Can one asset manager change the way we invest?

“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.

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A finance sector fit for generation S

Never before has the finance sector been under so much pressure to help deliver a climate-resilient, greener, and more equitable society. 

 

There is so much happening in this space that it’s hard to keep up with the news: green finance is an integral part of the G20 agenda for the first time this year; France became the first country to introduce mandatory climate change-related reporting for institutional investors; the U.S. state of California has required insurance companies to report on holdings in high-risk carbon assets; the revised text of the EU Directive on occupational pension funds (IORP2) now states that environmental, social and governance (ESG) factors need to be taken into account. The list goes on. 

 

These are very positive signs. We need the finance sector onboard if we are to deliver on ambitious global deals such as the Sustainable Development Goals (SDGs) and the Paris Climate agreement. Vast sums of capital beyond the reach of public finance are needed in areas such as energy efficiency and low carbon technologies. China alone aims to raise US$1.5 trillion for green projects through to 2020, 85% of this coming from private finance

 

Sustainability represents a significant growth opportunity for those countries, companies and investors that successfully anticipate the products, strategies, and services that the future will demand.  

 

On the other side of the opportunity coin, there is always risk. The biggest of all, in terms of financial value at stake and potential social impacts, is climate change. 

 

Climate change will have major impacts on the availability of resources, the price of energy, the vulnerability of infrastructure and the valuation of companies. Assets can be directly damaged by floods, droughts and severe storms, but investment portfolios can also be harmed indirectly, through weaker growth and lower returns.

 

Changes in policy, technology, and consumer preferences, for instance, can prompt a reassessment of the value of a large range of assets. Some assets can be left ‘stranded’ or worthless in this transition. These can include oil, gas and coal reserve assets that may never be burned, high-carbon industrial installations that may cease to operate prior to the end of their economic cycle, or real estate that will require significant energy efficiency refurbishment. The expected permanent value loss to global assets from climate change has been estimated as EUR3.8 trillion in present value terms – equivalent to the GDP of Japan!

 

It is not altruism. Prudent risk management and capital reallocation are the main forces working together to make the finance sector more sustainable. Worldwide policy actions to green the financial system have more than doubled over the last five years according to a brand new report by the UNEP Inquiry

 

Despite the current momentum, these are still largely localised initiatives and a lot more effort is needed to turn this momentum into a genuine global transformation. 

 

To put things in perspective, just one-fifth of the world’s largest 500 investors are taking tangible action to mitigate their exposure to climate-related risks according to the Asset Owners Disclosure Project. As for green bonds, despite their rapid growth - to US$41.8 billion in 2015 from US$11 billion in 2013 – they still constitute less than 1% of the overall global bond market

 

There is also inconsistent behaviour among investors. Blackrock, the world’s largest asset manager, issued a report stating that “all investors should incorporate climate change awareness into their investment processes”. This happened less than six months after they voted against a shareholder resolution which sought greater climate change disclosure at ExxonMobil's annual general meeting in May.

 

One force that I believe may tip the scale in favour of a truly sustainable finance sector is the growing influence of the so-called ‘Generation S’. 

 

Last year, Georg Kell, Founder of the United Nations Global Compact, introduced the term to define a set of people, from all age groups and backgrounds, who understand the power of sustainability to create positive change. They are conscious that the decisions they make today affect the quality of life for our children, grandchildren, and all future generations. When making career, investment and consumer choices, these individuals are purpose-driven: they choose companies and investors which combine economic value creation with environmental stewardship, social inclusion and sound ethics.

 

Generation S is not yet a majority, but is a rapidly growing movement that stands a fair chance of bringing about real change. 

 

In the UK, the NGO ShareAction is doing a great job mobilising members of Generation S. Their Pension Power campaign helps people discover how their savings are being invested – whether it’s funding agriculture or arms, renewables or fossil fuels – and gives them the means to engage their pension fund. Another positive example comes from the Netherlands. Dutch pension fund ABP surveyed its beneficiaries and found that they wanted their money to be invested more sustainably. This led the fund to significantly boost their responsible investment activities. 

 

Increasing the level of engagement that asset owners have with their beneficiaries is the first step in rebuilding consumers’ trust in financial services and improving accountability in the investment system as a whole.

 

Policy changes and risk considerations are important drivers of a more sustainable finance sector. However, I believe that a real shift will only fully happen with a big push from society. People like you and I who make decisions every day on what to consume, how to invest, and where to work. 

 

We can all be part of Generation S and help make the finance system a truly sustainable one. There is only one real growth story: a sustainable growth story. So I repeat Georg Kell’s question in his seminal article: are you in?

 

Andrea Marandino is sustainable finance and corporate risk specialist at WWF-UK.

 

Photograph: Flickr/ Moby.

 

 

 
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