Sponsored feature: Combining ESG with quants to help investors plan for real-world goals

Northern Trust’s ETF business, FlexShares, has combined its historic expertise in sustainable investing and quantitative strategies, with two new funds launching in March.

Investors are increasingly looking for sophisticated solutions to help them invest sustainably while still achieving outcomes to meet their objectives. Navigating the myriad environmental, social and governance (ESG) frameworks and datasets can be enormously challenging.

One firm tackling these challenges is FlexShares, the exchange-traded fund (ETF) division of Northern Trust Asset Management, which has combined its expertise in sustainable investing and quantitative strategies.

FlexShares offers ETF strategies that seek to help investors achieve real-world goals by providing solutions to construct, allocate and manage outcome-oriented portfolios. Its quant strategies are designed to help investors meet a range of objectives including capital appreciation, managing risk or volatility, gaining liquidity and generating income.

Christopher Huemmer, senior vice president and senior investment strategist for FlexShares ETFs, says the firm realised some years ago that several specific investor needs were not being met in the wider marketplace.

“What’s unique about what we are doing now is that we are applying our experience and rigour from our quant strategies, which we have done for over 25 years, then looking through a sustainable investing lens,” he says.

Pairing sustainable investing with quants
Northern Trust AM has run sustainable investment strategies for around 30 years and has become the third-largest passively managed sustainable fund management firm.

“Our processes allow us to target our factors, while being neutral to any uncompensated factors, whether those are sector or geographic exposure,” he says. “That really lends itself to being neutral in the investment process while still being able to have the factor exposures we are explicitly targeting.”

FlexShares has significantly ramped up its sustainable investing framework, combining factors to create an optimal portfolio in addition to ESG.

“This allows us to have real-world targets not just around the ESG score, but around climate as well,” says Huemmer.

“Our view is that sustainability is a key tenet of an investment process. It is a natural progression for us to pair the sustainability investing frameworks with actual financial analysis tools,” he adds.

FlexShares has leveraged its quantitative research to build a materiality framework around sustainable investing through Key Performance Indicators (KPIs) using two frameworks: the Sustainable Accounting Standards Board (SASB) and the Taskforce for Climate-related Financial Disclosures (TCFD).

The firm realised clients were struggling to find their way around myriad ESG frameworks, models and data providers, says Huemmer, so the firm stepped in.

“We have used various ESG datasets and scores from other providers for several years, but our clients have always asked for Northern Trust’s view. Given we are leaders in sustainable investing, they asked us to create our own score,” he adds.

Around two years ago, FlexShares started to investigate which path would be the most impactful for its clients.

Aligned with TCFD and SASB
FlexShares has taken SASB’s materiality roadmap, which identifies financially material issues that are reasonably likely to impact the financial condition or operating performance of a company and turned it into an actionable framework to create a materiality score, using various data providers.

The framework is aligned with FlexShares’ view for sector-specific data applications and has also incorporated the TCFD’s forward-looking risk governance framework.

The TCFD’s climate disclosure recommendations fall into four pillars – governance, strategy, risk management and metrics and targets – which are designed to show how companies disclose information. “We can use that as a forward-looking view of a company’s risk based on what they are disclosing and not disclosing,” says Huemmer.

As the TCFD forward-looking principles just focus on climate change, FlexShares has expanded these to look through a broader ESG lens.

The challenge for investors is that different industries are differently impacted by ESG factors, says Huemmer. “For example, greenhouse gas emissions and other environmental items are obviously of key importance to energy companies, while data security is more for important financial services firms.

“It is really a balancing act.”

Another challenge in creating sustainable products is that investors across regions will have different focuses and values they wish to apply.

Huemmer explains that each region has its own perspective on what matters most: “Throughout Europe, you can almost carve out three or four different regional areas that would have very different focuses from an ESG standpoint – whether based on fossil fuels, governance or social transition.

“One of an asset manager’s challenges in trying to create a product is how to navigate that landscape. We have looked at what data points are material from an ESG investment standpoint, and used our framework to inform what should we focus on.”

New funds based on ESG scoring
On March 1, FlexShares launched two funds, both based on the same sustainability and climate scoring but with different strategies. The first is focused on generating income by concentrating on financially strong companies that deliver high dividends. “Many investors have turned to dividend stocks to meet their income needs in the low-rate environment,” says Huemmer.

The second focuses on lower-volatility stocks. “This strategy is for investors who are looking to manage volatility and dial down their equity market risk while still participating in them,” he says.

Both funds focus on developed markets and use Northern Trust’s proprietary quality score that its ETF products have used for many years.

“These inaugural funds are the fruits of pairing our beliefs in sustainable investing with quantitative solutions to help investors plan for real-world goals. We are looking to incorporate this more and more into the European market, given that sustainability is a key tenet of the investment process.”

These funds are targeting a 50% reduction in carbon emissions to tally with the Paris Agreement to keep global warming below 1.5 degrees, while looking at a forward view of climate and an uplift in carbon risk trading.

Huemmer explains: “It’s not just about companies that are reducing their emissions today, but also looking forward to ask ‘which companies are transitioning to a greener environment?’ That’s our focus in these products.”

© 2021 funds europe



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