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A multi-factor approach to US equities meeting both alpha and sustainability objectives

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BNP Paribas Asset Management
 

Sustainable alpha over the long term, with rigorous risk management

Among the various regional developed country equity markets, the US market is by far the largest, the most efficient and most liquid. As a result, it constitutes a challenging environment for generating alpha over the long term. For this reason, investors have increasingly chosen for passive, rather than actively-managed, allocations to this market over the past decade.

Within the quantitative equity team at BNP Paribas Asset Management, we have developed a sustainable multi-factor strategy that offers investors a well-diversified and liquid exposure to US large caps. It is fully systematic with minimal discretionary intervention. It combines four factors: low volatility, value, quality and momentum. These factors have proven to be key drivers of equity returns over the long term.

  • Low volatility – overweighting stocks with the lowest volatility
  • Value – overweighting the cheapest stocks
  • Quality – overweighting the stocks of the most profitable companies
  • Momentum – overweighting stocks with the strongest upward price trend.

The strategy’s investment objectives are threefold:

  • Generation of sustainable alpha over the long term
  • Rigorous control of the investment risk
  • Integration of ESG and climate change objectives

Since inception, the strategy returned 11.3% versus 9.2% for the S&P 500 index, i.e. an excess return of 2.1%. Exhibit 1 shows the cumulative excess returns since inception [1].

Over the period, the tracking error was limited to 3.5% and the equity beta was equal to 1. The strategy invests only in stocks included in the index; there are no off-benchmark holdings. The strategy delivers a pure alpha, exclusively derived from the factors listed above.

Exhibit 1: Sustainable outperformance over the S&P 500 index, with a limited tracking error of 3.5%

ex-1-7

Source: BNP Paribas Asset Management, as of May 2019. Past performance is not indicative of future performance. Denominated in USD, gross of fees.

Table 1: Performance of the Multi-Factor Equity USA strategy since inception (June 2015)

Table-1

Source: BNP Paribas Asset Management, as of May 2019. Past performance is not indicative of future performance. Denominated in USD,  gross of fees.

ESG integration at each stage of the investment process

Sustainable investment objectives – and in particular ESG standards – are fully integrated into each stage of the investment process: they are inherent to our investment philosophy, portfolio construction and reporting.

Sustainable investing is now a core strategic component. Integrating sustainability objectives has become crucial in meeting investors’ expectations and needs. That is why BNP Paribas Asset Management’s quantitative equity investment team manages two ESG integration objectives in addition to the exclusions already in place:

  • An increase by 20% of the portfolio’s ESG score versus the benchmark’s ESG score
  • A reduction by 50% of the portfolio’s carbon footprint versus the benchmark’s carbon footprint.

In light of this, our strategy recently received the French Finance Ministry’s socially responsible investment (SRI) label. This certification was put in place to improve SRI visibility for investors in France and Europe. It allows professional and non-professional investors to easily identify investment products that incorporate ESG criteria into their investment policy.

In Table 2 and Exhibit 2, we illustrate the significant improvement in the portfolio’s ESG score. Indeed, the proprietary ESG decile, created by BNP Paribas Asset Management’s Sustainability Centre, is 3.78 versus 5.08 as of 31 May 2019. The ESG decile is on a scale from 1 to 10: 1 being the best, 10 being the worst. In this case, the improvement in terms of ESG is 24.5% versus the ESG score of the S&P 500 index.

Table 2: Comparison of the ESG decile of multi-factor US equity strategy versus the S&P 500

Table-2

Source: BNP Paribas Asset Management, as of May 2019. Performance in USD. Past performance is not indicative of future performance.

In addition to the ESG score improvement, the strategy also excludes the biggest polluter, ranked in ESG decile 10. In Exhibit 2, we illustrate the breakdown of the portfolio relative to its index. The portfolio clearly overweights stocks in the best ESG deciles (1 to 4) and underweights those in the worst ESG deciles (8 to 10).

Exhibit 2: Equity weighting by ESG decile of multi-factor US equity strategy versus S&P 500

Ex-2-1

Source: BNP Paribas Asset Management, as of May 2019.

Combining performance and sustainability is feasible in the US equity market

Our multi-factor US equity strategy is an active approach fulfilling several investment objectives: excess returns over the S&P 500 index, control of the investment risks (tracking error, beta, etc.), while integrating sustainability objectives.

 

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Investments in the aforementioned fund are subject to market fluctuation and risks inherent in investing in securities. The value of investments and the revenue they generate can increase or decrease and it is possible that investors will not recover their initial investment. Source: BNP Paribas Asset Management Holding.