ESG: The X-Ray of Finance
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Rising interest rates will make environmental, social, and governance (ESG) factors one of the most important sources of alpha for investment managers, according to Omar Selim.
Selim is CEO of Arabesque, an asset management firm that uses self-learning quant models and big data to assess the performance and sustainability of globally listed equities. At the 2017 CFA Institute European Investment Conference, he explained that the coming era of rising interest rates will change finance drastically. Those changes will put ESG at the forefront of investment management.
Omar Selim at #EICberlin: the next cycle of rising interest rates will "change everything," and will likely create a large shift to equities. "The spirit of investing will change." @ArabesqueAM
— Charlie Henneman CFA (@CHenneman) November 16, 2017
When central banks end their zero- and negative-interest-rate policies, moving out of the persistent lower-for-longer environment, asset managers will shift their focus from bonds to stocks. Selim pointed out that unlike fixed income, equity investments provide ownership of the company and an incentive to pay attention to the organization’s long-term prospects. In his view, the best gauge of future performance is the firm’s conduct in areas of sustainability and governance.
Kosta Ivanovski, CFA, head of the investments department at NLB Nov Penziski Fond, is a recent convert to the importance of ESG. His firm manages two pension funds with an estimated €430 million in combined assets, and Ivanovski began including ESG metrics in his company analysis after hearing past speakers discuss the topic at CFA Institute conferences.
Currently, Ivanovski gives ESG data a 20% weight when evaluating equities. However, he noted the difficulty involved in collecting high-quality information because companies in the region are not required to meet ESG reporting standards.
Selim expects that the retail investing space will see the largest impact from money moving into equities. Buying stocks will give casual investors a way to express their values and shift funds to areas that they think are important, which could create an investor base less focused on performance and more interested in a company’s greater impact.
Selim said that blockchain technology will facilitate this shift in priorities. The transparency of distributed ledger technologies will give retail investors a window through which to observe the consequences of their investments and the effects on end suppliers.
Omar Selim of @ArabesqueAM sees three big disruptions in finance: Equity is the new fixed income; big data and AI; and Generation S – S for sustainability (a new mindset). #EICBerlin
— Lauren Foster (@laurenfosternyc) November 16, 2017
Professional investors must change their perception of ESG analysis from a performance drag to a method of evaluating how a company conducts business, Selim said. As an example, he described two firms. The first sells solar panels but mistreats its employees and uses installation techniques that harm the environment. The second one, a tobacco company, has excellent benefits for its workers and tries to reduce the negative effects of its production methods.
By picking up on these differences, Arabesque’s algorithms find companies with better long-term prospects — in other words, they prioritize those that run their business sustainably and are less likely to face lawsuits or be subject to reputational damage.
In a world with renewed focus on equities and an investor base that cares about company values, Selim says that ESG will be to finance what the X-ray was to medicine.
This article originally appeared on the CFA Institute European Investment Conference blog.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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