Robeco Quarterly July 2019 by Robeco

Robeco

QUARTERLY Intended for professional investors only

#12/ July 2019

TRENDS INVESTING From digital toolbox to robotic surgery QUANT investing SUSTAINABLE investing

“Your money is like a bar of soap. The more you handle it, the less you’ll have” Eugene Fama

Robeco QUARTERLY • #12 / JULY 2019

10 | Why media spotlight does not drive the Volatility effect 11 | Large UK DC pension scheme embraces sustainability

13 | ‘Were markets efficient, prices should not tell anything about the future’

SUSTAINABLE investing

15 | Enabling insurers to achieve capital-efficient returns

And MORE

QUANT investing

CONTENTS

EMERGING MARKETS Five reasons for strategic allocation to China A-shares

OPINION Stronger mandate for Modi bodes well for Indian reforms

RESEARCH The five principles of value investing that have stood the test of time

GREAT MINDS – AMY DOMINI ‘Let’s use finance to make the world a better place’

TRENDS Health and wellness as the key trend

LONG READ The ‘digital toolbox’: emergency care for our health care system

INTERVIEW Mark van der Kroft – ’We strive to find the winners of the next decade’

COLUMN Masja Zandbergen – How to avoid greenwashing

Amy Domini – page 28

22 | Fighting plastic pollution, one bottle at a time 23 | Using the SDGs to judge corporate sustainability

25 | Removing CO2 on an industrial scale

27 | CO2 is at the highest level in three million years

Robeco QUARTERLY • #12 / JULY 2019

Sustainability

Gradual progress towards gender equality Companies still have a long way to go to make men and women equals in the workplace, a RobecoSAM study reveals. On the issue of pay, it will take 22 years at the current rate to close the salary differential, say Jacob Messina, RobecoSAM’s Head of Research, and Markéta Pokornà, SI Research Associate in the research paper entitled ‘Slowly but surely: gradual progress towards gender equality’ published in the RobecoSAM Yearbook 2019. “Corporate policies promoting gender diversity are a reflection of a well-managed company that realizes the value of diversity in stimulating creativity, fostering innovation, minimizing risk,

Norway leads the pack… sort of The Scandinavian countries are the countries with the highest share of electric vehicles in passenger car sales in 2018. However, in absolute numbers they are dwarfed by China. Norway 49.14% Iceland 19.14% Sweden 8.01% Netherlands 6.69% Finland 4.74% China 4.44% Portugal 3.44% Switzerland 3.18% Austria 2.54% United Kingdom 2.53% In absolute EV sales numbers: China 1,053,000 United States 361,000 Norway 73,000

Sources: ACEA, CAAM, InsideEVs, KAIDA

and increasing productivity in tandem with employee wellbeing. RobecoSAM’s gender measurement framework supports this view and suggests that companies with a more diverse and equal workforce are indeed better positioned to outperform,” adds Pokornà. The SAM Corporate Sustainability Assessment (CSA) measures gender diversity in the annual collection of data about companies’ ESG performance. The questions about gender-based practices cover four main topics: • The proportion of women on a company’s board of directors and whether gender diversity is part of the nomination policy and process; this is important as women are currently underrepresented on boards globally; companies need to demonstrate a transparent and formalized commitment to diversity at the highest leadership levels • Gender diversity in the workforce, including the percentage of women in management positions; in the belief that having a balanced mix of men and women boosts a company’s performance potential • Pay ratios; capturing data to determine whether remuneration is equal between the female and male workforce at different levels (non-management, management, executive)

• Employees and family care; although parental responsibilities still fall disproportionately on women, childcare issues can affect both sexes and require a balanced approach. “Gender diversity can only be achieved by promoting gender equality, not in terms of quotas or inaccurate measures of outcomes, but by addressing the social and cultural stereotypes that have limited women’s ability to maximize professional opportunities,” say Messina and Pokornà. “Albeit slowly, the needle is moving in the right direction.”

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Now we have to roll up our sleeves

We recently dug deeper into the 1,200-stock investment universe of our European Conservative Equities strategy where we select European stocks with a low absolute and distress risk, and attractive upside potential. Unsurprisingly, we found that more defensive sectors like utilities, real estate and consumer staples score well on the different factors considered in the model, although consumer staples remains relatively expensive and therefore relatively less attractive than other sectors. Also, we note that the financials sector is a special case as it consists of high-beta banks such as the universal large-cap banks in the Eurozone and low-risk financials such as reinsurance companies, and low-beta, high-dividend banks in Scandinavia and Switzerland. In terms of countries, we found that, despite relatively high valuations, Switzerland is the best-ranked country based on our bottom-up approach, primarily due to the relatively low volatility of Swiss stocks. The UK comes out as relatively uncorrelated with the rest of the European market and as quite attractive from a dividend perspective, but the volatility of UK stocks is rather high, on average. Meanwhile, the cyclical German market scores poorly on beta and negatively on momentum, while having an average valuation.

Editorial

Equities

Safety first

We’re moving in the right direction, but greater commitment is needed if we are to achieve the sustainability goals. In June, I and 900 other participants attended the Responsible Investor conference in London. Coincidentally, this edition marked the halfway point in a long journey. It was exactly 11 years ago, in 2008, that the first RI conference was held in Amsterdam. And it will be another 11 years until 2030, an important year for anyone who has sustainability on the agenda. That is the year, according to the IPCC, that we have to have CO2 emissions under control to limit further global warming to less than 1.5°C. 2030 is also the year by which the 17 SDGs have to be attained. The first RI conference in 2008 was attended by 135 people; this year there were 900. The number of PRI signatories has risen from 360 to 2,000 in that same period. And the amount of sustainably managed assets worldwide has increased from USD 5 trillion to over USD 30 trillion. These numbers prove that sustainable investing really is on the radar. We have seen positive changes unfold before our eyes, with northern Europe leading the way. Yes, sustainability is discussed increasingly often in the US and Asia too. But – thanks in part to the EU Action Plan – Europe is at the forefront of these developments. Everyone is on board: asset owners, asset managers, politicians and regulators. But that’s no reason for complacency. The wheels may have been set in motion, but we really need to shift up a gear if we are to achieve the ambitious goals. Thankfully, there is widespread consensus that the time of only talking and formulating goals is behind us. Now we have to roll up our sleeves. The time has come for strategic action in our industry, because minor tactical adjustments won’t get us there. This structural and irreversible trend requires a completely different mindset from the one that has typified our industry in the past. The two dimensions of successful investment – risk and return – have become three: risk, return and sustainability. At every level of the investment industry, we have to look beyond short-term performance and realize that our social responsibility is wider than the financial aspect alone. Although we have already seen a seismic change over the past 11 years, and 2030 may seem a long way off, an even greater level of commitment is needed in the next 11 years.

Peter Ferket, Head of Investments

Robeco QUARTERLY • #12 / JULY 2019

35%

48%

Once a year

More than once a year

USD 5 to 7 trillion of investments needed per annum to meet the SDG goals in 2030

GOOD HEALTH AND WELL-BEING

ZERO HUNGER

Source: VBDO survey among Dutch pension funds (2018)

Column

Cut!

Safeguarding economic, environmental and socialSafeguarding assets is aeconomic, prerequisite for a healthy environmental and social assetsand is a prerequisite for a healthy economy and economy the generation of attractive returns generation attractive returns in the future. in thethe future. Ouroffocus is therefore not only Our focuswealth is therefore one creating wealth on creating butnot ononly creating wealth and but on creating wealth and well-being. well-being.

What Robeco Robeco does What does

The 10-year US Treasury yield fell below the 2% threshold following the June FOMC meeting. Eight out of the 17 policymakers signaled lower Fed rates this year, seven of whom expect at least a 0.50% cut. Together with lower inflation expectations, with the central bank chopping its forecast for 2019 to 1.5%, a rate cut in July seems a done deal. Fed Chairman Jerome Powell did, however, mention several times that he and his colleagues would be eyeing the incoming data until the next FOMC meeting. But not cutting rates would

Proprietary research RobecoSAM’s Corporate Sustainability Assessment consists of an annual analysis Proprietary research of financially material sustainability RobecoSAM's Corporate Sustainability Assessment consists information from approximately 5,500 of an annual analysis of financially material sustainability listed companies information from approximately 4,500 listed companies Analysis Analysis We integrate sustainability analysis We integrate sustainability analysis with our financial analysis with our financial analysis

Exclusion Exclusion

Tobacco Tobacco

Recommendations Recommendations Our ESG analyses influence our views in Our ESG analyses influence our views on issuers of Credits issuers ofallcredits (instocks 35%(inof50% all ofcases) and (in 35% of cases) and all cases) stocks (in 50% of all cases)

Controversial Controversial weapons weapons

Controversial Controversial behavior andand countries behavior countries

Assetsunder undervoting voting Assets grew almost 12% 12% grewby by almost EUR 63 EUR 63 billion billion

2017 2017

EUR 70 EUR 70 billion billion

Voting & Engagement In 2018 we voted at a record number of 5,291 meetings. In 56% of all meetings we Voting & Engagement voted management In 2018against we voted at at aleast recordone number of 5,291 meetings proposal In 56% of all meetings we voted against at least one

Sustainability Inside

management proposal

Sustainability Focused

2018 2018

Impact investing

Assets under Assets under engagement engagement grew almost grew byby almost 60% 60%

EUR 236 EUR 236 billion billion

2017 2017

In 2018 we handled 240 engagement cases, covering: 2018 we handled 240 • In Environmental issues engagement covering: (like climatecases, change strategies) Environmental • Social topics issues (like climate change strategies) Social topics (like living wage and food security) (like living wage and food security) Governance issues (like culture and risk oversight) • Governance issues (like culture and risk oversight)

EUR 380 EUR 380 billion billion

our engagement,Shell Shell has FollowingFollowing our engagement, to set short-term targets agreed tohas setagreed short-term targets for cutting for cutting carbon emissions and carbon emissions and will link executive will link executive pay to meeting pay to meeting these objectives for the these objectives for the first time first time

2018 2018

As As per per December December2018 2018, only only applicable applicablefor forequity equityinvestments investments

lead to a severe downturn in risky assets, as markets have priced in a significant amount of monetary loosening. While one could argue that economic circumstances have not deteriorated enough to underpin a series of rate cuts, the Federal Reserve has been cornered by financial markets. It would be a bold, and at the same time very risky, decision to refrain from easing monetary policy.

• We look at the long-term We look at the longdrivers of ESG issues for term drivers of ESG companies issues for companies • We analyze how ESG We analyze how ESG risks and opportunities risks and opportunities influence valuations influence valuations • We vote and engage to improve ESG behavior We vote and engage to improve ESG behavior + + ESG integration leads to ESG integration leads better-informed decision to better-informed making decision making

Some examples: Some examples:

Sustainability Focused

USD 114 bln*

ESG

* as per December 2018

Quant Em. Sustainable Quant Em. Markets Sustainable Sust. Active European Equities European Markets Sust. Active

What investors can do 1Define a purpose

Impact investing

Ex-ante Ex-ante focus focus on stocks on stocks that that score score better better on on ESG and ESG and enenvironmental vironmental footprint footprint

Assets Assets integrating ESG integrating

Jeroen Blokland Senior Portfolio Manager

Sustainability Inside

Gender Gender equality equality

Smart Smart mobility mobility

SDG SDG SDG Credits Credits Credits

Equities

Implementation of sustainability in portfolios requires a step-by-step approach

Robeco QUARTERLY • #12 / JULY 2019

Five reasons for strategic allocation to China A-shares As the A-share market opens up to investors and with MSCI having taken an additional step to include A-shares, substantial capital flows are again expected into China’s onshore market. Besides this tactical reason to invest in Chinese A-shares, the market merits longer-term, strategic allocation as well, says Robeco’s Head of Research China, Jie Lu.

Speed read

Emerging markets

• The A-share market is the world’s second-largest equity market • Some of China’s best opportunities are only available in A-shares • A-shares offer significant diversification benefits and alpha potential

Simply put, the A-share market is too big to ignore. It offers unique investment opportunities that cannot be found in other markets and provides diversification benefits because of its low correlation with the major equity markets, including China’s offshore market. Jie Lu lists five reasons why he believes Chinese A-shares should be part of the strategic allocation of a portfolio.

The A-share market is the world’s secondlargest equity market

The increasing participation of foreign capital will also create a more balanced investor structure in the market, moving it from being retail dominated to a mix of institutional and retail investors. A higher institutional presence will help to improve corporate governance at A-share listed companies, which we expect will benefit shareholders. Furthermore, the inclusion of A-shares in the relevant indices has made not investing in them an active decision, which for index-aware investors implies taking an active underweight position. By November of this year, the current inclusion plan will be implemented. We expect full inclusion to take five to eight years, depending on progress in terms of market accessibility.

Some of China’s biggest opportunities are only available in local markets The Chinese A-share market accounts for 70% of the

The Chinese A-share market – the Shanghai Stock Exchange and the Shenzhen Stock Exchange combined – constitutes the world’s second-largest equity market after the US. Its current market capitalization is USD 8.4 trillion.

To foreign investors, the A-share market has effectively been a sleeping giant which has largely been ignored. Up until now, this has made sense, given the market’s closed nature. Now that it is opening up, investors can no longer put off deciding whether to invest in this market.

MSCI is increasing the A-share weight in its indices this year

This year, MSCI is increasing the weight of Chinese A-shares in the MSCI Emerging Markets Index to 20%, up from 5% in 2018. This is an important step as we expect it to lead to continuous foreign inflows. Apart from providing evidence of China’s intention to liberalize capital markets and of the progress in this regard, this move will also support the renminbi.

Robeco QUARTERLY • #12 / JULY 2019

Emerging markets

market capitalization of all Chinese listed stocks. It offers investors even more diversification potential than offshore H-shares: 10 of the 15 key sectors have over 70% of their market capitalization listed exclusively in China A-shares. The A-share market offers exposure to state-owned enterprises (SOEs) which we expect to make significant progress in terms of mixed-ownership reforms and improved corporate governance, making them increasingly interesting investment opportunities. The majority of SOEs are part of ‘old economy’ sectors such as materials and energy. Sectors that make up the ‘new economy’ – like health care, consumer products, services and technology – have recorded better growth than the market as a whole. These new economy sectors account for around 40% of total A-share market capitalization and represent a large pool of very interesting investment opportunities.

Low correlation provides diversification

Table 1 | Five-year correlation of Chinese A-shares with four major indices MSCI World

Global EM

APAC ex JP

MSCI China

Shenzhen Stock Exchange Composite Index

0.39

0.40

0.47

0.54

Shanghai Stock Exchange Composite Index

0.43

0.46

0.54

0.68

MSCI Emerging Markets Index

0.75

0.96

0.88

Source: Bloomberg, Morgan Stanley Research. Period: Apr 2014-Mar 2019.

A-shares become more broadly available to global investors. Table 2 shows the return of the Robeco Chinese A-share Equities strategy since inception in March 2017 against that of the MSCI China A International Index in the same period. As the track record shows, the A-share market’s structure and predominantly retail ownership offer substantial alpha opportunities. As this will change only gradually, these opportunities will be around for quite some time.

‘Like any other market, the space is not a bed of roses either’

The Chinese A-share market has a low correlation with global equity markets. One important reason is that it is still largely driven by local retail investors, who hold close to 50% of the market’s total free float market capitalization and account for 80% of total trading volume. Retail investors tend to have a shorter-term investment horizon and behave differently from institutional investors.

Conclusion A second reason is that the market has long been closed to foreign investors and, therefore, has not moved in step with global sentiment. And while the opening up to foreign investors will eventually increase the market’s correlation with other equity markets, this will take time. Currently, only 3% of market capitalization is foreign-owned, against 30% for Japan and 15% for the US. Table 1 shows the five-year correlation between the Shenzhen and Shanghai Stock Exchange Composite Indices and global developed equities, global emerging markets indices, Asia-Pacific ex Japan stocks and the MSCI China Index, which includes only offshore-listed Chinese stocks. For comparison purposes, the table includes the MSCI Emerging Markets Index, which is significantly more correlated to major global markets.

Early stage of development offers significant alpha opportunities

The Chinese onshore stock market did not open until 1990 and has only gradually been admitting foreign institutional investors since 2002. This market is set to grow further as corporate earnings improve, as more companies are listed, and as

Chinese A-shares are becoming increasingly important for global investors. There are five good reasons why they should be part of a portfolio’s strategic core allocation. Yet, like any other market, the space is not a bed of roses either. It is important to monitor the market closely, and changes in factors such as valuations and earnings will require tactical portfolio adjustments. This, however, does not detract from the strong case for a long-term, strategic position in Chinese A-shares. Table 2 | Annualized performance of Robeco Chinese A-share Equities strategy 30/04/2019 1 year

Since Mar-17

Robeco Chinese A-share Equities

-0.58%

16.89%

MSCI China A International Index (Net Return, CNH)

-3.38%

3.63%

Relative performance

2.80%

13.26% α

Source: Robeco. Figures for Robeco Chinese A-share Equities, gross of fees, based on net asset value, in USD. In reality costs such as management fees and other costs are charged. These have a negative effect on the returns shown. The value of your investment may fluctuate. Results obtained in the past are no guarantee of future performance.

Robeco QUARTERLY • #12 / JULY 2019

QUANTinvesting Center of attention Does the Volatility effect have anything to do with the fact that investors tend to favor stocks that feature frequently in the news? While this may seem like a trivial question, there is more to this issue than meets the eye. First, because grasping the underlying causes behind the existence of factor premiums helps determine whether a purported factor is just a statistical blip or a more permanent feature of markets. Second, because the answer to this question could potentially have important consequences for the way a low volatility strategy should be implemented in practice, for example concerning the way media-hyped stocks should be treated. This is enough reason for our quantitative research team to examine the issue more closely.

Robeco QUARTERLY â&#x20AC;˘ #12 / JULY 2019

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Why media spotlight does not drive the Volatility effect in equities Grasping the driving forces behind factor premiums is essential. The better we understand these premiums, the more we can say about the persistence of factors. With this in mind, we recently investigated whether investors’ appetite for stocks frequently mentioned in the news can explain – at least partially – the Volatility effect, as some academics suggest. Our empirical analysis shows this theory holds little water, say David Blitz, Rob Huisman, Laurens Swinkels and Pim van Vliet. One of the main assumptions of the capital asset pricing model (CAPM) is that complete information is always available to investors and that they process this information in a rational way. The truth, however, is that investors only have limited information. Instead of searching for all the information on every possible company, they often only buy the stocks of companies that grab their attention. In a paper published back in 2008, Brad Barber and Terrance Odean developed the concept of an ‘attention-grabbing’ effect. They found empirical evidence that individual investors are more likely to buy stocks that have been in the news. In an earlier paper2 published in 1996, Eric Falkenstein found that mutual funds 1

Figure 1 | Risk-adjusted returns for portfolios of stocks with high media coverage and five varying levels of volatility 4% 2% 0% -2% -4% -6%

Testing the effect of ‘attentiongrabbing’ on stock prices This behavior of both individual investors and fund managers suggests that the prices of attention-grabbing stocks tend to be temporarily inflated, which subsequently leads to lower-than-expected returns. Meanwhile, stocks that are not featured frequently in the news are more likely to be underpriced, which then leads to higherthan-expected returns. It is easy to conclude from this that more volatile stocks that feature more frequently in the news and grab investors’ attention have lower expected returns relative to the market as whole. And, therefore, that the low volatility anomaly can – at least partially – be explained by the ‘attentiongrabbing’ theory. But is that really the case? To find out, we tested two hypotheses using data on the 3,000 largest stocks in developed markets between January 2001 and December 2018. First, we investigated whether the volatility effect can be found in stocks that are mentioned frequently in the media. We then analyzed whether the low returns seen for high-volatility stocks are caused by frequent media coverage for these stocks.

Two hypotheses rejected Low volatility

High volatility

Source: Robeco, Blitz, Huisman, Swinkels, Van Vliet (2019). Sample period is January 2001 to December 2018. Our sample consists of the largest 3,000 stocks listed in developed equity markets at each point in time. All stocks are double sorted in five times five portfolios based on past one-year size-adjusted media coverage and past one-year daily return volatility. The five bars represent the five volatility sorts for the group of stocks with high media coverage. Average arithmetic alpha per annum from a regression on the equally-weighted market portfolio.

prefer holding stocks of companies that had featured frequently in the news in the previous year.

Our calculations show that media coverage does indeed tend to be higher for stocks in higher-volatility groups and volatility is higher for groups of stocks more frequently

Robeco QUARTERLY • #12 / JULY 2019

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in the news. In other words, ‘glittery’ stocks tend to be the stocks with relatively high volatility, while the ‘boring’ stocks that the media does not write about tend to be less volatile.

Figure 2 | Risk-adjusted returns for portfolios of stocks with high volatility and five varying levels of media coverage 0% -2% -4%

However, we found clear evidence of the volatility effect even among stocks with the highest media coverage, as Figure 1 illustrates. The bar chart shows the risk-adjusted returns of those stocks with the highest media coverage, relative to the market portfolio. The chart clearly shows that the low volatility effect has not disappeared for stocks with high media coverage. The average risk-adjusted return is 3.2% per annum for stocks with low volatility, while this is -4.9% per annum for stocks with high volatility. Meanwhile, we also found that the most negative returns in the group of most volatile stocks tend to be achieved by those with low media coverage, not by those with high media coverage, as

-6% -8% -10% -12%

Low attention

High attention

Source: Robeco, Blitz, Huisman, Swinkels, Van Vliet (2019). Sample period is January 2001 to December 2018. Our sample consists of the largest 3,000 stocks listed in developed equity markets at each point in time. All stocks are double sorted in 5 times 5 portfolios based on past one-year size-adjusted media coverage and past one-year daily return volatility. The five bars represent the five media coverage sorts for the group of stocks with high volatility. Average arithmetic alpha per annum from a regression on the equally-weighted market portfolio.

the ‘attention-grabbing’ theory suggests. Figure 2 illustrates this. It shows the risk-adjusted returns for stocks with high volatility depending on their level of media coverage. These risk-adjusted returns range from -10.2% per annum for stocks with the lowest media coverage to -4.8% per annum for those that appear most frequently in the media.

Based on these results, we reject the two hypotheses tested and conclude that the volatility anomaly cannot be explained by the ‘attention-grabbing’ theory. 1 Barber, B.M. and Odean, T., (2008) ‘All that glitters: The effect of attention and news on the buying behavior of individual and institutional investors’, The Review of Financial Studies. 2 Falkenstein, E., (1996), ‘Preferences for stock characteristics as revealed by mutual fund portfolio holdings’, The Journal of Finance.

Large UK DC pension scheme embraces sustainability via factor indices In 2018, a large, fast-growing UK defined contribution multi-employer pension scheme was looking for a better alternative to its approach of passive allocation to equity markets. It sought a solution that would feature both balanced exposure to different proven factors and ambitious sustainability targets. The client was looking for a solution that would satisfy their overall fiduciary duty of generating attractive risk-adjusted returns, while making a positive impact on the environment, say Robeco’s Peter Walsh and Viorel Roscovan.

Launched around the middle of this decade, this client provides UK employers with high-quality, competitive, lower-risk

Robeco QUARTERLY • #12 / JULY 2019

pension solutions for employees, without the burden of governance. The trust reached the milestone of GBP 2 billion of assets under management (AuM) in 2018

and represents approximately 50,000 scheme members in Great Britain. Initially, conversations with this client essentially revolved around factor investing as a transparent and costefficient way to achieve attractive risk-adjusted returns over the long term. However, before long, the client decided that the sustainability profile of the solution was also an essential topic.

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This was due to the fact that ESG integration had become part of the fiduciary duty of UK pension funds, according to the code of practice published by the UK Pensions Regulator. For this specific mandate, the client wanted to achieve a significantly better sustainability profile than a market index and wanted to apply a values-based exclusion list. Reducing the environmental footprint was also deemed an important goal. One very particular request from this pension trust was that, for cost and transparency reasons, the solution would be managed in the form of a bespoke index, that could be replicated by their preferred fulfillment partner. At the same time, the client was aware of the shortcomings of generic products offered by many index providers. Many generic solutions still involve a significant amount of exposure to unrewarded risks as well as undesirable negative exposure to proven factor premiums. Moreover, these products also often entail inefficient index construction processes, leading to unnecessary turnover, high concentration in some countries or sectors, or excessive exposure to large capitalization stocks.

Overcrowding and arbitrage Most importantly, generic index-based products are prone to overcrowding and arbitrage. The fact that their methodology is publicly available means that upcoming trades can be identified in advance and other investors can opportunistically take advantage of this. A recent Robeco study estimated the cost of this transparency of public US factor indices to be 16.5 basis points per year at the expense of the index investors. Moreover, these costs seem to be rising as factor indices become increasingly popular.

‘Many generic solutions still involve a significant amount of exposure to unrewarded risks’ The client and its consultant were well aware of all these pitfalls. They were therefore looking for a solution rooted in the extensive experience of an active factor-investing manager, capable of explicitly tackling these challenges.

The defining features of Robeco’s proposition Robeco had already been working closely with the scheme’s consultant for several years and had informed them of our approach of efficiently harvesting factor premiums in a sustainable way. Robeco has been a thought leader in the field of factor investing, researching and actively managing factor investing strategies for more than 15 years. Our solutions offer significant competitive advantages over their generic counterparts.

also ensures appropriate diversification and prevents unintended geographic or sector biases, while keeping turnover as low as possible.

In addition, our factor indices benefit from Robeco and RobecoSAM’s pioneering expertise in sustainability investing, without compromising returns. In fact, the involvement of RobecoSAM during the selection process was key to convincing the client that the sustainability component of the mandate was of the highest quality. Robeco’s factor index strategies explicitly integrate ESG criteria in their construction process by ensuring that the weighted sustainability score of the index is significantly higher than that of the market-cap weighted parent index. The index construction methodology tilts the index towards stocks that are attractive from a factor perspective, while also improving the overall sustainability profile of the index in terms of the ESG score and environmental footprint.

For example, they use enhanced factor definitions developed by Robeco, based on extensive research and years of experience managing factor investing strategies. This ensures our solutions avoid unrewarded risks and prevent unintended exposure, as well as classic factor clashes (for example between value and momentum), in order to maximize the risk-adjusted return potential. In this way, we avoid the typical pitfalls associated with generic factor indices, often marketed as smart beta.

Another important feature of Robeco’s offering is our ability to report on sustainability achievements in a timely and precise manner. We have developed a number of reporting tools that enable us to closely monitor the characteristics of a portfolio, including in terms of the ESG score or the environmental footprint, and to compare them to the characteristics of the desired benchmark.

We also apply a time-tested proprietary index-construction methodology that ensures the index is overweight stocks that exhibit attractive valuations, strong positive momentum, high quality and low expected risk. The methodology

Given these advantages and the private transparency offered, solutions from our factor index offering were a natural choice for this client. The chosen solution, the Robeco Global Sustainable Multi-Factor Equities Index, harvests factor premiums

Robeco’s Multi-Factor Equities Indices

Robeco QUARTERLY • #12 / JULY 2019

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in a systematic manner, with a bottomup stock selection process based on a balanced mix of four factors: value, momentum, quality, and low volatility. In practice, Robeco’s Factor Index team rebalances the index on a quarterly basis, based on new quantitative stock rankings and the proprietary index construction algorithm. Our partner, S&P Dow Jones Indices, updates the index for market events and sends the outcome to the client’s preferred fulfillment partner to track the index. This results in a solution with efficient exposure to factors and a high capacity. The index also considers ESG and

‘The index also considers ESG and environmental footprint attributes’ environmental footprint attributes of each stock as key parts of the index construction. More specifically, in addition to applying RobecoSAM’s values-based exclusion list, the strategy strives for an ESG score that is 20% higher than the parent index. We also aim for a significant reduction in the environmental footprint of the sustainable multi-factor index. We

target a reduction of at least 20% in terms of greenhouse gas emissions, energy use, water consumption and waste generation. Both ESG score uplift and environmental footprint reduction targets have been consistently met since inception. Ultimately, the objective of our sustainable multi-factor index is to outperform capweighted and generic factor indices on a risk-adjusted basis over the long run.

‘Were markets efficient, prices should not tell anything about the future’ What exactly drives factor premiums? Trying to gain a better understanding of well-known equity factor premiums has been at the heart of Milan Vidojevic’s research. Vidojevic (pictured), who over the past five years has divided his professional time between VU Amsterdam, Columbia University and his work as a researcher at Robeco, recently defended his PhD dissertation. We talked to him about the main conclusions of his thesis, in particular concerning the Momentum, Quality and Low-Risk factors.

How would you explain, in a nutshell, the main focus of your research? “Understanding where people’s expectations about the future come from, is at the core of research in finance. We try to figure out what a company’s stock is worth by discounting its expected future cash flows. We decide whether to buy or rent a house based on the expectations of our future income, the expectations of where the housing market will be in the future and so on. So the question as to how people’s expectations come about and, consequently, how the prices that they are willing to pay for financial assets are

Robeco QUARTERLY • #12 / JULY 2019

opportunities of their investments. If this is true, then the only way to obtain high returns is to take on more risk. The other camp believes that investors are not fully rational and instead that their expectations are based on systematic mistakes. For instance, they can be overly optimistic about the future prospects of some firms and pessimistic about others. Because of this, certain assets can be incorrectly priced, which presents an opportunity to capture these inefficiencies without taking on additional risk.”

‘Tests we conducted showed that the quality and low-risk premiums are, in fact, different’ determined, are of key importance.” “When it comes to the theory, broadly speaking, there are two camps: one that argues that the market is fully efficient, meaning that all investors are rational in assessing the potential risks and

“Financial economists have documented a number of factors that have historically been associated with high returns. Some prominent examples are value, momentum, quality, size and low-risk. And yet, to date we have not been able to agree on whether these factors work

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because they are the compensation for risk or because they are a result of mispricing. My thesis is an attempt to contribute to this discussion. I study what drives these factor premiums.” If we take momentum, for example, what are your main conclusions? “The momentum effect represents one of the biggest challenges for financial economists and one of the biggest failures of the efficient markets hypothesis (EMH). The idea behind it is that if the recent returns of stocks have been strong, they will continue to do well in the near to intermediate future, and those with poor returns continue to do poorly. If markets were efficient, past prices should not provide any information about the future, as the current price already does that.” “And yet, momentum exists! Back in 2011, three Robeco researchers, David Blitz, Joop Huij and Martin Martens published a paper in which they showed that one can construct an even better momentum strategy than one that is based on past total stock returns. They called it the ‘residual’ momentum. This strategy has historically generated returns that are comparable to those based on the conventional momentum, but with half

the risk! Their findings are used extensively in our quantitative strategies.” “One of the papers in my dissertation builds on this research and tries to understand what market forces generate the residual momentum. It finds that they are behavioral in nature. In particular, market participants can be slow to process information about firms, and as a consequence it takes time for prices to adjust. That is why we observe that in the case of residual momentum, stock prices tend to steadily increase up to five years after a stock is bought. This is in stark contrast to the conventional price momentum, for which we observe an increase up to one year in the future and a strong reversal thereafter. The market mechanisms that drive these two factors are quite different.” How about low risk and quality? Some proponents of the EMH have argued that the low-risk effect could be explained rationally, that is, as quality in disguise. You’ve looked into that. What was your conclusion? “Yes, my very first academic paper, which I did with David Blitz, addresses this question. This was in response to a recurring question we were getting

from Robeco clients. Back in 2014 and 2015, academic research into the quality premium picked up. A flurry of studies were released presenting very compelling evidence that high-quality firms outperform low-quality firms. Around the same time, two papers came out claiming that ‘low-risk is just quality in disguise’ and people started wondering whether they should consider the low-risk factor at all.” “Low-risk firms tend to be very profitable, conservatively managed companies, and some preliminary tests showed that investors would not benefit from investing in the low risk factor if they had already invested in the quality factor. Our work shows that this conclusion was quite premature, and the more comprehensive tests we conducted showed that the two premiums are, in fact, different. Investors can therefore benefit from allocating to both of them.” You have also conducted research in the macro-finance area. What are your main conclusions? “I know that one should not pick favorites when it comes to their papers, but for me it is hard to deny that my macro-finance paper was the one I had most fun writing. I am, in fact, an economist by training, and during my undergraduate program at the University of Toronto I studied macroeconomics and macroeconometrics extensively.” “I am deeply interested in how certain macroeconomic events affect the returns of firms in general, and the returns of our favorite factors, in particular. In my paper, I examine why the low-risk stocks move together with bonds, and what the implications are for investors. These research questions were also inspired by the conversations I had with our clients who expressed concerns about these matters. Therefore, it is quite important for us to be able to effectively address them.”

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Enabling insurers to achieve capital-efficient returns The Solvency II regulation, that requires insurance companies in the European Union to hold capital buffers against adverse movements in their portfolios, is pushing these investors to shift their attention from optimizing the risk-adjusted return to optimizing the return on capital. In search of such capital-efficient returns, insurers often turn to high yield markets and alternative asset classes, in addition to investment grade fixed income. But Robeco’s Patrick Houweling and Frederick Muskens argue that factor investing represents an attractive alternative to generating capital-efficient returns.

Insurance companies are significant investors in credits and hold capital buffers to protect their portfolios against negative events. Insurers are also always looking for the best way to diversify their investments and to enhance their return on insurance capital. Factor-based credit strategies provide an attractive alternative to traditional, fundamental, researchbased credit strategies for insurers. Their differentiated investment style and their ability to utilize a broader investment universe explain why factor strategies provide an important source of diversification relative to the fundamentally managed portfolios of insurers.

Systematic method A multi-factor credit strategy uses a highly systematic method to construct the portfolio, taking into account multiple quantitative factors and neutralizing the portfolio’s exposures in terms of interest rate duration and credit beta. Meanwhile, fundamental strategies typically only follow one style, often carry or value, and regularly take duration and/or beta bets. In terms of the investment universe, a

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this subset consists of the larger, more liquid names and their more recently issued bonds. Because of these differences, while the realized returns of most fundamental strategies tend to be positively correlated, the realized returns of our factor strategies are negatively correlated with those of their fundamental peers. Adding a factor strategy to a portfolio of fundamentally managed credit strategies therefore strongly improves diversification.

‘Adding a factor strategy to fundamental strategies improves diversification’ factor-based strategy can efficiently invest in all companies and bonds, irrespective of their size. Fundamental managers inevitably have to focus on a smaller subset, given their limited resources for analyzing issuers. Generally,

Attractive returns Importantly, by systematically harvesting factor premiums, factor-based strategies can be expected to deliver both a

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higher risk-adjusted return and a higher return on capital than passive credit portfolios in the long run. Numerous academic studies on various asset classes, including stocks and bonds, have shown that factor portfolios deliver superior risk-adjusted returns over a full investment cycle, compared to a portfolio that passively tracks the market index. Other studies have shown that the outperformance of successful actively managed funds can to a large extent be explained by their exposures to factors1. Moreover, explicitly integrating insurance capital requirements into factor credit strategies can further enhance the return on capital. In our research, we found a strong positive correlation between the Solvency Capital Ratio (SCR) and credit volatility. Therefore, a factor portfolio not only generates a higher return-to-volatility ratio (i.e. Sharpe ratio) than the market, but also a higher return-to-capital ratio. Because factor investing strategies are

‘Factor strategies are rules-based and can easily incorporate additional quantitative objectives’ rules-based, they can easily incorporate additional quantifiable objectives, such as the SCR. It is therefore relatively straightforward to tilt a portfolio towards bonds that score well with regard to factors while avoiding bonds that have poor factor scores, in order to construct a portfolio that generates a higher risk-adjusted return and a higher return on capital than a portfolio that passively tracks the market index.

Cost-efficient building block Robeco’s multi-factor credit strategies offer exposure to the low-risk, quality, value, momentum and size factors. We apply enhanced definitions for each factor. Compared to more generic factor definitions, such as those typically used

in academic research, these enhanced definitions lead to higher risk-adjusted returns. Our strategies also explicitly take liquidity, transaction costs and turnover into account, and construct well-diversified portfolios with a better sustainability profile than the index. They therefore offer more realistic expectations for attainable improvements in the returnon-capital ratio. Ultimately, our factor credit strategies provide a cost-efficient building block for insurers. These strategies can also be tailored to address specific requirements, for example when insurers wish to match a liability cashflow stream or aim for a certain level of income from a low-turnover buy-and-maintain credit portfolio. 1 See for example: Carhart, 1997, ‘On Persistence in Mutual Fund Performance’ on equity funds and Israel, Palhares & Richardson, 2018, ‘Common Factors in Corporate Bond Returns’ on credit funds.

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Stronger mandate for Modi bodes well for Indian reforms India needs jobs, infrastructure and renewed economic growth. Modi’s previous term in office resulted in several significant reforms, which are a step towards those goals. The stronger mandate he was given with last month’s elections is an opportunity for him to make more progress.

would emerge from the May 2019 elections with a reduced majority. Instead, it took a larger-than-expected majority, winning 353 seats out of 543, with Modi’s Bharatiya Janata Party alone gaining more than 303 seats. Prime Minister Modi will continue with an absolute majority, which gives leverage for further, much-needed reforms.

Speed read

Opinion

• Political uncertainty is gone, ensuring policy continuity • Macro picture favorable, but more reform needed to boost growth • Strong earnings growth likely after 5 years of subdued growth

Our view is that the immediate priority of the government is to revive economic growth and boost jobs creation. India has seen some economic slowdown during the last year, particularly in consumer expenditure. Growth is expected to pick up again in the next year.

As one of the fastest-growing large economies in the world, with a market capitalization of USD 2.2 trillion, India has some undeniably favorable structural trends. For example, a median age of 25 and an expanding working-age population gives the country a strong demographic advantage compared to other emerging and developed markets.

One of the steps in that direction is to bolster foreign direct investment (FDI), particularly in the manufacturing area, and increase employment in the manufacturing sector. FDI restrictions remain in sectors such as ecommerce, yet they have already been eased in many areas, including agriculture and construction.

India is also well-positioned on the balance sheet front. The average emerging market debt-to-GDP ratio is 195%, compared with the 283% average for developed markets, based on Morgan Stanley Research data. India’s debt is at only 134% of GDP. India is also relatively insulated from the ongoing US-China trade friction. Its economy is quite diversified and it has a whole host of sectors that contribute to earnings. Taken together, these favorable trends are supportive for equity markets. Yet government reform needs to progress further in order to support long-term growth and to bring about improvement in the business environment.

Likely near-term policy agenda and what it means for investors It was anticipated that the ruling coalition of National Democratic Alliance, or NDA,

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Another priority is the increase in public infrastructure spending, which has stagnated since 2012. India’s infrastructure spending

Figure 1 | EM sector weights (MSCI) 100% 80% 60% 40% 20% 0%

China

Information Technology Industrials

Korea Taiwan South Africa Brazil (South) Financials Telecommunications

Russian

Mexico

Malaysia Thailand Indonesia India

Federation

Consumer Discretionary Real Estate

Materials

Energy

Health Care

Utilities

Consumer Staples Cash and/or Derivatives

Source: Investec Research

Opinion

to file taxes. GST has also formalized the rules of trade with the adoption of E-Way bills – documents for movement of goods that apply across the entire territory of India and enable them to move across state borders. This step has unified the country’s national market and lowered internal barriers to trade.

Figure 2 | GDP (%YoY) 9

8.2

7.4

7 6

7.1

6.4

7.2

7.3

6.7

5.5

5 4 3

The new Bankruptcy Code created a clearer framework for debt recovery. It enhanced the timeliness of bankruptcy proceedings and created incentives for debt negotiation and resolution as opposed to bankruptcy and liquidation.

2 1 0

FY13

FY14

FY15

FY16

FY17

FY18

FY19E

FY20E

Source: CEIC, BOB Research

has fallen from 11% of GDP in 2012 to 8% in 2018, according to CEIC Data.

Recent steps to improve the ease of doing business

‘Indian equity markets have significantly outperformed other emerging markets’

The Indian government has taken a number of successful steps to improve the business climate. These range from the reform of the taxation system to a new bankruptcy code and a financial inclusion program. As a result of these steps, India has jumped 30 places in the World Bank Ease of Doing Business Index, to reach a rank of 100.

The new Goods and Services Tax (GST) has completely changed the indirect tax structure and made trade smoother. As a result, India moved up in ease-of-paying-taxes rankings, which measure the amount of time and paperwork required in order

High earnings growth, favorable macro picture and demographics Indian equity markets offer a combination of high earnings growth, high GDP growth and positive demographics. Taken together, these factors make it an attractive destination for investors.

Indian returns have exceeded those of the MSCI EM index by 14% in 2018, the biggest outperformance since 2014 and the second best in about a decade, according to Bloomberg data. Corporate earnings are expected to be up 22% in 2019 and up 20% in 2020. This compares favorably to earnings growth of just 3% in 2019 and 10% in 2020 for MXAPJ.

Portfolio positioning Figure 3 | 10-year outperformance 300 280 260 240 220 200 180 160 140 120 100 31-32009

31-32010

MXEF

31-32011

31-32012

31-32013

31-32014

31-32015

31-32016

31-32017

31-32018

31-32019

Our biggest bets in the Indian market are structural growth themes that are supported by trends such as urbanization, digitalization, a rising middle class, growing financial inclusion, and increasing consumer spending. In our portfolio we give preference to financials, IT, consumer discretionary, and energy. We also like industrials as they are expected to be supported by an increased infrastructure spending.

MXIN

Source: Bloomberg

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The five principles of value investing that have stood the test of time The value investment style continues to struggle against growth investing, as equity investors chase easy returns in volatile markets. Boston Partners co-CEO and Portfolio Manager Mark Donovan looks back on his experience spanning decades to highlight the universal truths that can guide all investors in a transitioning market.

Speed read

Research

• Value style has underperformed as investors chase easy growth • Market downturns cause stampedes into ‘expensive defensives’ • Investors should go back to the founding principles of bottom-up

There are few phrases in finance that are more tired, simple, or consistently proven false than the assertion that “this time, it’s different”. And more than 85 years after Sir John Templeton identified these as the four most costly words in finance, the only things that have changed have been the reasons cited to explain why one market boom is any different or more rational than the market cycle that preceded it.

elaborate forecasts, incorporating an endless number of currency assumptions, oil-price scenarios, or a range of monetary policy possibilities creates a paradox of choice. And rather than offering any clarity, this forward-looking scenario-building adds to the noise and generally distracts more than it divulges.

Bottom up beats top down

Related to the idea that the future is unknowable is the fact that many investors can pay undue attention to macroeconomic factors. It’s not that investors shouldn’t be aware of what’s going on in the economy or understand how it can influence an investment thesis; it’s just that the odds are stacked against those who claim to have any unique insight. From an investment perspective, what makes macro strategies

Given the clockwork-like cyclicality of these pronouncements, though, it can be worthwhile to regularly revisit the five foundational principles of investing. In our experience, the following five fundamental truths have stood the test of time, even as these principles seem to be discounted during temporary bouts of market irrationality.

The future is unknowable

The fact that we cannot predict the future is perhaps the most obvious of these fundamental truths. What makes this point particularly relevant today is the research-driven arms race being waged across the asset management industry to gain any edge, however fleeting or illusory. This may have hit a peak last year, with the launch of an AI-driven hedge fund that pays data scientists in cryptocurrency to crowd-source updates to its algorithmic, machine learning model.

But even spreadsheets can become a dangerous diversion when they feed into overconfidence. The ease with which analysts can create

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‘The odds are stacked against those who claim to have any unique insight’ 19

even harder is that accurate forecasts, however rare, still offer no guarantees as to how the markets will ultimately react. In the US, one study showed that the average mutual fund investor underperformed the S&P 500 by 470 basis points in the year following Donald Trump’s victory in the 2016 US general election. A flight to safety following the vote left investors underexposed to the ensuing rally that caught many unaware.

Management matters

Naturally, the inverse to relying on the ‘unknowable’ to inform strategy is to focus intently on the variables that are both discernible and can be quantified. This is why true value investors take a bottom-up approach to security analysis and scrutinize, in depth, company fundamentals, business momentum and catalysts for growth. What shouldn’t be overlooked is the role of strong governance and capable management.

This is an area that has improved exponentially for public companies, post Enron. That’s not to say that lapses in governance don’t occur. The collapse of UK construction company Carillion demonstrated this last year. But with greater regulatory scrutiny and the growth of the activist investor universe, directors are far less likely to rubber stamp new initiatives and will be quicker to demand accountability when companies underperform.

Games are lost, not won

Just as we expect company management teams to exhibit discretion in their pursuit of growth, the same philosophy applies to investors. Increasingly, for instance, many ‘stock pickers’ have shown a tendency during extended market runs to abandon fundamental analysis in favor of momentum strategies. They will pile into stocks that are already winning, and are becoming increasingly expensive, in the hopes they will continue to win. The problem with momentum strategies is two-fold: for starters, while momentum can certainly work as long as stocks keep winning, investors expose themselves to sharp reversals when fortunes turn. Plus, momentum ignores a fundamental truth about long-term investing: value matters.

Stay true to philosophy and process

Make no mistake, these haven’t necessarily been easy times for value investors. The monetary stimulus coming out of the great financial crisis coupled with fiscal stimulus in more recent years has driven asset prices ever higher. In this environment, investors simply need to be in the market, in any capacity or anywhere within it, to generate returns. And this is driving the more desperate fund managers to dial up the risk to justify their fees.

When we begin to hear the detractors start to screech that value or fundamentals no longer matter, this is typically a sign to double down on our philosophy, which has proven itself throughout time. We’re already seeing indications that the next value cycle has begun to take shape, thanks to Brexit concerns and trade issues creating space and differentiation between the more cyclical areas of the economy. In summary, the Wall Street Journal, in a ‘Streetwise’ column, actually tried to make the case that quarterly earnings no longer matter. But our approach is the same regardless of the backdrop, because when we get the fundamental story right, and craft a portfolio of companies showing attractive value characteristics, strong business fundamentals and catalysts for growth, we can eliminate the uncertainty of trying to find a new path. To quote World War II general Omar Bradley, we like to set our course by the stars, not by the lights of every passing ship.

‘Momentum ignores a fundamental truth about long-term investing: value matters’ 20

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SUSTAINABLE investing A plan with a lot of bottle Plastic pollution is one of the biggest environmental threats of our time. One million plastic bottles are bought globally every minute, of which nine out of ten are single use. Many end up in the ocean, with 8 million tons of plastic dumped at sea each year. So, what are we doing about it? Robeco is actively engaging on plastic pollution, and in addition to these efforts, is a corporate sponsor of the UK group Refill. They aim to slash plastic waste by encouraging people to top up their bottles at an army of refilling stations. Our lead story tells how it has gone so far.

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Fighting plastic pollution, one bottle at a time The fight against plastic pollution is one of Robeco’s engagement themes for 2019. One group taking direct action on this is the UK-based Refill scheme, which aims to cut single-use plastic bottle waste by encouraging people to fill them up again instead.

Under the scheme, thirsty Britons can replenish their bottles with tap water provided free at 18,000 high street shops, cafes or businesses listed on the app, rather than buying and then discarding plastic bottles. A smartphone app used to find the locations where this can be done has now been downloaded over 100,000 times. The initiative is run by City to Sea, a not-

for-profit organization which is supported by the UK water industry. Robeco signed a sponsorship partnership with the group in October 2018, because we also believe strongly in taking direct action to improve the environment.

in the Netherlands, New Zealand, Japan and Greece.” “Robeco has helped us to put more funding in the app to help with the roll-out of Refill London, and it’s a win-win, because Robeco can then use the Refill brand at industry events to engage with this issue and give people a tangible experience of stopping plastic pollution.”

The power of engagement Scary statistics Research by Refill shows that the average person in the UK will use 150 plastic

Fee says she decided to work with Robeco after realizing that engaging with investee companies to solve ESG problems can be as, if not more, effective as boycotting them through exclusions. It follows recent success with a groundbreaking agreement to set short-term carbon footprint targets linked to executive pay at Royal Dutch Shell.

‘Robeco invests in the companies we campaign against, so initially it didn’t seem like a resonant partnership’ water bottles every year, of which half are not recycled. More than 15 million are littered, landfilled or incinerated every day, producing 233,000 tons of CO2 emissions a year. If just one in ten people refilled once a week, it would mean 340 million fewer plastic bottles a year in circulation. “We’ve increased our number of app users past 100,000, and have also increased the retention of app users, so more people are coming back to use it, which is great,” says Natalie Fee, founder of City to Sea. “That is spread over 160 local schemes managed by over 250 volunteers who run Refill in their communities. And we’re now expanding into Europe, working with Refill

“I’m really excited about Robeco engaging on plastic for the next three years,” she says. “It helps me learn and get a different perspective, and feel more optimistic about the change coming from within the corporations, as the plastic polluters have more pressure from their shareholders.” “Robeco invests in the companies we campaign against, so initially it didn’t seem like a resonant partnership. But after a lot of reading, meetings and due diligence, I learnt about the power that Robeco can have through active engagement. What turned it for me was seeing the changes that Robeco has brought about at Shell.”

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Working within the system “It’s a way of working within the system. It may still mean increased returns for the investors, but it can certainly speed up the changes we so desperately need to see when it comes to companies taking responsibility for their emissions and polluting practices.” Robeco’s three-year engagement will focus on food and beverage producers that make extensive use of plastic bottles and food trays for packaging, along with the plastics manufacturers themselves. As part of this program, Robeco has become a signatory to the Plastic Solutions Investor Alliance, an international coalition of investors that engages with publicly traded consumer goods companies on the threat posed by plastic waste and pollution. “With our engagement, we aim to

Making a difference

‘We see a growing awareness that single-use plastic is a material topic’ stimulate the transition to recyclable, reusable and/or compostable packaging,” says Carola van Lamoen, Head of Active Ownership at Robeco. “We have full support from both our clients and our own investment teams for our engagement program on single-use plastic.” “We see a growing awareness among companies, investors and other stakeholders that single-use plastic is a material topic that needs to be addressed. We collaborate with other investors in our dialogues with companies; our partnership with City to Sea further strengthens our engagement approach.”

It is starting to make a difference at a corporate level. “Attending the Plastic Recycling Show Europe in Amsterdam in April 2019 showed us that many industry players are now setting targets to increase use of recycled plastic in their products to support a transition to a circular economy for plastics,” says Peter van der Werf, Senior Engagement Specialist at Robeco.

“We encouraged petrochemical companies that produce virgin plastic material to diversify by investing in recycling capacity. In addition, we asked beverage companies to support deposit return schemes globally to increase their ability to source recycled PET for their bottles.”

Using the SDGs to judge corporate sustainability Investors are already latching on to the benefits of the Sustainable Development Goals (SDGs) as an increasingly powerful form of impact investing. Careful screening of companies to assess their suitability for investment can also be used to assess whether they are fit to serve society in general, says RobecoSAM analyst Michael van der Meer.

He believes the United Nations’ 17 goals, ranging from eradicating poverty to fighting climate change, provide a useful means of assessing corporate sustainability, as “no firm is an island” in the modern era, as well as being an excellent investment opportunity. Robeco and RobecoSAM have developed a three-step process that calculates

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the contributions that companies can make towards achieving the goals. Some companies that once thought of themselves as operating for their own ends have gradually evolved to become less selfish, more aware and more accountable: but many have yet to recognize their duty to be sustainable, says Van der Meer, Senior Sustainable Investing Analyst for emerging markets at RobecoSAM.

Larger economic ecosystem “Initially, companies adopted a firmcentric view of the world in which their existence revolved around solely maximizing profits; and good behavior was only to avoid government fines,” he says in an article for the RobecoSAM Yearbook 2019. “Later, as companies recognized their roles as agents within a larger economic ecosystem, they began to accept and adopt basic principles of corporate responsibility, concepts that were previously associated with corporate philanthropy. Corporations are now

SUSTAINABLE INVESTING

beginning to recognize the merits of a fully integrated approach to sustainability – one that incorporates corporate responsibility and strategic decisionmaking – as an imperative to ensure long-term success.” “To meet their return requirements in the long-run, investors also need to be aware of the interdependencies of the environment in which companies operate. In this context, the SDGs are a useful framework for helping evaluate whether companies are producing products and services that have long-term value for society. Only these companies will have the potential to adapt and thrive in the long run, making them sustainable investment choices.” “Perceived short-term inefficiencies – for

‘Corporations are now beginning to recognize the merits of a fullyintegrated approach to sustainability’ example, paying above the minimum wage, which contributes to a number of SDGs including ‘no poverty’, ‘decent work’ and ‘good health and well-being’, increase the longer-term durability of portfolios and should therefore be integrated into investments.”

Avoiding reductionism Van der Meer concedes that one of the problems of the SDGs is that they

are too broad and complex for effectively setting priorities, especially for governments. In parallel with this, the financial industry often takes a ‘reductionist’ approach in which a complex phenomenon is reduced to analyzing the sum of its parts. Neither is helpful for long-term investing in multiplex and overlapping issues.

“In traditional finance, investments are assumed to be independent and uncorrelated,” he says. “This thinking is exemplified in firm-specific analyses, such as a discounted cash flow model applied in isolation. While straightforward to implement, such models suffer from short-term time horizons (3-5 years)

Figure 1 | The UN Sustainable Development Goals

Source: United Nations

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which means that non-linear events materializing in the long-term typically get excluded.” “Modern portfolio theory made progress by understanding that different assets behave and interact differently. This recognition of basic interdependencies is what we now consider conventional finance. Other approaches which broaden the analysis include looking at ESG factors which influence expected returns.”

Universal owners A conceptualized institution that has become central to aligning investors’ and society’s goals is the ‘universal owner’, Van der Meer says. These are institutional investors with highly diversified, long-

‘Perceived short-term inefficiencies increase the longer-term durability of portfolios’ term portfolios that are representative of global capital markets, such as pension funds. “It is said that universal owners have a disproportionate interest in ensuring the sustainability of their portfolios because they must achieve returns not just today, but essentially in perpetuity,” he says. “For example, in the US, investors with such long-term liabilities (more than

10 years) own nearly half of domestic equity markets.”

“Ultimately though, as the direct and indirect beneficiaries (or perhaps the ultimate liability holders) of the decisions of universal owners, all of society has a stake in their ability to achieve a sustainable return on capital invested.”

The SDGs therefore provide an actionable way to bridge the interests and decisions made now to both future outcomes and future returns.

Carbon Capture and Storage: removing CO2 on an industrial scale We produce CO2 on an industrial scale, and we need to remove it on an industrial scale. That was the key message of a Robeco roundtable on Carbon Capture and Storage (CCS), a vital means of combatting global warming.

The event, staged by the Dutch CIO Exchange and co-hosted by APG, a pension provider, heard a number of expert speakers on how the technology can be used, its relevance in our investment portfolios, and whether it presented an investment opportunity. About 50 people from different fields, from academia to investors in the oil and gas industry, took part. Most of the focus in recent years has been on trying to reduce the amount of CO2 added to the atmosphere to meet

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the Paris Agreement. This aims to limit global warming to well below 2°C above pre-industrial levels by the second half of this century. CCS prevents the release of CO2 into the atmosphere by capturing these emissions once they have been created by burning fossil fuels, and then storing or using them (CCUS).

Three-step process Opening the forum, Robeco CIO Peter Ferket said ten investors including Robeco now belonged to the CIO Exchange’s Energy Transition Working Group, which has seven listed European oil and gas companies in scope for engagement on this topic. Niels Berghout, an analyst with the International Energy Agency, said one of the major challenges we are facing today is that 70% of the world’s energy still comes from fossil fuels, and will continue to do so in the decades to come, especially in China and India. CCS is one of few technologies enabling us to abate the associated emissions.

‘The use of CCS needs to be ramped up hundreds of times to meet the climate targets’

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He said CCS is a three-step process of capturing CO2 from a power or industrial facility, then transporting it by pipeline or ship, and finally storing it safely underground. Most existing facilities can be retro-fitted with carbon capture technology, but it is cheaper to incorporate it in the manufacture of new plants. This stops it getting into the atmosphere in the first place.

‘CCS was by no means new, having been proven technology in use since the 1970s’ be met, then the required contribution of CCS rises to 32%. He said 23 large-scale projects were currently operating, but “the use of CCS needs to be ramped up hundreds of times to meet the climate targets”.

2°C, in line with the Paris Agreement.

He further explained that CCS was by no means new, having been proven technology in use since the 1970s. He reemphasized the critical role it has to play in the decarbonization of heavy industry if the world is to meet the goals of the Paris Agreement.

The company perspective Berghout said that if the world truly wanted to achieve the well-below-2degree scenario, then CCS needs to account for 14% of all cumulative CO2 reductions from today until 2060. If the more ambitious 1.5 degree target is to

John MacArthur, Vice-President of Group Carbon at Shell, highlighted that the majority of scenarios produced by organizations such as the IEA, IPCC and Shell include a large component of CCS that limits the temperature rise to below

In summary, a majority of delegates said they believed that carbon capture and storage was indeed part of the climate change solution, and should form part of engagement between asset managers and the oil and gas industry.

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CO2 is at the highest level in three million years The issue of carbon capture is becoming more important after tests showed the amount of carbon dioxide in the atmosphere is now at a level last seen in prehistoric times.

A study by the Potsdam Institute for Climate Impact Research shows that the level of 405 parts per million (ppm) of carbon dioxide recorded in the atmosphere in 2017 was last seen on Earth three million years ago. Samples of sea bed sediment, ice and other particles dating back that far were used to compare today’s levels with that of the Pliocene era. At that time, the temperature was 2-3 degrees Celsius higher than pre-industrial levels, and the average sea level was up to 25 meters above what it is today. Humans had yet to evolve, wooly mammoths roamed the Earth, and the continents were up to 250 kilometers from their present locations, which meant North America was still connected to Asia.

rises to a maximum of 2 degrees above pre-industrial levels by 2100, and preferably no more than 1.5 degrees. A report issued by the Intergovernmental Panel on Climate Change in October 2018 said the world had little chance of meeting the Paris targets unless drastic action was taken now. It said the 2-degree target would probably be reached by 2030 and that global warming of 3 degrees by the end of the century was more likely. Investing in those companies that help combat global warming and engaging with those that don’t will become more important going forward, says Robeco portfolio manager Chris Berkouwer. “Our portfolio is structurally overweight companies that have a much lower environmental footprint than the global average,” he says.

Investing in solutions “The portfolio basically reflects a balance of solution providers to the climate problem, as well as companies with whom we engage to change for the better. For example, we invest in providers of biobased renewable fuels and wind turbine makers, which also helps in fighting climate change.” “Of course, the easiest way out is not to invest in CO2-emitting industries at all, but that’s too simplistic, and often doesn’t solve the underlying problem. The best long-term solution is actually to engage with companies such as the oil majors to move them in the right direction, actively discussing with them how to lower their environmental footprint and keep managements accountable for their actions.”

The findings make particularly grim reading regarding sea levels, as melting ice caps from global warming is seen as the biggest threat to modern human existence. Rising carbon dioxide from the Pliocene onwards caused climate change, which ushered in the ice ages, creating the polar caps. Reversing this would mean sea levels rising as much as 80 meters, although this would take thousands of years.

Faster global warming The research also means that global warming is progressing at a faster pace than previously thought, making it harder to meet the conditions of the Paris Agreement. These seek to limit temperature

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Amy Domini

‘Let’s use finance to make the world a better place’ Great Minds

Amy Domini has been involved with sustainable investing for more than three decades. She assisted with the launch of Robeco’s first SI fund in 1999. Now she chairs Domini Impact Investments in the US. We talked with her about how far SI has come, the challenges that remain, how she invests, and what she would do if she were president of the world.

It’s been 20 years since you were involved with the launch of Robeco’s first SI fund. How much do you think has changed in sustainable investing over that time? Is it now mainstream, or still work in progress? “It’s hard to argue that SI is not now mainstream when some of the world’s largest financial institutions are not only offering a product in this space, but are claiming this space as their future. On the other hand, the sustainability field has not come together to the point at which I would consider mainstreaming to be complete. For that, the data set that financial institutions rely upon needs to be universally available.“ “I compare this to financial data. We get earnings figures, and we know what earnings mean; we get depreciation figures, and we know what depreciation means; we have figures for market cap, cash flows, and so on. Not everyone uses them all, and we have different systems for our own best picks, but we all have the same data to start with. Currently, we have to fill in the blanks on sustainability. Furthermore, data around the world varies; different nations have different disclosure laws, and there are different definitions about things like diversity, but these obstacles can be overcome. Until they are, I don’t think we can reach complete mainstreaming.” What do you think are the main challenges regarding the full adoption of SI? We recently ran a myths series, where some people still think it costs performance. What would be your top five impediments? “I really got my momentum during the dialog that took place globally in the 1980s over the role that corporations were playing in aiding and abetting a system of slavery through

apartheid in South Africa. Divesting involved companies became a big deal, so I found myself called in to discuss the concept of using ethical criteria when making investment decisions. As a result, I felt very strongly that there were two primary barriers: performance and what I would call now confusion, particularly about what standards to apply when we use screens. These two problems still exist.” “Back then, the pushback from the audience was ‘anything that limits your universe is going to hurt your performance’. These concerns have largely been dealt with, as we in the industry demonstrate that this performance ‘give-up’ is not real; that the introduction of these criteria leads to something extraordinary, which is the quantitative way of measuring qualitative information. We can actually measure the quality of a company’s management and measure its corporate culture. For instance, if I see a company that has five product safety recalls, two community controversies, an underfunded pension account and an overpaid CEO, a picture is emerging. If their competitor doesn’t have those things, a comparison emerges, and we gain advantage from the insight.” “I believe that those two impediments ‘it hurts performance’ and ‘what do you look at?’ are still there, but we have the tools to overcome them. Another impediment is that there is a school of thought that says, ‘There is a better way to do this’. These people argue that charities are a better way, that governments are a better way, but I think this is an extremely naïve approach. When you consider the estimated USD 542 trillion in derivatives settlements annually versus the USD 80 trillion or so in global GDP, which one is stronger? Finance is much bigger than trade. And then consider that we have a fantastic infrastructure of instant

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Great Minds

‘I do not believe that the right use of capitalism is to disseminate a harmful product as widely and as cheaply as possible’

communications and relationships globally with this information: Elon Musk tweets something at 3 o’clock in the morning and traders in Bangkok immediately take an action on it. It would be completely nonsensical to ignore this powerful, wonderful tool called finance to achieve goals concerning human dignity and ecological sustainability. I just think the idea that there are better ways to do it is wrong-minded.” “Fourth, there is the person who still says, ‘forget about all that, I just want to make money’. It’s slightly different from, although close to, the performance argument. I see this as problematic generally with the fiduciary who says: ‘I cannot be confused by all these matters; I am a person of goodwill, and I care about these things, but I cannot let it interfere with my primary directive, which is to allow these people to retire in dignity’. They’re making assumptions that are wrong. To retire with dignity requires more than money.” “And fifth, one emerging trend bothers me: single-issue funds. If you are only concerned about solar power, animal rights or being a vegetarian, that’s a different goal from people and the planet. That’s a way to make you feel good about your investments being consistent and aligned with your lifestyle; it’s not about bringing about a world of universal human dignity and ecological sustainability. These single-use funds rarely succeed – the best ones have been in the green area, and that was only after they admitted that they care about people too. All the others haven’t really gotten a lot of traction. I think people get the big picture; let’s use finance to make the world a better place.” There has been some soul-searching in the asset management industry over this supposed ‘fiduciary duty’ to make a profit. What’s your take on where the industry is going? “This has always been a difficult issue. There is a school of thought that you need to get the ‘best’ weapons companies and the

‘best’ tobacco companies for your portfolios, but my own feeling is that this goes back to the right use of capitalism. I do not believe that the right use of capitalism is to disseminate a harmful product as widely and as cheaply as possible. Capitalism does disseminate food, clothing, shelter, communications, education and other comforts for humankind widely and cheaply, and that’s a good thing. But when it comes to disseminating products that kill when used as intended, like a gun, I think we have to question whether this is the right use of capitalism, or whether these products should be limited to government-owned corporations.”

“Most traditional investors want to invest in companies that will make money over time, and to do that, they need to do well in various market conditions. There have been market periods – certainly when the US invaded Afghanistan and Iraq – when oil and weapons were the only securities going up. That was a very bad time for responsible investment portfolios – all of them underperformed for two years. Responsible investing does introduce a bias, but then so does small-cap investing, or value investing, or any other kind of investing; eventually you return to the norm. And the norm in responsible investing is that you identify superior management teams with stronger corporate cultures producing better products. That’s a good formula for success, especially for fiduciaries.” How is the growing awareness of global warming shaping the SI agenda? Do you agree with the IPCC’s synopsis that it may be too late to meet the 2-degree target? Or are you more optimistic? “From a Wall Street perspective, climate change creates an opportunity – you invest in solutions to climate change, technological solutions. We’re not seeing a lot of people rushing out to plant trees, which should be the first step. Big financial service companies prefer to chase the new technologies necessary to save the world from climate change, rather than finance these low-cost solutions. Nonetheless, it opens the door to mainstream.” “After South Africa ended apartheid in 1994, and most

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Amy Domini is considered to be one of the founders of sustainable investing, having embraced it in the mid-1980s when it was essentially a protest

responsible investors in the US were willing to reinvest in South Africa, there was a period of time when people talked about concern over the environment as being ‘the next South Africa’ for the industry. It kind of receded, but now it’s come back again with strength. Done in conjunction with human rights, concern over climate change is a powerful driver of SI.” “We’ve seen the devastating results of climate change raise costs of flood insurance and property and casualty insurance. We had a big utility here in the US, Pacific Gas & Electric, that lost USD 2 billion in three days due to the California forest fires. These are definite indications that the acceleration to the dismantling of the planetary norms that make human life possible also hurts some companies. But concern over climate change is still not as big a motivator here in the US as it should be. We’ve had a real assault on science here for a couple of decades, and the result has been that there’s a whole category of people who for 15 years thought they could not be re-elected for office if they acknowledged this climate change problem. There are two things I invest for – people and the planet – so clearly this is one of my personal drivers.” What about the energy transition from coal, oil and gas to renewables? The world still needs fossil fuels, so how do you view this arena? “Over the last two years, Domini Impact Investments has moved to the explicit removal of energy sector companies from our universe. Many years ago we had a couple of fairly large oil and gas companies; then we moved to the position that natural gas was transitional, and we wouldn’t have oil; then all natural gas companies started fracking, and we moved down further. Even though we could buy gas companies, we never found any that were good enough to buy using our criteria. While there’s a moral argument about fossil fuels, there’s also a practical argument that results from the data points that we look at with regard to human health and safety and ecological sustainability. We just couldn’t find a company in those energy sectors that met what we’re looking for. We’ve excluded coal since the start. Most economies still rely on coal, but they also still allow smoking and guns.” What are the main drivers now behind Domini Impact Investments? How were your Impact Investment Standards devised and deployed? “We have three basic products: a bond fund, an international

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movement. In 1989, she co-founded the sustainability consulting firm KLD Research & Analytics, which a decade later would advise Robeco on the launch of its first sustainable fund, the Duurzaam Aandelen fund. In 1990, she created the world’s first sustainability index, the Domini 400 Social Index, tracking the companies which had the best records using socially responsible or other ethical criteria. After the KLD partners separated, she founded Domini Impact Investments, which runs two equity funds along sustainability guidelines and one bond fund which is designed to channel capital to poor communities. In 2005, she was named on the Time 100 list of the world’s most influential people. She was later honored by President Clinton for services to sustainable investing and philanthropy. She is the author of ‘Socially Responsible Investing: Making a Difference and Making Money’ and ‘The Challenges of Wealth’, and co-author of ‘Investing for Good’, ‘The Social Investment Almanac’, and ‘Ethical Investing’. She has also served on the board of the Church Pension Fund of the Episcopal Church in America, and the Interfaith Center on Corporate Responsibility. She is a member of the Chartered Financial Analyst Society and is the Chair of her firm.

equity fund and a domestic equity fund. The bond fund is a marvelous setting for the caring investor, because you can have a bond that is created to build a dormitory for a college, or a new wing for a hospital in a low-income neighborhood that’s situated in a downtrodden city. You are directly lending for social purpose, which allows us to make direct investments in answers to social and environmental problems. We buy a broad range from green bonds to social bonds to direct purpose investments that are useful to lifting people out of poverty, or giving them shelter, and are clear-cut impact investments.” “In our international and US equity funds, we apply the same standards in looking for companies that are above average with regards to universal human dignity and ecological sustainability. Certain obvious things come to the fore: access to capital, communications, clean water and health care, and clean air and food and shelter, access to the comforts of life. We are very keen on the access theme.” “As for the US domestic fund, in late 2018 we changed strategy.

Great Minds

Some 90% of the portfolio is run with a beta strategy, where social and environmental criteria are our primary factor. And for 10%, we allocated to the kind of company that is uniquely special in answering these issues of access and availability. We called this section ‘thematic solutions’; we had been running a portfolio with this methodology for more than five years, so we had a strong confidence in it. And to the present day, that 10% of the portfolio has added positive alpha to the ordinary portfolio, and the whole fund has finally outperformed broad market benchmarks.” “Thematic solutions include the kind of names that would encompass new opportunities; one company partners with universities to allow a person in Nepal to get a Harvard degree by attending classes on the internet. Another company takes blood samples and reads very quickly whether you have Ebola or any one of a number of other diseases that plague hard-toreach populations, so that rapid diagnostics can help determine actions.” “Our funds also exclude certain things. Sure, if I do a survey of my shareholders and ask how much they care about alcohol, it’s not going to come across as a big exclusionary screen. But we do exclude it because it is harmful, not only for the abuser, but also to the immediate family and to other people; the innocent person who walks into the path of the drunk driver. We take this position with gambling as well – it’s not only harmful to the abuser, but the family and community as well. These products we view as addictive and dangerous to larger society, and are not a good use of capitalism.” Did the Domini 400 Social Index make its mark on investing culture, particularly in the US? “For the period of time after the end of apartheid in South Africa, it was the performance of the Domini 400 Social Index that drove the interest in this field. People could not believe that it kept outperforming! It would only outperform a little more frequently than it would underperform. But when it outperformed, it would outperform by more, and when it underperformed it did so by less, so the gap kept widening. That was worth gold on Wall Street. That index did I think carry the field to the new stage where people said there’s something going on here. What was going on was the identification of strong corporate culture and solid management teams, especially in goods and services.” “But then the KLD partners separated, and the index became

part of MSCI. The MSCI KLD 400 Social Index as it exists today is now very different from what I would design – for instance, it holds oil and gas. They would say that the typical responsible investor is invested in oil and gas today (*including Robeco).” What are the challenges of measuring ‘impact’ (particularly financially), given the alphabet soup of definitions for what constitutes sustainable investing, from ESG to SRI? Is the focus really on the ‘social’, the ‘responsible’, or the need to still make money? “To be in my camp, you need three components. Firstly, you need to apply social, ethical and environmental standards for what you invest in. Secondly, you need to engage with corporations, or wherever the power is, as this may be community groups, other organizations or the government itself. (That last one has been less fruitful for us here in America lately.) Finally, you need to find ways to make a direct impact, such as by making a loan to a housing unit in a distressed neighborhood. We provide the result of all our investments in the Impact Report on our website.” “One important impact of applying standards has been the surge in reporting along the Global Reporting Initiative guidelines; another has been the surge in a new breed of person called the Corporate Sustainability Officer. We as the investor are not interested in trying to drill down through the corporation and write an essay about what they’re doing; my end goal is to be provided with universal data points akin to what we have in finance. I argue that the creation of these reports and sustainability officers is an impact that would not have happened without our existence. Sustainable investing made that happen; again, I refer to our Impact Report.” What about engagement? Given that you are a smaller investor with highly specific goals, how does that work at Domini? “Engagement is best used to help define a problem. There is a problem when a building in Rana, Bangladesh collapses and more than 1,000 workers die. You don’t know the complexity of what drives people to work in such a building – it takes a lot of dialog with a lot of NGOs, with corporations that are supplying from that factor, and with investors, to create a standard for sourcing garments from Bangladesh. Until we have that dialog, we can’t just walk in and say we have a standard – we don’t know what that standard should be. I see engagement as creating a construct within which we can have standards. Thereafter you have the capacity to say it is a well-managed facility or it isn’t.”

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‘Fiduciary responsibility, especially in the US, needs to be more clearly tied to the whole person’

on things like sanctions and responsible banking. We have contributed an individual to many of their initiatives in order to attempt to represent what investors might be able to bring to the table. Now that the UNPRI has such widespread adoption, the UN has found financial service companies can help.”

“During 2018 we engaged with 94 companies. One opportunity presented itself in Japan. In Japan, diversity historically has focused on people with physical handicaps – they haven’t focused on the kinds of things that we focus on in the West. We’ve had a letter-writing campaign for seven or eight years now to remind Japanese corporations that there are two genders, and it would be nice to see representation of both on their boards of directors and top management. And here’s where you get to the cultural side of things – Japanese companies think they should answer the mail, so they write back and say, ‘that’s very interesting’. Over the years we’ve had some successes and seen women serve on boards of directors. The ball starts moving, and that’s why we do it.” Are you directly involved with the UN’s Sustainable Development Goals, or is there any indirect overlap with them in your work? “We are strongly supportive of the goals. The SDGs address a great many of the issues that we look at. Our historic evaluation of ecosystems buckets the goals 6, 7, 8, 12, 13, 14 and 15, which concern environmental sustainability, climate resilience, renewable and alternative energy, sustainable materials, resource efficiency and so on. We’re fortunate that the United Nations headquarters is in New York City, where our research team is located, so we have been involved with their committees

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You’ve won a considerable amount of plaudits during your long career… do you still get excited about SI today as when you started? If you were ‘president of the world’, what would you change? “I’m still giddy about it; I think my battle has goals that I now see as urgent; these are threefold. First is the need for disclosure or transparency about corporate impact, and how they affect communities and the planet. The next thing I would ask for is putting some sand in the speed of financial transactions, as this is converting the investor into a gambler. Financial systems serving as a casino is a lousy way to run a planet. We really need to do something that slows down the speed and ease of transactions; taxing them is probably an elegant solution, but there may be other ways of slowing it down.” “And finally, fiduciary responsibility, especially in the US, needs to be more clearly tied to the whole person. You really don’t retire in dignity based on your income. If you live in a dangerous neighborhood and you’re afraid to go out after dark, that is not retiring with dignity. If your grandson has asthma, you don’t care that you have an extra 100 dollars in your pocket due to the flourishing coal industry; you’re more interested in your grandchild’s health. The definition of fiduciary responsibility must explicitly address the whole future of retiring, not simply the pocketbook of the retiree. We need three things to happen: greater transparency as to a company’s impact on people and the planet, avoiding the corrupting of financial systems by gamblers and defining fiduciary obligation to the whole person. With this I would have seen my ultimate goal, and I would feel I can rest.”

Health and wellness as the key trend There is no denying that young consumers care about their health. This is reflected in a variety of choices – about diet, sports, wellness, leisure, work, travel and even clothing. Investors adopting a more defensive investment strategy would be wise to gradually make space for value stocks in 2019. The industry has a few underlying drivers, the most important one being the strong growth of small and local brands, particularly in emerging markets. The health and wellness trend reinforces it, as it drives the need for higher-quality ingredients. The rising demand for convenience is another contributing factor, whether it be for on-the-go meals or shorter average meal preparation time. The healthy consumer trend as a whole is also driven by the internet, which has lowered the barriers to entering the market.

Speed read

Trends

• Millennials and Gen Z value healthy lifestyles • Trend driven by local brands, social networks • Opportunities for food producers with well-rounded portfolios

Millennials and Gen Z use fitness trackers and smart watches to track training data and health information. And they eat more natural and organic foods, with healthier ingredients and fresh herbs and spices. “For millennials, wellness is an ongoing commitment,” says Robeco portfolio manager Jack Neele. Particularly noteworthy is Gen Z’s attitude to consumption, which has become more like an expression of individual identity, and a matter of ethical concern. The healthy consumer space is truly diverse, with subthemes ranging from fitness to food ingredients. It also includes beauty, sleep, personalized care, athletic apparel, personalized nutrition, travel, hospitality and mental wellness. Within this vast universe, the industry of healthy and organic food is growing the fastest. For example, low-calorie sweeteners and vegetable snacking are becoming increasingly popular.

Traditional packaged food companies are under pressure These days, young consumers eat healthily and rely on the internet to find the healthiest foods. The advancement of internet and e-commerce have lowered barriers to market entry for startups in this area. “It has never been easier to launch a brand and advertise it on networks like Instagram,” says Neele. All these factors have disrupted traditional food producers. “For years, they have been focused on efficient manufacturing and lowering prices, often at the expense of quality and health characteristics,” says Neele. So it comes as no surprise that the returns of most of the USbased traditional packaged food producers have been falling compared to the S&P 500 Index since at least 2017.

What are the implications for investors?

Investors can benefit greatly from having an understanding of the healthy consumer universe. The structural winners in this trend could either be new entrants who are able to benefit from it, or traditional food producers Figure 1 | US Tradional Package Food versus the S&P 500 index (Jan 2017-March 2019) 35.0% with a well-rounded product portfolio.

The organic food industry has multiple drivers

15.0%

-5.0%

-25.0%

-45.0%

-65.0%

01-2017 04-2017 07-2017 10-2017 01-2018 04-2018 07-2018 10-2018 01-2019 S&P 500 Index

Source: Robeco Trends Investing

Company A

Company B

Company C

Company D

Source: Robeco

“We believe that within the space, the specialty ingredients market is seeing significant growth and presents an important investment opportunity,” says Neele. The production of the enzymes necessary for making probiotic yoghurt is just one example. The specialty ingredients market is currently worth around USD 75 billion, it is growing fast and delivering high margins and returns.

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LAST BUT NOT LEAST Health care desperately needs digital tools Todayâ&#x20AC;&#x2122;s health care is plagued by multiple malaises that range from soaring costs to wrong incentives, lack of preventive care and a siloed industry structure. Digital tools offer a solution and can pave the way for better, faster and cheaper health care. For example, artificial intelligence will make administrative processes more efficient, provide new insight into diseases and lead to new therapies. Telemedicine will make care accessible anytime, anywhere, and at a lower cost. Genomics will transform health care as it opens the door to personalized medicine. Last but not least, robotic surgery is less invasive, and leads to fewer complications, lower recovery times and better outcomes.

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The ‘digital toolbox’: emergency care for our health care system Vera Krückel, Trend researcher, Trend Investing Equity team

Digital health will offer attractive and wide-ranging investment opportunities for at least a decade to come. Today’s health care is plagued by multiple malaises that range from soaring costs to wrong incentive structures, lack of preventive care and a siloed industry structure. Digital tools offer a solution and can pave the way for better, faster and cheaper health care. While almost all major sectors of the economy have seen massive change over the last years through digitalization, health care has stubbornly stuck to its − at times − archaic methods. The system is inefficient and costly, and information is fragmented and static. And above all, there is insufficient focus on the patient, with too much of a one-size-fits-all approach. The industry business model is built on the wrong incentive structures as it envisages profits rising through ongoing management of disease rather than through prevention and comprehensive cures.

Flaws in the system and catalysts for change

We see a number of factors coming together to eventually change the health care sector. These will be economic, regulatory, technological or societal in nature and are thus quite wide-ranging. On the economic side, health care costs are currently increasing at the rate of GDP plus 2%. If this growth is not halted, it could seriously endanger the solvency of some health care payers. Therefore, regulatory change has been enacted; in the US, the system is transitioning to ‘value-based care’, in which business models are geared more towards the outcome rather than just the number of treatments performed. Last but not least, we expect to see a societal and generational shift: patients still live in a paternalized world where they have little insight into their own health, let alone having an actual say about how they are treated.

‘Ironically, the sicker a society becomes, the more profitable the health care industry will be’

Digital tools have already transformed industries such as retail and media, and there is no reason why health care would be any different. Digitalization can help the industry both to reduce costs and improve health care outcomes. Analytical tools including artificial intelligence will make administrative processes more efficient, provide new insight into diseases and lead to new therapies. Telemedicine will make care accessible anytime, anywhere, and at a lower cost. In some cases, telemedicine may even improve the quality of care.

The digital toolbox encompasses a broad range of solutions such as health information technology, mobile and telehealth, telemedicine, quantified self and remote monitoring tools. We further broaden the scope by adding to the list technologies such as artificial intelligence, genomics sequencing and the allimportant prevention or ‘healthy living’.

We expect the economics of digital solutions to be healthy, too, and the best investment opportunities will be in companies which are aligned with the dual objective of reducing costs and improving outcomes in health care.

Many of these tools, such as artificial intelligence, have been developed and optimized in other sectors. Increasingly, they are advancing to a point where they can also play a major role in a mission-critical industry such as health care. In effect, the

The digital toolbox for health offers tools for better health care

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Health care in numbers $2.6 billion Average cost of developing a drug and getting it approved1

8.1 years Average time to develop a drug and get it approved1 combination of cheaper hardware, such as low-cost sensors or robotics, better software, such as machine-learning algorithms, and the genomic revolution are what make the digital toolbox possible. We further subdivide the digital toolbox into consumer- and producer-facing solutions. Here we focus on the ‘producer’ side of health care.

Investment implications Great change leads to great opportunity. As we are in the very early stages of the process, we expect the space to offer structurally attractive investment opportunities for many years to come. The revolution will play out over at least a decade as regulators will ensure the transition occurs in an orderly fashion and at a moderate pace. The investment universe is very broad, consisting of many small players, many of whom are still in the private sphere. Some of the business models and technologies are new and unproven.

$60,000 Average family income in the US $8,000 Cost of health plan deductibles or co-pays 25,000 petabytes Estimated volume of global health care data by 20212

16 Average number of electronic health-record vendors in use at US hospitals3

18% Percentage of physician’s work devoted to gathering information 1. DiMasi JA, Grabowski HG, Hansen RA. Innovation in the pharmaceutical industry: new estimates of R&D costs. Journal of Health Economics 2016;47:20-33. 2. Feldman, Martin and Skotnes; Big Data in Healthcare Hype and Hope, 2012 3. Cerner

The data

is a prerequisite for all further innovation, the owners of such datasets will play a key role in paving the way to better health care.

A clean and comprehensive data layer forms the foundation of health care innovation. Providers of electronic health records are in a good position to form the foundation of the health care industry. Becoming the de facto standard in the industry would give these providers a significant competitive advantage. Electronic health records will connect data siloes to each other, enabling a continuum of care. As a comprehensive patient record

The value and information content of a properly functioning data pool is enormous and could put an end to the siloed approach to health care. The ideal database consists of a privacy-protected and comprehensive record of the patient, derived from various sources including points of care (a hospital, primary care physician, etc.), lifestyle and wearable data, insurers (claims and payment data),

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‘Digital tools are a combination of breakthroughs in health care and tools borrowed from other verticals’

genomic profiles and metabolic data. Big tech has already recognized the opportunities in health care, with Apple having launched an electronic health record for iPhone users and Microsoft hoping to market its cloud environment to the health care industry, for example. Telemedicine players such as Teladoc and Babylon Health (unlisted) are creating patient dashboards on their telehealth platforms. The health record companies Cerner, Allscripts and Epic (unlisted) already have an edge in this area thanks to their established position in electronic health records. To maintain this lead, they would need to innovate and reinvest in order to connect other datasets to their records. These would offer a holistic and complete overview of the patient and/or disease types, thus enabling entirely new kinds of analytics and leading to new insights. Blockchain applications can potentially protect privacy and hand over control of that data to the patient.

Artificial intelligence Once there is a solid data layer in place, new data analytics tools can help to enhance productivity and lead to the development of tools to support clinical decision-making, such as diagnostic image recognition. They can also improve clinical trials, which might lead to the discovery of new drugs. Firms that have structured sets of health care data (e.g. images) and also those that build the algorithms to collect that data can be beneficiaries. ‘Boring’ AI – productivity gains through workflow streamlining – will be the near-term benefit. Today, 18% of physicians’ work is administrative, an additional 12% consists of simple tasks and 25% of US hospital budgets go towards administrative expenses. For example, with speech recognition, records of patient visits can be added to electronic health records automatically, significantly lowering the documentation burden. AI will benefit those hospitals that tend to embrace new technologies early on and thereby save costs. And those that actually develop the optimization tools stand to benefit even more. These include revenue-cycle management companies like Medidata Solutions, HMS Holdings, Evolent Health or Benefitfocus. In terms of clinical decision-making, the hope is that artificial intelligence − in combination with greater computing power − will compress the clinical trial funnel by making it possible to pre-screen for the most promising molecules and find new

patterns. Also, virtual simulations of drug performance can decrease the need for costly animal and human trials, and shorten the time to market.

The large pharma companies, especially those that spend significant amounts on R&D, such as Roche or Merck (around 20% of sales) will benefit the most from these applications. Those who offer AI tools to make clinical research more cost-effective through better data, such as IQVIA, will benefit much more directly and therefore sooner than other parties. Other clinical research organizations such as PRA Health Sciences are also well positioned.

Genomics Genomics will transform health care as it opens the door to personalized medicine. Information on genetic markers can make diagnostics, treatments and prevention more targeted, effective and cost-effective. The producers of genome sequencing machines, tool manufacturers and testing labs all stand to benefit from this. Leading the way to personalized care, sequencing companies will be the main beneficiaries of the genomics revolution. Diagnostic tools and labs will also see increased demand for their services. DNA − or deoxyribonucleic acid − is the language of life; it contains information on eye color, predisposition to disease, your ancestry, whether you like cilantro (yes, that is genetically determined) and probably many other things we have yet to discover. The cost of sequencing a full human genome, i.e. determining the entire source code, has declined from USD 100 million to less than USD 1,000 over the last 15 years. It is hoped that by 2025, up to 2 billion human genomes will have been sequenced and that the cost will drop to a mere USD 100. The resulting dataset from sequencing large populations will be of immense significance to medicine; pharmacogenomics will tell us in advance which drugs will be effective for which people. Similarly, tailoring doses to the individual to achieve the most effective dose for that specific person can spare patients nasty side effects, as the ‘average’ dose is unnecessarily high for many people. While knowing your predisposition to disease is useful, being able to actually change your DNA and eliminate a diseasecausing gene would take treatment to a whole new level. This is where ‘Clustered Regularly Interspaced Short Palindromic Repeats’ − also referred to as ‘CRISPR’ − comes in. CRISPR is a technique

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that allows you to modify individual genes in a very precise and targeted manner.

‘We see the enablers of the genomic revolution as some of the bestpositioned players in health care’

We think genomics will transform medicine and we see the enablers of the genomic revolution as some of the best-positioned players in health care. Sequencing companies such as Illumina are the large and direct beneficiaries. Investments in CRISPR companies such as Editas Medicine or CRISPR Therapeutics are a lot more adventurous.

Telemedicine Online patient visits are often more convenient, of higher quality and cheaper than on-premise care. Together with remotemonitoring devices, a telemedicine platform can provide useful solutions for health care providers and patients alike. It will be interesting to see how telemedicine platforms themselves develop, but companies that produce sensors and lasers deserve our attention, as well. If telemedicine companies succeed in building a network effect, that would constitute an especially attractive moat. The global telemedicine market is still nascent, with a penetration rate of only 5% (measured as a percentage of participants making use of telemedicine when offered by their insurer). However, at an estimated size of USD 26 billion (2018, Statista) the market is already sizeable. Going forward, the market is expected to grow significantly and reach USD 41 billion by 2021. The value of telemedicine will increase further as companies move towards integrated internet health platforms or one-stop solutions, including additional services such as express drug home delivery, lifestyle advice and monitoring to manage a patient’s health holistically. A significant portion of the virtual-care market will be doctor-to-doctor − or D2D. Another segment of telemedicine is the remote monitoring market, which is worth an estimated USD 17.5 billion (2018) and is growing rapidly. The declining costs of sensors as well as the rising speed of connectivity, with 5G potentially opening further applications, will help facilitate this growth. Tracking and diagnostics are a further application of telemedicine. Soon, you will be able to download mobile apps for breath analytics, blood pressure measurement, glucose monitoring and more. Eventually, it will be possible to monitor a patient’s vital

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signs remotely after they are discharged following surgery. Canada Health Infoway found that for every USD 1 invested in telehomecare, they were able to create a USD 4 value for the system.

We see companies which offer remote monitoring devices, sensors, patches, and medical lasers benefiting from this development, including Philips, iRhythm, Dexcom, Medtronic and Abbott. Insurance companies can benefit, too, through reduced costs, but the telemedicine names, which could offer new health care platforms, will be the biggest beneficiaries. These include Teladoc (US), Babylon (UK, unlisted), Ping An Health (China) and SHL Telemedicine (Israel).

Robotic surgery Surgery with robotic assistance is less invasive, and leads to fewer complications, lower recovery times and better outcomes. This space is very attractive, with pioneering market leaders driving innovation, and there is room in the market for new entrants. There are competitive advantages to be gained through intangible assets such as a good safety record, or increasing switching costs. Robotic surgery is growing steadily as it has demonstrated its capability to produce better outcomes. With ample room for growth and strong innovative players active in the market, it is a very attractive segment from an investment perspective. Overall, as a percentage of total potential market size, penetration levels are still very low, at around 2-3% of all surgical procedures. We think this is bound to change as more types of procedures open up for robotic surgery. The market size of robotic surgery is around USD 60 billion. Growth is expected to be around 8-9% over the next five years (KBV Research). The integration of enhanced imaging, augmented reality and data analytics support through machine learning will further enhance the value proposition of robotic surgery. We think robotic surgery has ample room to run as improving economics will drive penetration rates further. Intuitive Surgical is the clear market and innovation leader in this space, enjoying a large share of the market and, therefore, a significant moat. Stryker focuses mainly on orthopedic robotic surgery. Given the significant growth potential in existing and new markets, we see plenty of room for other players to enter as well, such as Abbott, Medtronic or Mazor Robotics.

Mark van der Kroft

’We strive to find the winners of the next decade’ Interview

Some investment themes do not play out in a year. Robeco’s head of Trends and Thematic Investments, Mark van der Kroft, talks about the strengths and unique approach of his team, as well as the challenges trends investors face and the reasons behind the current revival of interest in trends investing.

People say trends investing is enjoying a revival – do you believe this is the case? “We have indeed seen an increase in demand for our trendsbased strategies both in Zurich and Rotterdam. On the one hand, we have seen an enormous increase in demand for passive investments, which are cheap and easy to buy, and don’t entail the risk of getting it wrong versus the benchmark. On the other hand, this is creating opportunities for truly active investment solutions that offer the alpha that investors are still looking for.” “Another driver is the potential for what I would call a low-return environment in the next couple of years, which will make the alpha we generate in trends investing even more important. A 4% outperformance is simply worth more in a flat market than in a market that is up 20%.” What are the challenges of trends investing? “A key challenge is distinguishing long-term trends from shortterm hypes and monetizing the longer-term opportunities. Our research is based on identifying these trends and selecting those companies that are able to benefit from secular or disruptive changes.” “That said, it remains important for our strategies to offer excess returns versus the required benchmark. The challenge is that

we really take a long investment horizon while at the same time striving to avoid short-term noise and short-term performance pressure.” How does Robeco’s approach differ from that of peers? What makes it stand out? “I think we stand out for several reasons. First and foremost, we have been investing in trends and themes for a very long time – from around the late 90s, when our first fund was launched. Robeco Trends and Thematic Investments is unique not only because of its history, but also because of its team of portfolio managers and analysts. Most of them have worked at the company for a long time, and have also been responsible for a specific fund for 15 years or more.” “Second, in-depth research has always provided the strong foundation for all our investment strategies, and within Trends & Thematic Investments, we have developed a broad research-based toolset. Finally, sustainability is at the heart of our thematic approach. Trends & Thematic Investments is in fact part of a combined, complementary investment platform. Trends investing is what we do in Rotterdam; thematic sustainable investing in Zurich.” What is the bright spot and, conversely, what is the flip side? “The bright side – or what I would call ‘different’ side – is that it is a truly active, long-term and forward-looking investment strategy.

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‘Sustainability is at the heart of our thematic approach’ It does not look into the past when it comes to portfolio construction and therefore is not benchmark-oriented. We ask ourselves which industries and, in particular, which companies will be the structural winners in the next decade, following on from the structural and disruptive changes that we are witnessing today? And, as a result, which companies will not be part of that future?” “So we do not spend time on past winners but try to find the winners of the 2020s. Most of all, trends & thematic investing is about avoiding the losers – companies or industries which do not or cannot adapt to a changing and disruptive world.” “The flip side is that periods of lagging performance can be tough, but we firmly believe that over a longer time span, our strategies pay off, which history confirms.”

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How do you see the future of trends investing? “We are very positive about the future of trends investing. Of course, we’ve had an enormous tailwind over the past three years, as our investment style has benefitted from a macroenvironment where growth has been scarce so growth stocks have been bid up. In that sense, I would not be surprised to see some setbacks in the short term, because nothing goes in a straight line.” “If you take a longer-term view, the popularity of active and high-conviction thematic investment styles will continue to grow. We have strong, highly experienced teams both in Rotterdam and in Zurich with investment strategies which deliver on their longer-term promises. That combination, along with a strong sustainable footing, makes us truly unique.”

Column

How to avoid greenwashing With the rise and rise of new sustainable funds, the question of how to avoid greenwashing becomes more prevalent, and there is a lot of attention in the media for this. Whereas in the past a fund would simply be labeled (Socially) Responsible or not, the market is now distinguishing between different ways of implementing sustainability. In my opinion, a strategy is only sustainable if it is also financially sustainable. So, integrated thinking is important. How do long-term ESG trends and external costs such as climate change, loss of biodiversity and rising inequality lead to changes in business models? ESG investing no longer means only using exclusions, or only reducing an investment universe to the ‘best-scoring’ names. It means thinking hard about sustainability and how it affects companies and investment strategies. It’s about integrated ESG… Structurally integrating ESG information into the investment process helps our teams make better decisions. It does not, however, reduce the universe, and they are still allowed to invest in companies with low ESG scores so long as they believe the risks are more than priced into the market. This method of integrating ESG, although infinitely more difficult and profound in its application than only using ESG scores to reduce the universe, is often not categorized as a sustainable strategy. Clients who want to invest in sustainable strategies simply do not want to invest in ‘bad’ ESG companies, even if this is already reflected in the share price.

Now, this all requires dedicated resources and research. If you ask an investment team to add ESG to their process, you need to give them the resources and knowledge to be able to do so. They did not get this stuff at university or in their on-the-job-training most of the time. At Robeco, we have many different sustainability specialists working with all the investment teams, and we do not have a separate sustainable investment team. Everyone participates. There is also a wealth of ESG data around, so being able to understand and judge this data is most important. …and Active Ownership Another way of implementing sustainability is through Active Ownership. Last year, our team of 13 dedicated specialists engaged with 214 companies. The engagement takes place over a three-year period, allowing us to track and measure the progress of companies. Some asset managers claim to engage with 2,000 companies per year. In my opinion, that cannot be more than asking one or two questions on ESG at a regular meeting, or sending a standard letter. You need to have substantial resources in place to be able to do this in a credible way. Voting behavior is also interesting. Research shows that some of the larger (passive) investors almost always vote with a management’s recommendation, even on shareholder proposals relating to environmental and social issues. That doubts the credibility of that manager, I think. We see that social and environmental shareholder proposals are becoming better formulated and more in line with long-term shareholder value creation. So, last year we voted in favor of those proposals in 72% and 78% of the cases, respectively. This brings me to my key point: walking the talk. How credible is a fund provider if they provide a few very good SI funds, but are not doing anything in their other products, or in their own operations, such as their voting behavior? Transparency is most important: asset managers need to clearly show what is and what is not part of the strategy of the fund, no matter whether it is called sustainable or responsible, or something else.

Masja Zandbergen, Head of ESG integration

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CONTACT Robeco P.O. Box 973 3000 AZ Rotterdam The Netherlands T +31 10 224 1 224 I www.robeco.com