Clean Infrastructure through Industrials-Colored Glasses

The focus on improved US infrastructure has lingered at center stage this week, as the business and investment worlds continue to weigh in on the pros and cons of President Biden’s proposed $2 trillion American Jobs Plan. Though the plan has faced much criticism in Congress, there are still ambitious efforts underway to get a clean infrastructure bill passed by the end of the summer.

With this backdrop, we turn our attention back to our clean infrastructure investment theme by further analyzing the Environment Flow portfolio we built for last week’s Factor Spotlight. This week, we look at the Environment Flow portfolio through the lens of the Wolfe Research QES US Industrials (“Wolfe US Industrials”) risk model to understand how this theme stacks up against the overall Industrials & Materials sectors.

Revisiting the Methodology

As a recap from last week, we constructed an “Environment Flow” portfolio based on the Russell 3000 Industrials, Materials, and Energy sector. This portfolio is a market-neutral portfolio, with the long and short books weighted by the one-year change in the Environment pillar score from the MSCI ESG Ratings dataset. The long (short) side represents names with a positive (negative) change in the Environmental pillar score that would be more (less) attractive to investors interested in companies that are improving their environmental impact. Last week’s Factor Spotlight includes more details on the methodology for the Environment Flow portfolio. For this week’s analysis, since we’ll be focusing on Industrials & Materials, we screened Energy names out of the final portfolio.

To evaluate our Environment Flow portfolio with an Industrials-first lens, we’ll be using the Wolfe US Industrials risk model, which uses an estimation universe of US all-cap Industrials and Materials securities, as opposed to using a broad US universe. In addition to factors that are common across other sector and broad market models, this sector-specific model includes several factors relevant for understanding the behavior of the industrials and materials sectors. This covers fundamental factors, such as EBITDA-to-EV, macro factors, such as sensitivity to Oil Prices, Industrial Metals Prices, and Interest Rates, and granular industry factors, such as Machinery and Building Products.

While the model’s estimation universe is comprised of the industrials and materials sectors, the model is able to cover all US equities due to the time series regression methodology used to estimate the security sensitivities to the factors. Please refer to the risk model factsheet for more information on the construction and factors used in this model.

Clean Infrastructure with an Industrials Lens

Using the Wolfe US Industrials risk model, we can see the systematic characteristics of the portfolio relative to the entire US Industrials & Materials sectors. Note that the short book is loaded as a long portfolio for a ‘more intuitive’ intuition around the exposures.

When using the industrials-focused risk model on the Environment Flow portfolio, we can draw some interesting conclusions by tying the factor characteristics of the portfolio to the current macroeconomic environment. Relative to the overall industrials and materials sectors, the long leg of our theme represents low volatility, high profitability, low valuenames. These securities also show high sensitivity to the Metal Beta and Oil Beta factors, meaning that as industrial metal and oil prices increase, these names will do well. Given the positive outlook for the US economy to continue on the path to reopening, it is likely that we will continue to see industrial metal and oil prices rise, in which case high beta to these commodities will be a desirable position for these names.

On the short side, the Environment Flow theme also represents low volatility names with even higher profitability than the long side. However, we also see high growth characteristics in the short names. Conversely to the long side, the Metal Beta and Oil Beta factors do not appear in our list of top factor exposures for the short book, indicating that there is neutral (i.e. close to 0) exposure to the negative Environment Flow names. Taking this a step further, we also see highly negative exposure to the Interest Rate Beta factor, which we know from past analysis has been a strong factor in the current rising rate environment. The neutral Metal Beta and Oil Beta factor exposures, coupled with the strong negative Interest Rate Beta factor exposure makes these names great contenders for successful shorts to represent the Environment Flow theme.

Can Investors Help Turn Over a New Leaf for Infrastructure?

Industrials and Materials have historically been challenging areas for ESG investing, but renewed capital flows focused on clean infrastructure may be just the right jump start for these sectors. The above analysis shows that as investments in clean infrastructure and job expansion grow, there are many opportunities available for investors in the industrials and materials space to find desirable exposures, especially when considering factors tied to the macro climate.

Whether by isolating the Environment Flow theme to tilt research ideas towards clean infrastructure or if by fully embracing the theme via thematic baskets, it’s clear that there is an opportunity for investors to not only provide boon to their portfolios, but also to encourage momentum behind the shift towards environmentally mindful business practices.

US & Global Market Summary

US Market: 04/05/21 - 04/09/21

• U.S. stocks climbed to record levels wrapping up the week with solid gains amid rising reopening optimism.
• The Nasdaq rallied 3.1% as major technology names outperformed. Apple jumped more than 8% for the week, while Amazon and Alphabet both gained > 6%.
• The producer price index jumped with The March PPI data showing a rise of 1%, over 2x above economist estimates.
• The Labor Department reported first-time jobless claims for the week ended April 3 totaled 744,000, well above the expectations.
• Federal Reserve Chairman Jerome Powell called the recovery from the pandemic “uneven” on Thursday, signaling a more robust recovery is needed.
• The CBOE Volatility Index, aka the “Fear Gauge”, has been trading under the 20 threshold for eight sessions straight.

‍Normalized Factor Returns: Axioma US Equity Risk Model (AXUS4-MH)

• Growth’s rebound hits a higher gear this week to sit atop the US factor leaderboard once again, moving further away from its Extremely Oversold status seen on 3/18.
• After finally showing signs of life last week, Momentum saw a strong jump and moves closer to positive territory.
• Size maintains a sharply positive trend and moves even further into Overbought space.
• Volatility eked small gains this week, putting the brakes on its most recent ongoing decline.
• Market Sensitivity slid further into negative normalized territory after crossing over the historical mean two weeks prior.
• Value’s fall accelerates this week from its recent peak on 3/22, as Growth continues to gain strong favor from investors.
• US Total Risk (using the Russell 3000 as proxy) declined by 22 basis points.

‍Normalized Factor Returns: Axioma Worldwide Equity Risk Model (AXWW4-MH)

• Growth continues its immense global bounce (at the expense of Value), rocketing to the top of this week’s global leaderboard leaving its recent perch in Oversold territory further in the dust.
• Profitability continues its steady climb and moves even deeper into the Overbought space.
• Momentum continues to move upward as well with positive territory in its sights.
• Market Sensitivity and Volatility both continued their recent declines.
• Earnings Yield fell by -0.32 standard deviations this past week moving away from Extremely Overbought territory.
• Value moved crossed the negative threshold this week further illuminating a global growth vs. value reversal.
• Global Risk (using the ACWI as proxy) decreased by 39bps.

Regards,
Alyx