The New Frontier - Investments in Clean Infrastructure

This past week on March 31, the Biden Administration announced the American Jobs Plan, which proposes a $2 trillion plan to invest in US infrastructure. The plan highlights several areas of public investment designed to address the climate and racial inequities that have arisen in part due to an aging national infrastructure and lack of focus on research & development. If passed, the proposed plan will result in massive investments in transportation infrastructure, clean drinking water, and sustainable housing efforts, to name a few.

Some of the direct beneficiaries of this plan will likely include companies that have committed to improving their business practices related to climate change impact, effective usage of natural resources, and minimizing (or eliminating) waste. Coupling the infrastructure plan with the current focus that the asset management industry is putting behind ESG aware investing, it’s clear that companies who have demonstrated that their business practices contribute to reducing environmental impact will be the ones attracting both public and private investment.

In this week’s Factor Spotlight, we leverage the MSCI ESG Ratings dataset, specifically the Environment pillar score, to understand which companies have made improvements in the environmental impact from their business operations and the potential implications for market leadership changes coming out of the increased investment in these companies.

Introducing MSCI ESG Ratings via the Omega Point Data Cloud

Given our dedication to bringing meaningful and timely insights to investors portfolios, Omega Point recently released the Data Cloud, which is intended to bring investment-aware financial data to the fingertips of our users. We’re excited to announce that the MSCI ESG Ratings dataset is officially available to our audience through the Data Cloud.

The MSCI ESG dataset provides extensive and detailed data across all three ESG pillars; however, we’ll be focusing on the themes and key issues that make up the Environment pillar. The table below shows the key issues hierarchy for the Environment pillar.

As the MSCI ESG Ratings Methodology Guide explains, the Environment pillar score is a 0-10 score that is based on an aggregation of the underlying key issue scores. The scores evaluate the company’s exposure to risk or opportunity and its ability to manage that exposure.

Building an “Environment Flow” Portfolio

For our analysis, we’ll be focusing on the Industrials, Materials, and Energy sectors in order to isolate those companies that have the opportunities to operate at the top of the clean infrastructure supply chain. The MSCI ESG ratings are normalized by industry and will provide an effective way to rank the companies within our infrastructure sectors.

We used the following methodology to create the Environment Flow portfolio.

1. Limit the Russell 3000 to the Industrials, Materials, and Energy sectors defined by GICS.
2. Create a “flow” measure by calculating the 1 year change (3/31/2021 vs 3/31/2020) in the Environment pillar score for all securities.
3. Remove securities with 1 year change in score equal to 0 (i.e. no net change in the Environmental pillar score).
4. Create a market-neutral portfolio (“Environmental Flow - Russell 3000”), weighted by the flow measure calculated in step 2. Here, 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.

The resulting portfolio represents our projected thematic basket which represents the names that, based on their improvement (or worsening) of the key environment issues, would experience inflows (or outflows) as investors look to move their assets to ESG-aware investments.

Industry Profile of the Environment Flow Portfolio

Though we limited our universe to infrastructure-related sectors, there is still granularity that emerges when breaking down the Environment Flow Portfolio by industry.

Industry Exposures - Environment Flow - R3000 Portfolio

On the long side, we see that the companies capturing the positive Environment Flow theme represent Chemicals, Oil & Gas, and Commercial Services & Supplies. As an example, the top weighted Chemicals security in the long book is Linde PLC (LIN), which has a mission to make our world more productive through high-quality solutions that sustain and protect the planet.

We see their focus on this mission reflected in LIN’s Environment key issues scores, where their Carbon Emissions score has improved by almost 5 and their Water Stress score by almost 2.

MSCI Environment Pillar Key Issues Scores - Linde PLC

The short side of the portfolio, which represents companies that have worsened their Environment Pillar score, shows heavy exposure to Machinery, Building Products, and Oil & Gas. This implies that investing in the Environment Flow theme could create some underexposure these industries.

Environment Flow Risk Exposures

Using the MSCI Barra US Total Market Equity Model for Long-Term Investors (“Barra US risk model”) shows us the other systematic bets inherent in the Environment Flow Portfolio. Note that the short book is loaded as a long portfolio for a more intuitive intuition around the exposures.

The names representing this theme on the long side are small & mid cap value stocks with low profitability, low quality, and high leverage. The short side is represented by small & mid cap stocks with high momentum, high leverage, and high beta. Our theme shows net long bets to Value, Dividend Yield, and Size and net short bets to Profitability, Momentum, Growth, Quality, and Beta.

Implications for Investors

Using the above analysis, we have started to investigate the characteristics of stocks we can expect to be impacted by the expected flows that will come as a by-product of the current spotlight on public investment in US infrastructure. Isolating the Environment Flow theme will allow investors are able to more effectively deploy capital to support those innovative firms that will not only be good investments for their portfolio, but also help in the fight to improve our environmental footprint.

In future Factor Spotlight posts, we will continue to demonstrate workflows that surface insights around sustainable investing. If you are interested in seeing the names behind the Environment Flow portfolio or in using thematic baskets to take advantage of or mitigate risk from certain responsible investing trends, please reach out to us directly.

US & Global Market Summary

US Market: 03/29/21 - 04/01/21

• The market enjoyed a solid move higher during a truncated week of trading, as we closed out the first quarter of 2021. The S&P 500 closed above 4,000 for the first time.
• In a reversal of the prevailing 1Q trend, TMT outperformed the broader market, with the NASDAQ up 2.6% on the week.
• The jobs report, released while the market was closed for Good Friday, came in at +916,000 nonfarm payrolls - vastly exceeding consensus expectations of +647,000. Unemployment fell to 6% from 6.2% in Feb.
• The ISM Manufacturing Sector index saw a March reading of 64.7, a notable increase from 60.8 in February and the highest level since December 1983.
• The market also digested the unveiling of President Biden’s $2.25 trillion infrastructure spending bill and tax plan.

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

• The rebound in Growth continued, as the factor exited Extremely Oversold territory after bottoming out at -2.44 SD below the mean on 3/18, and is now -1.73 SD below the mean.
• Size kept up its sharply positive trend, up +0.26 standard deviations and now firmly in Overbought space at +1.38 SD above the mean.
• The ongoing decline in Volatility resulted in an Extremely Oversold label at -2.20 SD below the mean.
• Market Sensitivity dipped further into negative normalized territory after crossing over the historical mean last week.
• Value continued to fall from its recent peak of +2.01 SD above the mean on 3/22, declining by -0.35 standard deviations as Growth curried favor from investors this week.
• US Total Risk (using the Russell 3000 as proxy) saw an increase of 24 basis points.

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

• Growth experienced a huge bounce globally as well, rising from a recent nadir of -2.36 SD below the mean on 3/18 to -1.4 SD below the mean today. It remains an Oversold factor.
• Profitability also saw a half standard deviation move upwards, and is now classified as an Overbought factor at +1.33 SD above the mean.
• Momentum shed its Oversold label as it saw enough of an increase to land at -0.72 SD below the mean.
• Market Sensitivity and Volatility both continued to decline on a normalized basis, with Volatility falling deeper into Oversold space at -1.62 SD below the mean.
• Earnings Yield saw a reversal - declining by -0.24 standard deviations this past week after cresting at +2.65 SD above the mean on 3/25. It’s still Extremely Overbought at +2.37 SD above the mean.
• Value fell by over half a standard deviation towards the mean after peaking at +1.37 SD above the mean on 3/16.
• Global Risk (using the ACWI as proxy) increased by 17bps.

Regards,
Alyx