainability desires.
The two forces disrupting finance
Number one: Equity is the new fixed income.
Selim believes that today’s zero interest rate environment is the new normal. 60% of world’s money is currently invested in fixed income, primarily gilts, bonds and treasuries, and this new normal means they will need to look for returns elsewhere.
“Money will have to flow to the other asset classes and equity is the only class that has the necessary liquidity, transparency and regulation. Real estate is regional, commodities are function of geopolitics, and foreign exchange belongs to the central bank.”
With that comes a growing interest in how the returns are made. Fixed income investors have limited interest beyond the coupon being paid. With equities, the performance of the investee company determines the investors’ success. “In fixed income, I transfer the risk from one party to another. In equity, I share the risk with the company, and with that comes a change in my attitude”, argues Selim.
Number two: Sustainability research is to finance what the X-ray is to medicine.
Arabesque commissioned Oxford University to undertake the most in-depth review of studies of the link between Environmental Social and Governance (ESG) performance and financial performance. From over 200 academic papers, the review found an 80% positive correlation between the company’s ESG position and its stock price performance.
Sustainability research is a “different, a deeper way looking into a company” Selim says. And with great progress being made in our ability to read from large volumes of data quickly, the industry is now able to use sustainability as a metric for assessing a company’s ability to make a good return.
How are Arabesque’s funds outperforming the MSCI by 7%?
Selim enjoys using simple metaphors. He compares Arabesque’s investment approach to preparing a good meal: “if you want to get a good meal you need two things – good ingredients and a recipe. To us, ESG is just about selecting the right ingredients, because over time it’s just a good meal”.
Arabesque uses an ESG matrix that analyses 200 parameters to understand what is material to a company. If you’re looking at a mining company, data on energy consumption, health and safety, waste and water management are material. For a bank or a software company, issues like compliance, anti-corruption, legal and governance will be more relevant.
The Arabesque algorithm also ranks companies in the same jurisdiction. By assessing the material issues, Arabesque is able to cut out the bottom 25% to get “the best in class approach”.
Arabesque has 7,000 stocks in its database, organised by sectors and countries. The investment process starts with the analysis of the top 1,000 stocks, which are then distributed across 5 core strategies to balance the portfolio. At that point, the machine learning begins, with the algorithm choosing the combination of the 100 top picks.
Whilst the process sounds magical, Selim admits that it’s not perfect yet. “We are just working with the first 10% of information quality”, and the opportunities will increase as information levels improve. Importantly, Arabesque ranks the top 5% of global equity funds with 7% of outperformance of MSCI in 2 years.
As Selim proudly puts at the end: “we are the firm that implements your values into the finance”. And, this probably best sums up the spirit of this unique asset manager who so elegantly moulds finance, sustainability and Artificial Intelligence into the same equation.
Will it challenge the short-term world of finance in the same way that Tesla is revolutionising the car industry? There will be many who hope so.
Elina Yumasheva is head of content at The Crowd.
Photograph: Arabesque Partners.