What KPIs Drive Green Investing?

Continuing our series on sustainable investing, we’ll be digging into the Environmental pillar of ESG in order to determine the specific KPI that the market has valued most within that bucket over the past 5 years. Our market and factor (US & Worldwide) updates will follow, with our chief takeaways being that Earnings Yield is surging in the US, while Market Sensitivity and Volatility are flagged as overbought in both our US and global models.

‍Environmental Performance Decomposition
Last week, we looked at general performance in each of the Environmental, Social, & Governance portfolios that we constructed using KPIs from OWL Analytics.

‍Methodology:

• Take OWL Analytics’ 12 main KPIs (hierarchy below) and create equal weighted portfolios that are long the top 200 and short the bottom 200 companies in the Russell 1000, ranked by their exposure to those KPIs.
• Bucket and aggregate each of these 12 portfolios into one of the three higher level portfolios that they belong to.
• Create a sector neutral version of each of those portfolios to remove sector bias, then measure performance from 2014-2019.

As we’d established earlier, we’re measuring performance in a sector neutral fashion. Here’s a table with the broader results:

Now we’ll break out the performance of the Environmental bucket by each of the three individual components:

‍Environmental Transparency (Sector Neutral): 2014-2019

The most profitable portion of the Environmental pillar, this portfolio generally drifted upwards (in fits and starts), and then saw a major drawdown between Feb and July 2018. Since hitting a nadir of -0.59% on 7/9/18, there’s been a recovery in the KPI. This is a mostly factor-driven portfolio, with only 0.31% of the 3.39% in cumulative return coming from alpha.

‍Pollution Prevention (Sector Neutral): 2014 - 2019

This portfolio saw prolonged weakness in the beginning of this period, drifting down to a bottom of -5.2% on 9/28/15. Since then, returns have generally climbed, although the bucket experienced the same swoon in early 2018 that we saw in Environmental Transparency. 2.5% of the current cumulative returns of 3.1% can be attributed to alpha, which makes this basket a little more attractive from an investment standpoint.

‍Resource Efficiency (Sector Neutral): 2014-2019

This last KPI has been the weakest of the three, mostly losing money throughout this date range. It bottomed out at -5.75% on 6/18/18, and has since seen a fairly steep recovery path. While still showing negative cumulative returns, the basket does show a way into positive return territory if it continues the current trajectory. Interestingly enough, of the -1.9% in return, factors contributed +2.24% while alpha represented performance drag of -4.15%.

‍Conclusions

‍Due to positive performance and high return from alpha, it looks like Pollution Prevention is the KPI that investors might want to target the most under the Environmental umbrella. What we find notable is that all three legs of the Environmental portion of ESG have seen very positive movement since mid-2018.

This week's market and factor update:

‍US Market (7/12/19 - 7/18/19)

• The S&P 500 and NASDAQ closed at new highs on Friday (not captured in above graphic). The S&P 500 is now up 20.7% YTD.
• Investors were encouraged by solid corporate earnings, government approval of the T-Mobile and Sprint merger, and better than expected economic growth as 2Q GDP grew at a 2.1% pace vs. 1.9% consensus.
• Looking beyond the headline number, consumer spending showed +4.3% growth vs. +1.1% in 1Q. Business investment, however, fell by 0.8% which was the biggest drop in 3.5 years.
• The House passed a two-year spending agreement to lift the debt ceiling, boosting spending by $320B over the limit set in 2011 and suspending the debt ceiling until the end of July 2021.
• All eyes are on the Fed next week, with the market decisively baking in a 25bps rate cut in spite of the better-than-expected economic data.

Here’s how factors have moved over the past week in both US and global models, using our normalized return indicator:

‍US Model

• Earnings Yield had the biggest increase, surging +0.61 standard deviations in the past week and nearing the cusp of an Overbought designation.
• Value reverted to the mean and continued marching upwards on a normalized basis, bouncing back from a recent trough of -1.39 SD below the mean on 6/24.
• Volatility, Market Sensitivity, and Profitability slowly drifted higher into Overbought territory.
• Momentum continued to fall beyond the mean after reverting from its recent peak of +2.79 SD above the mean on June 10th.

‍Global Model

• Worldwide Profitability saw a big jump in normalized returns, +0.55 standard deviations over the past week.
• Just like in the US, the risk-on factors of Market Sensitivity and Volatility have been bid up into Overbought territory.
• Momentum continued to fall globally, and is on pace to enter Oversold space in the near term.

Regards,
Omer