Screening Stocks with an ESG Overlay

Over the past several weeks, we’ve decomposed the performance trends of various ESG KPIs (courtesy of OWL Analytics). Not only have we measured how individual ESG KPIs have performed independently, we’ve also seen how the aggregated pillars of Environmental, Social, and Governance have played out over the past 5 years. Through our analyses we’ve established that companies that share favorable scores across these KPIs have performed well, especially as of late. And with headlines like this one popping up seemingly every day, it’s clear that sustainability is becoming an increasingly integral investment theme.

This week, we’re introducing the new Omega Point ESG overlay, which allows you to see ESG exposures alongside traditional factor exposures in your portfolio (as well as for individual stocks and indices). We’ll also provide this week’s market and factor update: risk has continued to tick up in the US and worldwide, while most factors have sold off heavily on a normalized basis.

‍Finding Stocks Using Omega Point’s ESG Overlay

‍As mentioned, we’ve embedded OWL’s ESG KPIs into our system and z-scored them so you can simultaneously see ESG exposures alongside factor exposures. This new framework allows you to go beyond looking at alphas in your portfolio through the lens of a standard factor model, to dig into ESG exposure for portfolios, indices, swaps, and individual stocks. In the following, we’ll demonstrate how an investor can easily leverage this ESG overlay to find stocks that match his or her desired factor and ESG criteria.

For this exercise, let’s imagine that one of our PM’s allocators has looked at her daily exposure in Omega Point and charged her with mitigating the portfolio’s negative exposure to the environmental KPIs:

Objective: Find stocks that exhibit high growth at a reasonable valuation (to match her investment strategy), that also score well on Environmental Transparency and Pollution Prevention to fulfill the allocator’s mandate.

Quantitatively speaking, we are looking for top quartile (z-score ~0.7) stocks across growth, valuation, environmental transparency, and pollution prevention factors.

‍Step 1

‍Add the universe that the search will be performed on (in this case the Russell 3000)

Step 2

‍Apply a filter to find companies with Growth exposure of 0.7+

Step 3

‍Apply a filter that targets Earnings Yield exposure of 0.7+, to capture companies with a solid P/E ratio

Step 4

‍Apply a filter for companies with exposure of 0.7+ for the two ESG metrics of Pollution Prevention and Environmental Transparency

This process has allowed the PM to quickly narrow down the entire Russell 3000 to twonames that achieve her criteria and would help offset her negative exposure to these environmental KPIs. She can then pull up the security profile for any of the names and get a full view of a company’s ESG exposure:

Now she can use the Simulator tool in Omega Point to add a hypothetical GNW position in any (or all) of these names and see what the ex-ante impact would be on her portfolio’s exposure and risk.

As shown, this new ESG overlay is a powerful addition to a portfolio construction toolkit, allowing an investment professional to truly differentiate signal from noise in the nascent but burgeoning sustainable investing movement.

‍This Week's Market and Factor Update:

US Market (8/9/19 - 8/15/19)

• It was a particularly volatile week for the market, although all major indices saw some bounce on Friday (not captured in above chart).
• Delays in tariff implementation led to some gains on Tuesday, but weak data out of China and Germany augured poorly for the global economy.
• Treasuries were in full focus as the 10-year note inverted with the 2-year note, fomenting recession fears among both Wall Street and Main Street.
• Retail sales were up 0.7% vs 0.3% consensus, the strongest reading since March.

‍US Model

• Market Sensitivity and Volatility continued to sell off as investors flee risk-on assets.
• Growth continued to shoot back towards Neutral after having been Oversold for a couple of weeks.
• Momentum has started to see positive normalized gains as it climbs out of Overbought territory.
• Size fell 0.69 standard deviations in one week, and is plunging towards Oversold space.
• US Total Risk (using the Russell 3000 as proxy) increased +0.13% week-over-week, unsurprisingly.

‍Worldwide Model

• Momentum also saw a strong reversion trend worldwide, as it continues to head back towards the mean.
• Profitability peaked at +1.96 SD above the mean on 8/8 and has been reverting since.
• Market Sensitivity and Volatility continued to sell off, just as we’d seen in the US.
• Global Total Risk (using the ACWI as proxy) increased by 21bps to 12.39%.

Regards,
Omer