Robeco quarterly september 2017 by Robeco

Robeco

Intended for professional investors only

QUARTERLY IN ASIA IT’S ALL ABOUT DYNAMICS – 36 FIVE-YEAR EXPECTED RETURNS – 7 WHY SIN STOCKS OUTPERFORM – 20 THE FUTURE OF THE EURO – 26 LONG READ: THE RATIONALE BEHIND TRENDS INVESTING – 32

QUANT investing SUSTAINABILITY investing #5 / September 2017

”‘Have we entered the economic ice age?’ The importance of this question is clear. If we have, the 2017 rebound will be shortlived, with bond yields likely to decline again and the outlook for risky assets becoming vulnerable. If not, the reverse looks more likely. Our critical assessment shows that certainly not all of the secular stagnation arguments are convincing.” Lukas Daalder CIO Investment Solutions

Robeco QUARTERLY • #5 / SEPTEMBER 2017

Tactically timing exposures to different factors? Not that easy!

Whether or not investors should tactically time their exposures to the different factors is certainly one of the most hotly debated issues among factor investing experts these days. In fact, the controversy has now escalated well beyond the typical arguments between theorists. The predictive power of credit momentum for equities Factor investing in credit markets is coming of age Factor investing also works with Chinese A-shares

SUSTAINABILITY investing

Research reveals why sin stocks outperform

11 13 15

And more…

QUANT investing

CONTENTS OUTLOOK Expected Returns: financial markets are coming of age

RESEARCH Bonds are from Venus, equities are also from Venus

RESEARCH The future of the euro

TRENDS Behind every cloud is a data center

RESEARCH Net alpha is not a measure of manager’s skill

LONG READ The rationale behind trends investing

INTERVIEW ‘In many ways Asia has left the West behind’

COLUMN The vision thing

Some industries remain off-limits to many investors on ethical grounds. And this creates a dilemma, since some of the most contentious businesses are highly profitable, which means following your conscience may cost your clients money. Climate change faces threat from two unlikely sources

Two worlds colliding – insights from ESG integration

Private equity managers show progress in ESG integration

Robeco QUARTERLY • #5 / SEPTEMBER 2017

Sustainability

UN PRI: Robeco flying high The UN Principles for Responsible Investment (UN PRI) have awarded Robeco excellent scores. Robeco obtained the highest possible score for the sustainability of its strategy and governance. ESG integration and active ownership in equity, fixed income and private equity strategies also received excellent scores, with four A+ and two A ratings. Peter Ferket, Head of Investments and Member of Robeco’s Executive Committee: “Sustainability Investing is and will remain an important strategic pillar for Robeco, so I’m very happy with these excellent UN PRI assessment results, especially with the A+ for the most important module, Strategy & Governance. I’m convinced that constantly improving our SI approach and collaborating closely with RobecoSAM will enable us to remain a global leader in Sustainability Investing.” This year, for the first time, Robeco conducted an internal audit on the

assessment report, underlining Robeco’s thorough approach towards the assessment. Robeco is one of the very first asset managers in the world to have done this. As clients and other stakeholders are increasingly scrutinizing the sustainability investing approaches of asset managers,

Summary SummaryScorecard Scorecard AUM AUM

Module name Module name

Robeco score Robeco score

A+ A+

<10% Private Equity <10% 07.07. Private Equity

DIRECT && ACTIVE OWNERSHIP MODULES DIRECT ACTIVE OWNERSHIP MODULES

10-50% Listed Equity - Incorporation 10-50% 10.10. Listed Equity - Incorporation 10-50% Listed Equity - Active Ownership 10-50% 11.11. Listed Equity - Active Ownership 10-50% Fixed Income - SSA 10-50% 12.12. Fixed Income - SSA <10% Fixed Income - Corporate Financial <10% 13.13. Fixed Income - Corporate Financial 10-50% Fixed Income - Corporate Non-Financial 10-50% 14.14. Fixed Income - Corporate Non-Financial

A+ A+ A+ A+ A+ A+ AA AA

AA BB BB BB BB

Source: PRI Assessment report 2017, showing the applicable Robeco scores. Source: PRI Assessment report 2017, showing the applicable Robeco scores.

To paraphrase Mark Twain, ‘the reports of the death of inflation are greatly exaggerated’. Why did inflation not return, after years of quantitative easing? Well, it did. Inflation has in fact materialized, but not in the sphere of goods and services,

Median Score Median Score

INDIRECT - MANAGER SELECTION, APPOINTMENT && MONITORING INDIRECT - MANAGER SELECTION, APPOINTMENT MONITORING

Will hurricane Harvey be the Most Expensive Ever? Estimates of Harvey’s costs vary from USD 70 bln to USD 190 bln. These were the most expensive hurricanes so far.

Source: FiveThirtyEight

Robeco score Robeco score

A+ A+

01.01. Strategy && Governance Strategy Governance

Inflation is not dead

USD 160 bln USD 70 bln USD 48 bln USD 35 bln USD 27 bln USD 24 bln USD 24 bln USD 21 bln

An overview of the categories in which Robeco was assessed and the 2017 scores can be found below.

Assessment Report 2017 Assessment Report 2017

Hurricane Harvey

Katrina (2005) Sandy (2012) Andrew (1992) Ike (2008) Ivan (2004) Rita (2005) Wilma (2005) Charley (2004)

there is a growing demand for accountability and verification. This is an important step in that direction.

but rather in the realm of financial markets (real estate, equities and bonds). As these assets are not included in the inflation target of central banks, we do not see them as inflationary, though.

Source: Mashable

Robeco QUARTERLY • #5 / SEPTEMBER 2017

Moving on from ESG integration to SDG impact

The reason why ‘quants’ started paying closer attention to credits only recently is plain and simple. To conduct empirical analysis, quants need data, and historical datasets on individual corporate bonds were hard to find for a long time. Nowadays, such datasets have become more widely available and, as a result, the number of research articles has risen substantially. “We counted as many papers on factor investing in credit markets that were published over the last 18 months as in the five years before,” Houweling says.

Robeco QUARTERLY • #5 / SEPTEMBER 2017

Editorial

Credits

Credit quants are coming

Just ten years ago, sustainable investing still suffered the stigma of being the last redoubt of sandal-wearing eco-warriors. However, since then we’ve taken some giant leaps forward. With the introduction of the UN PRI in 2006 the commitment of asset owners and asset managers to integrate ESG factors into investment processes has grown tremendously. As a long-term signatory to UN PRI, Robeco participates in the annual PRI Reporting and Assessment process. At Robeco we have the strong belief that integrating ESG factors in our investment processes leads to better-informed investment decisions and benefits society. Therefore we continuously strive to further improve integration of ESG factors in all our investment processes as well as our engagement with companies on ESG related matters. We are proud that our efforts have been recognized in the 2017 PRI assessment with the highest A+ score for five modules and high A scores for two modules – these scores being at least one notch higher compared to the median score in the PRI Assessment. Like UN PRI has been the driving force for ESG integration, the Sustainable Development Goals (SDGs) will be the same for impact investing – it will be a ‘license to operate’. But you need data and information to measure companies along the SDG yardstick. And that’s not easy, though it is possible. Just as we now have much more information on ESG integration than ten years ago, a universal test methodology will have to be developed to reveal this information. Various parties, including RobecoSAM, have been occupied with this task for many years already. In the ideal scenario, the industry would join forces to develop a single yardstick. However things progress from here, the days are long gone when you could get away with boasting a couple of impact funds. Within a couple of years, the industry will have to report on the impact portfolios have on the 17 SDGs. And although this doesn’t exactly make things easier or cheaper, it does mean our industry has a fresh opportunity to offer clients more value on various fronts. And money talks – these developments will eventually funnel the money into companies and sectors that will have a positive long-term impact on our world, alongside a healthy financial return on investments.

Peter Ferket, Head of Investments

The current bull market in US equities is now the second-longest and secondbiggest since World War II. It started on 9 March 2009, so it has lasted for more than eight-and-a-half years. During that time, the S&P 500 Index, including dividends, rose 320%, or a very healthy 18.4% per year. Only the decade-long rally of the nineties was bigger and longer. That bull market eventually ended when the dotcom bubble burst.

So, is another bear market imminent? Valuations indicate it might be. While US equities are not as expensive as they were during the dotcom bubble, they are pricey. However, equities in other regions are valued much lower than at the end of the 90s. In addition, we don’t seem to be heading for a recession. Historically, equity markets tend to slump ahead of recessions. That doesn’t mean we shouldn’t expect a (healthy) correction, which appears to be overdue. But it also seems too early to call the end of the bull market.

One plus one sometimes does add up to three Emerging markets

Column

When will it end?

Over the past years, emerging markets have been quite volatile. Since last year, however, they have been showing a strong recovery and inflows show that investors have found their way back to emerging markets. In deciding which strategy to select, they may consider combining two or more of them. This allows them to benefit from diversification, which can reduce risk and offer more stable alpha. Inflows into emerging markets have improved significantly. After a long period of outflows, the tide turned in 2016 and, with a short-lived dip following Trump’s election, inflows have gathered pace. Over the first half of this year, over USD 40 billion found its way into emerging markets. Depending on their portfolio objective, investors have a wide range of emerging markets strategies, styles and approaches to choose from. This can vary from low-risk strategies aiming to benefit from the low volatility anomaly, emerging markets smaller companies strategies

that capitalize on strong domestic growth, to enhanced indexing as an alternative to passive emerging equity allocations. Combining two or more of these strategies can diversify the portfolio. But what does this mean concretely for the portfolio’s risk and return characteristics? To get an indication of the benefits of diversification, in our latest research we took two global emerging markets strategies with the same objective, i.e. to achieve alpha at a set risk budget. The main difference was that one is fundamentally managed and the other quantitatively. We found that two global emerging equity strategies, which have both proven capable of delivering alpha, can be even more robust when combined. Diversification across low-correlated strategies can reduce risk and offer more stable alpha. Even if an investor has a preference for a fundamental or a quantitative strategy, it would be worthwhile considering a combination of the two approaches, as this can enhance returns and reduce risks.

Jeroen Blokland Senior Portfolio Manager

Robeco QUARTERLY • #5 / SEPTEMBER 2017

Expected Returns: financial markets are coming of age Outlook

Riskier assets are expected to return less as financial markets face a ‘coming of age’ over the next five years. That’s the core theme in Robeco’s new ‘Expected Returns 2018-2022’, which foresees markets entering a new era once central banks start ending their stimulus programs. The economy is set to undergo gradual normalization following the decade of turmoil since the global financial crisis, and this will affect all asset prices.

At the heart of the outlook – and all its predictions for the future returns of equities, bonds and other asset classes – is the end of quantitative easing, to be replaced with quantitative tightening. The gargantuan scale of the stimulus programs, running into trillions of dollars, has succeeded in stabilizing markets following the near-collapse of financial systems a decade ago. However, the road ahead won’t be all smooth, since ‘Expected Returns’ also predicts more volatility ahead as markets adjust, and says a recession in western economies will finally materialize. “If we look at the various trends that we expect to shape the financial markets in the next five years, coming of age seems to be a recurring theme,” says Lukas Daalder, Chief Investment Officer of Robeco Investment Solutions and a co-author of Expected Returns. “Narrowly defined, ‘coming of age’ refers to reaching adulthood, but is more broadly interpreted to mean the start of a new stage of development; the next step in an ongoing evolution. Using this broader meaning, we have seen numerous developments in recent years and decades that are now on the verge of entering a new stage, which can have important consequences for financial markets moving forward.”

decade ago ushered in an unprecedented era of historically low (and even negative) interest rates, plus USD 7.2 trillion in central bank bond-buying,” he says. “What will happen to financial markets once central banks start to reverse this process?” “On balance, we have lowered our outlook for most assets, and expect to see more volatility ahead. This may sound more negative than it is: the weighted returns for a well-diversified portfolio will actually decrease only slightly.”

Core predictions As part of that lowered outlook, developed market stocks are expected to earn an average of 5% a year, down from the 6.5% forecast in the previous 2017-2021 edition. Emerging markets equities are forecast to see annual gains of 6.25% against 7.25% last time. At the same time, the outlook is less bearish on government bonds. Over the next five years, benchmark German 10-year government bonds are expected to deliver returns of -2.5%, which is slightly better than (or not as bad as) the -3.5% predicted for this asset class last year. And as AAA-rated bonds become relatively more attractive, the opposite scenario is foreseen for subinvestment grade: high yield bonds are predicted to return 0.25% over the next five years, which is much less than the 1.0% forecast in last year’s report.

Will QT be a cutie? Daalder says the biggest influence is likely to be when central banks begin to replace QE with a new phenomenon – quantitative tightening, or QT. “The stimulus programs that started as an antidote to the Great Recession and Global Financial Crisis a

Robeco QUARTERLY • #5 / SEPTEMBER 2017

As for alternative investments, commodities are expected to return 2.75% a year in the coming period, the same as last year’s prediction, though indirect real estate is expected to deliver slightly less, with returns of 4.25% against 5.0%. Cash – the

Outlook

placebo against which all other investment returns are compared – is expected to return an average of 0.5% over the five-year period.

unfortunate string of cyclical headwinds rather than a structural phenomenon, the opposite will apply. Assessing the case of secular stagnation is therefore worthwhile, especially in a five-year context.”

Baseline economic scenario Overall, the baseline economic scenario is again characterized by continued economic recovery, while economic stagnation is seen as being less likely, and a period of surprisingly high growth has become more probable. “Our baseline scenario is for economic recovery, to which we attach a 60% probability, unchanged from last year,” says Daalder. “We have lowered our growth and inflation outlook in this scenario, reflecting our expectation of a mild recession somewhere during the next five years. This will not be the major event we have witnessed in 2008-2009, so the impact will also not be as marked.” “The main change in the other two less likely scenarios is that of either stagnation on the negative side, or surprisingly high growth on the positive side. Given that we think a gradual return to normalization is continuing, the probability of secular stagnation has therefore been lowered from 30% to 20%. Likewise, the prospect of a highgrowth scenario, characterized by a boom-bust dynamic probably fueled by debt as interest rates remain low, has been raised from 10% to 20%.”

The issue as to whether investors have become complacent in assessing risks, as markets have shrugged off successive economic and geopolitical threats, is addressed in the special feature entitled ‘Volatility: Getting back to normal’. Patterns of volatility are analyzed to establish the real risk levels inherent in markets, with the conclusion that investors have actually been quite ‘on the ball’. The outlook is all about returns, so where do they actually come from? Stocks and fixed income securities are not as different as you might think, according to the special feature ‘Origin of returns: Bonds are from Venus, equities are from… Venus too, actually’. Answering another leading question, about the future of the euro, is handled in ‘Eurozone: To integrate or to disintegrate – that is the question’. (Summaries of both features appear later in this magazine on pages 17-18 and 26-27). Finally, as passive investing continues to be popular, Robeco remains exclusively dedicated to active fund management. Part of the reason for this is explained in ‘Passification: There’s no one-size-fits-all for multiassets’, in which the lack of a global benchmark for a multi-asset passive portfolio is examined by our specialists.

Special topics The secular stagnation theme is discussed in more detail in one of five special topics – up from three last time – contained within the 106-page ‘Expected Returns’ publication. In ‘Secular stagnation: Have we entered the economic ice age?’, Daalder says that although a number of arguments for this damaging phenomenon hold water, their influence has diminished. “If secular stagnation really exists, the current economic rebound will only be a temporary episode; a mere blip, forgotten by next year,” he says. “If this is the case, bonds will continue to surprise positively, while risky assets will become vulnerable. If, on the other hand, the whole thing is a misconception based on an

The report follows last year’s award-winning Expected Returns 2017-2021, entitled ‘It’s always darkest just before dawn’, which was voted Best Investment Paper of 2016 in the Savvy Investor awards. So has the dawn broken? “Yes and no,” says Daalder. “Given an environment in which volatility has remained historically low, and amid central banks’ ongoing efforts to provide ample liquidity, it seems as if everything is going to be fine for financial markets, particularly for risky assets.”

You can download the full publication at www.robeco.com/expectedreturns

Robeco QUARTERLY • #5 / SEPTEMBER 2017

QUANTinvesting The factor-timing arena Whether or not investors should tactically time their exposures to the different factors is certainly one of the most hotly debated issues among factor investing experts these days. In fact, the controversy has now escalated well beyond the typical arguments between theorists. Numerous articles on this subject are being published in mainstream financial media and prominent academics have been asked to weigh in. In principle, it seems logical for an investor to time his investments in one particular group of stocks or bonds with similar characteristics in terms of valuation, volatility or momentum, for example, depending on his views on future market developments, just as in traditional asset allocation. However, there is still a sizable gap between theory and practice.

Robeco QUARTERLY â&#x20AC;˘ #5 / SEPTEMBER 2017

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Tactically timing exposures to different factors? Not that easy! Should investors try to time their exposure to different factors? Factor-based strategies have become increasingly popular in recent years. But how to implement them in practice still remains a puzzle for many newcomers. Deciding whether to tactically monitor and adjust exposures to different factors and, if so, how to go about it, is one of the most hotly debated issues among academics and practitioners.

In recent years, the growing awareness regarding the benefits of strategic allocation to a number of well-rewarded factors has led increasing numbers of investors to consider this option. But while single factor-tilted portfolios have proven they can significantly outperform the market over the long term, they can also experience periods of disappointing performance relative to other single-factor portfolios and even to classic market-cap weighted benchmarks.

This phenomenon has been demonstrated extensively in the academic literature. In a recent paper1, for example, Elroy Dimson, Paul Marsh and Mike Staunton noted that “a factor that is ranked high in performance in a particular year may remain high, may end up in the middle, or may slip to low in the following year”. Their research focused on five of the most commonly targeted factors: size, value, income, momentum and low volatility. For each of them, they presented detailed annual return figures recorded since the financial crisis, and ranked the factors

from the best to the worst in terms of performance. Periods of relative underperformance of single-factor portfolios can last for years, testing the patience of many asset owners. A FTSE Russell survey carried out in 2016 actually showed that deciding whether to tactically monitor and adjust exposures to different factors and, if so, how to go about it, ranked seventh among investor concerns when it comes to factor-oriented allocations.

To time, or not to time… Intuitively, it would seem logical for an investor to time his investments in one particular group of stocks or bonds with similar characteristics in terms of valuation, volatility or momentum, for example, depending on his views on future market development, just as in traditional asset allocation. In practice, however, things are not so simple. Indeed, academics and practitioners continue to debate this issue and can be divided into roughly two opposing camps. The first of these assumes single-factor performance can be forecasted relatively accurately and therefore advocates tactical factor timing, at least in moderation. One popular timing approach is to look at the relative valuation of different singlefactor portfolios. This usually involves analyzing classic measures of valuation, such as price-to-book or price-earnings ratios. The idea is to increase exposure to factors that trade at a discount compared to their historical norms, and to reduce exposure to those exhibiting high valuation multiples compared to their historical average.

Robeco QUARTERLY • #5 / SEPTEMBER 2017

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The second group considers factor timing – not to mention general market timing – too difficult, and therefore not really worth the effort.2 Among other things, they argue that different measures of valuation often lead to conflicting conclusions. Moreover, they think that deciding factor exposure based mostly on its valuation is misguided, since some of the proven factors, such as momentum or quality for example, also typically clash with the value factor.

Valuation is important At Robeco, we agree more with the second approach. As a result, we usually recommend that our clients either opt for broad diversification across the different

‘We recommend either broad diversification across factors, or to opt for one particular factor of strategic interest’ factors we exploit in our strategies, or for one particular factor of strategic interest, but bearing in mind they will be faced with short-term underperformance. This does not mean valuation should be ignored, on the contrary. Investors should

closely monitor their exposure to the wellestablished factors and make sure they avoid unintended factor biases. This is also why the enhanced singlefactor definitions, which are used in Robeco’s factor investing strategies, always take valuation criteria, among others, into account. That way, we can avoid buying stocks which are overpriced. This improves both the factor characteristics of our enhanced factor strategies and the efficiency of the exposures both in our single- and multi-factor solutions.

1 E. Dimson, P. Marsh, M. Staunton; ‘Factor-Based Investing: The Long-Term Evidence’, 2017. 2 C. Asness; ‘My Factor Philippic’, 2016.

The predictive power of credit momentum for equities Research carried out by Robeco shows that not only equity prices, but also credit prices, can help predict equity returns. Companies with high medium-term bond returns tend to achieve higher stock returns in the subsequent month. Moreover, using credit data adds to the information already provided by equities. Based on these findings, Robeco has decided to integrate credit information into the Momentum factor used in its quantitative stock selection models, say Joris Blonk, Bart van der Grient and Wilma de Groot from Robeco's quant investment team.

Momentum is one of the strongest and best-documented market anomalies ever found in financial markets. The momentum effect is the tendency of securities that have performed well in the past months to continue to do so in the future, and, conversely, of poorlyperforming stocks to continue performing poorly. But while most studies carried out on the momentum effect over the past few decades focused only on one single asset class, recent papers have also covered potential spillover effects from one asset class to another. In an article published in 2014, George 1

Robeco QUARTERLY • #5 / SEPTEMBER 2017

Bittlingmayer and Shane Moser showed that within a sample of high yield bonds, abnormal price declines of bonds are likely to be followed by abnormal price declines in the corresponding stocks in the subsequent month. In another paper2 published the following year, Arik Ben Dor and Zhe Xu created equity portfolios based on bond momentum data going back as far as twelve months. They found that such portfolios would have achieved significant positive returns, with lower drawdowns than traditional equity momentum strategies. These results encouraged Robeco to carry out its own research on the spillover

effect of credit momentum into equity markets. Because of its long history in credit research, Robeco can make use of a rich global database containing detailed information on bonds included in either Bloomberg Barclays U.S. and Euro Corporate Investment Grade or High Yield indices, going back to the early 1990s. The fact that databases with such breadth and depth are much more difficult to obtain for bonds than for equities could be a reason why relatively little research has been carried out so far in credit markets. In this sense, our study can certainly be considered an important milestone in the academic literature.

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month leads to a stronger spillover signal. Most equity momentum strategies exclude data from the most recent month, in order to avoid the ‘short-term reversal’ effect, also well-documented in the academic literature. However, our simulations showed that portfolios that take into account credit information of the most recent month tend to significantly outperform those that exclude this data. In other words: the short-term reversal effect is lacking in the spillover signal and taking into account credit returns of the most recent month therefore improves this signal.

Credit momentum matters We started our analysis by considering the standalone performance of a credit momentum spillover signal. For each month in the period from January 1994 to December 2016, we ranked all the stocks in our universe, which included US and European MSCI constituents and a number of liquid off-benchmark names for which we had both stock and bond return data available from the last 12 months. This resulted in approximately 800 companies being ranked at monthly intervals, on average. Our findings confirmed the idea that information from credit markets also matters for future stock returns. Stocks from companies with bonds experiencing highly positive credit momentum over the previous 12 months, significantly outperformed low credit momentum stocks in the subsequent month. More importantly, we found that taking into account credit returns in the last

Our calculations also showed that the spillover effect could be documented both in US and European markets. So far, the academic evidence for the credit momentum spillover effect had remained limited to US markets, to the best of our knowledge. But our proprietary global credit database allowed us to study the effect of credit momentum in European markets, as we have sufficient coverage in euro denominated bonds dating back to 2002. These results can therefore also

ahead stock returns on the past credit momentum values of a company and other characteristics, including past equity momentum. The results of our regressions showed that 12-month credit momentum provides information not offered by traditional equity momentum and that this added value comes from both the most recent month and the spillover signal during the rest of the past year. Intuitively, it makes sense that equity and credit momentum provide different information, as investors in both markets focus on different aspects of a company. The market capitalization of a company could theoretically increase without bounds, while the value of a corporate bond’s future cash flows will remain limited. As a result, equity investors typically focus more on the upside potential of a company and credit investors tend to focus more on downside risks, in particular default risk. Since the launch of Robeco’s multi-factor stock selection models in the early 1990s, the equity price momentum factor has always played an important role. All our quantitatively managed equity strategies include momentum as a factor. Based on our recent findings, we have now decided to also take into account the credit spillover signal in the momentum factor of all our quantitative stock selection models used in the Core Quant, Conservative Equities and Factor Investing strategies. By combining price information from stock markets, as well as credit markets, we intend to move towards a broader ‘company momentum’ signal.

‘Even though equity and credit momentum factors are positively correlated, both signals provide unique information’ be considered an out-of-sample test of existing academic work.

Two complementary signals One important conclusion is that even though equity and credit momentum factors are positively correlated, both signals provide unique information. To confirm that, we performed a FamaMacBeth (1973) regression analysis, regressing the individual one-month

1 G. Bittlingmayer and S. Moser, ‘What does the corporate bond market know?’, Financial Review, 2014. 2 A. Ben Dor and Z. Xu, ‘Should equity investors care about corporate bond prices? Using bond prices to construct equity momentum strategies’, The Journal of Portfolio Management, 2015.

Robeco QUARTERLY • #5 / SEPTEMBER 2017

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Factor investing in credit markets is coming of age Factor investing strategies for credit markets are increasingly on the radar of researchers and investors. At Robeco, we see three clear trends: a rising number of academic papers on the topic, a strong demand from investors and a growing range of fixed income ‘smart beta’ funds on offer, say Patrick Houweling (pictured) and Jeroen van Zundert, from our quant credits team.

These days, many investors are familiar with incorporating factor investing or smart beta into their equity portfolios. However, equities are by no means the only asset class in which factors can improve the risk-return profile of a portfolio. Empirical studies show that the concept of factor investing can also be applied to many other markets, in particular to corporate bonds. “I see a growing number of research papers, seminars, products and indices for fixed income smart beta and more specifically for investment grade and high yield credits,” says quantitative researcher and portfolio managers Patrick Houweling. According to Houweling, the reason why ‘quants’ started paying closer attention to credits only recently is “plain and simple”. To conduct empirical analysis, quants need data, and historical datasets on individual corporate bonds were hard to find for a long time. Nowadays, such datasets have become more widely available and, as a result, the number of research articles has risen substantially. “We counted as many papers on factor investing in credit markets that were published over the last 18 months as in the five years before,” Houweling says.

A growing market This trend in the number of articles and reports has occurred alongside the rapidly growing interest on the part of institutional investors in so-called ‘smart beta’ fixed income funds. Various recent surveys confirm this. For example, an annual study by index provider FTSE Russell found

half years, we have held about 250 client meetings and presentations on this topic.” According to another study by market intelligence consultant Spence Johnson, European respondents anticipated that for fixed income, the annual growth rate in factor investing would be 19%. This is the highest rate of all asset classes. In particular, the consultant expects the popularity of non-equity smart beta products to grow faster than that of equity products. Of the total of EUR 48bn predicted to be invested in ‘other’ smart beta asset classes by European investors in 2019, EUR 42bn is expected to be invested in fixed income strategies.

‘We counted as many papers over the last 18 months as in the five years before’ that 27% of the participants have either already invested in fixed income smart beta products, or are considering doing so in the next 18 months. “We clearly see rising interest in factor credit strategies,” says Houweling. “Over the past two-and-a-

The asset management industry has also spotted the potential of fixed income smart beta. For example, a recent newspaper article in the Financial Times indicated that 25 smart beta fixed income ETFs are already available, and another 25 are being registered. “The fact that more and more fixed income smart beta products are

The graphic below illustrates the rapid rise in the number of research papers and broker reports on factor investing in credit markets (per factor) published over the past ten years.

Robeco QUARTERLY • #5 / SEPTEMBER 2017

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Cumulative number of papers per factor

60 50 40 30 20 10 0 2008

2009

Source: Robeco

2010

Low Risk

available in the market is another major trend”, says Houweling.

Three case studies There are many ways in which credit portfolios can benefit from factor investing strategies. Different real-life case studies help illustrate the very diverse situations in which this kind of investment approach is worth considering. These case studies also improve our understanding of the implications of applying factors to credit markets. For example, a large sovereign wealth fund, which had almost its entire credit holdings invested in passive portfolios, was looking for an alternative because passive strategies typically underperform after costs. Moreover, index-based portfolios invest more in companies with a high debt load, which is not comforting for an investor. “This client liked the rules-based and transparent investment process of factor investing, as well as its modest turnover and fees compared to traditional active management,” says Jeroen van Zundert, a quantitative researcher at Robeco. “In the past, these had been key arguments in favor of passive over active investing.” Similarly, an Italian private bank wanted to replace an underperforming active asset

2011

2012

Value

2013

2014

Momentum

2015

2016

2017

Size

manager. This bank was looking for an investment strategy that would provide distinctive, diversifying alpha. However, it also wanted to achieve alpha using an evidence-based investment philosophy. “Factor investing, being an evidence-based

strategy offers diversification by generating alpha in a different way. Second, for passive investors, factor investing can be an attractive alternative, as it does not have the structural weaknesses and inefficiencies associated with traditional market cap-weighted benchmarks. On the other hand, like passive index-based investing, factor investing also offers transparency, low turnover and modest fees. Third, it provides an opportunity to implement the factor investing approach in a client's portfolio for multiple asset classes. Applying multifactor investing to both equities and credits enhances returns, without increasing risk.

‘Investors should always look at new strategies with a critical eye’ approach to active investing, was therefore a natural fit for this bank,” Van Zundert says. A third example concerns an Australian insurer which, after implementing factor investing in its equity portfolio, was looking for a factor-based approach for other asset classes too. “This client was attracted to credit factor investing, as the evidence for credit factor investing is mounting, and so is the number of investment products available,” Van Zundert says. “The investor felt the time was right to implement factors in its credit portfolios.” According to Houweling, these different case studies show that there are three main reasons why clients may choose a factor-based strategy for credit markets. First, it acts as a style diversifier for those who already invest in classic credit products. The quantitative, rules-based

Tailor-made strategies Now that the use of factor investing in the credit market is coming of age, asset owners have started to think beyond regular off-the-shelf products. Houweling and Van Zundert underscore that investors increasingly ask for tailor-made solutions. For example, clients may have specific requirements regarding the investment universe, the factor mix or the level of turnover. They may also have particular risk constraints or ESG targets. “In those cases, we can definitely customize the standard solution,” says Van Zundert.

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One way to adapt a strategy to a clientspecific requirement is by adjusting the investment universe. “For instance, a German pension fund did not want to have exposure to financials, so we developed an ex-financials solution,” says Van Zundert. Another example of possible customization has to do with the way bonds should be dealt with if they have been downgraded from investment grade to high yield status. Most investors allow some high yield bonds in their investment grade portfolio, but some do not want to invest in high yield at all. Constraining the time-to-maturity of the investable bonds, in order to better match a client’s liability structure for example, is another customization option. In addition to these investment universe adjustments, factor investing can also

be combined with other concepts. For example, a UK-based pension fund wanted to combine factor investing with the ‘buyand-maintain’ approach. Buy-and-maintain means that after a bond is bought, the intention is to hold the bond until maturity, unless it becomes too risky. The low risk and quality characteristics, which also imply low turnover, are useful for determining which bonds to buy and, if necessary, to sell. “This is why we proposed adjusting the factor mix in order to make it more suitable for a buyand-maintain approach,” says Van Zundert. Last but not least, improving the sustainability profile of a factor portfolio is another important area of possible customization. In some cases, for example, clients want to reduce the CO2 emissions, water use, energy consumption and waste

generation of the portfolio compared to the benchmark. Since a factor strategy is already rules-based, the incorporation of additional rules, such as environmental footprint reductions or other ESG dimensions, is relatively straightforward.

Thorough research needed But despite the growing number of products and research papers available, investors should always look at new strategies with a critical eye, says Houweling. “Asset managers have to do their own thorough research,” he warns. “Especially when it comes to the practical implementation of factor strategies in the credit market and dealing adequately with the illiquidity of corporate bonds. After all, we think that some fixed income smart beta strategies are ‘smarter’ than others.”

Factor investing also works with Chinese A-shares Are there any differences in the way factors behave with A-shares compared with other markets? “In our most recent assessment, we focused on finding evidence of factor premiums in A-share markets recorded between 2000 and 2016 and using the relatively little research has been carried out and published on the subject. Robeco definitions applied by Robeco to each one of the different factors we exploit. In was actually a pioneer in this field. Back in 2008, we already found evidence that this context, low volatility showed strong and robust risk-adjusted performance, our emerging markets stock selection while value and quality also showed model also has predictive power in good predictive power in differentiating this market. We consider A-shares to future winners from losers. For be a good testing ground for factors, momentum, though, the results were a especially since these markets are not bit mixed.” integrated and ownership patterns are clearly different. The majority of Chinese “We found that while some of the criteria stocks are owned and traded directly by individual investors, while for the US it is we use to measure momentum, for example revisions of analysts’ earnings the other way around.”

Many characteristics set A-shares apart from other equities. But does that mean that the major anomalies that underpin factor investing do not apply to mainland China’s stock markets? Well they do, even though there are differences owing to specific structural features of these markets. In fact, when designed appropriately, factor investing works pretty well with A-shares, says Weili Zhou, a quant researcher at Robeco.

Why did Robeco engage in researching factors in A-shares? “Chinese A-shares offer considerable potential for investors. Although the Shanghai and Shenzhen stock exchanges were re-established only in 1990, the market capitalization of companies listed on these venues has grown extremely rapidly. The total A-share stock market has become the second largest in the world.” “Although interest in factor investing in these markets is growing rapidly,

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forecasts, showed strong predicting power, as expected, while others such as medium-term price movement trends proved less effective. It seems that Chinese investors often overreact to news and then pull themselves back together again, resulting in frequent price reversals. Interestingly, however, we also found that our momentum ‘residualization’ technique, which enables us to focus on stocks with good intrinsic momentum, still proved effective.” Could you comment on the strong low volatility anomaly in this market? “Our findings suggest that the low volatility anomaly is fairly strong for A-shares. The annualized return dispersion between the top (low volatility) and bottom (high volatility) decile of stocks sorted based on 3-year volatility is more than 10%. To a certain extent, I think this could be attributed to the nature of Chinese investors. More than 80% of market participants are individuals, who tend to be less patient, more short term-oriented, compared to institutional investors. Until recently, they also tended to be heavily leveraged. At the same time, we observe that average turnover and volatility are considerably higher in the A-share market than in other major stock markets despite the

fact that trading costs are relatively expensive.” “These elements reinforce two of the most frequently heard explanations for the low volatility effect: the ‘lottery tickets’ and the ‘winner’s curse’ effects. The first theory assumes investors tend to overpay for highly volatile stocks

What are the challenges for quant investing in China? “First and foremost, the quality and coverage of the historical database. One example of a potential issue is backdoor listings. This term is used when a firm that may not qualify for a public offering process purchases one that is publiclytraded and uses it as a shell company. Backdoor listings have also been used to bypass general bans on IPOs. Over 120 cases have been reported over the 2014-2016 period. As a result, an apparel company can turn into a logistics group overnight. Likewise, a cheap low risk stock can become an expensive high risk one.”

‘A-shares are particularly good testing ground for factors’ because they are attracted by their option-like payoff, just as they would be to lottery tickets. Meanwhile, the second explanation is that investors tend to overpay for stocks when they lack precise information about the company or the security itself. This phenomenon applies more to highly volatile stocks than to those with lower volatility.” “The behavior of Chinese investors also has consequences for other anomalies. For example, it also probably explains why medium-term momentum strategies do not work so well with A-shares, while enhancement can be found if we differentiate overreaction from underreaction.”

“Chinese A-shares also tend to be more frequently suspended, often due to systematic market shocks. The impact of suspension should be handled carefully in any historical simulation, in order to detect whether a company has a low volatility due to ‘low risk’ or ‘no trade’, for example. Dealing appropriately with suspended stocks in a portfolio is another important issue.” “Last but not least, the A-share database may record financial report figures which are supposedly ‘correct’, but which are actually forged. In the H-shares market, we have witnessed a few cases of fraud leading to either suspension or price crashes.” “All these issues attest to the need for tight human oversight and strict due diligence criteria, in addition to the rules-based investment process. When you have a stock in your portfolio or you are about to buy one, it is important to follow it closely. At Robeco, our quant portfolio managers have abundant experience in cooperating closely with fundamental colleagues to ensure this oversight is performed properly.”

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Bonds are from Venus, equities are also from Venus Where do returns come from? The old notion that bonds are from Venus and equities are from Mars is outdated, says Lukas Daalder, Chief Investment Officer of Robeco Investment Solutions.

Speed read

Research

• Macro Risk Factor Approach is vital to understanding returns • Some factors such as growth and inflation affect all assets • Animal spirits in markets play a role in riskier arenas

the Macro Risk Factor Approach. Instead of looking at assets as independent categories with their own unique return drivers – where bonds are supposedly from Venus, the planet of peace and safety, and equities are from Mars, the god of war and turbulence – it looks at the common factors underlying all of them. “Of course, given the noisy character of financial markets, it is almost impossible to fully explain the returns of every asset class by examining just a limited number of underlying drivers,” Daalder says.

‘Given the noisy character of financial markets, it is almost impossible to fully explain returns’

Instead, investors should look at six macro factors that research shows are responsible for the bulk of all profits made on assets, be they bonds or equities, he says. Daalder specializes in trying to predict the returns on assets in his regular monthly outlooks, and in the new edition of Expected Returns 2018-2022.

“But research carried out by Robeco and others shows that six factors explain, on average, 80% of the returns of the various asset classes. They are intuitively easy to understand, hold up under

“One very basic notion is that returns need to be earned and for that to happen, some form of growth is required,” Daalder says. “If there is no economic growth and no inflation, the returns on broader asset classes are likely to be suppressed too. Nominal growth boosts earnings, which pushes stock prices higher and leads to higher dividends, improving your returns.”

Nominal growth lifts all returns “In a scenario of rising inflation, higher compensation will be required to postpone consumption, pushing nominal bond yields higher. In a sense, nominal growth is the tide that lifts all asset returns, which is also why we should question whether stagnation is secular or not. If it is, returns are going to stay low in the future.” “But this does not necessarily mean that there will be no returns if nominal growth permanently drops to zero. In a prolonged zero growth scenario, some regions or sectors are likely to show growth while others decline. Even if the broader equity market remains unchanged, there are still always relative returns to be made.”

The Macro Risk Factor Approach Trying to figure out where returns do in fact come from has led to the development of a new model in dynamic asset allocation:

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Research

the scrutiny of our statistical analyses, and are a valuable additional tool in explaining the composition of the underlying returns.”

Two groups of factors Daalder says the six factors can be divided into three that are linked to the wider economy, and three to the ‘animal spirits’ that are an integral part of financial markets, and thereby to unexpected changes in risk premiums. The three pure macro factors are changes in real interest rates and inflation, which particularly affect bonds, and economic growth, which is more important for equities. Three less tangible factors are linked to the ‘fear and greed’ element of markets. These are credit risk, which is associated with bond spreads and default risks; equity risk, often caused by what Alan Greenspan once famously called “irrational exuberance”; and emerging markets risk, which is the political risk associated with more unstable markets.

So how would this work at a portfolio level? “Rather than just seeing the individual assets, we now get a better understanding of the ‘true’ risks underlying any portfolio,” says Daalder, who co-manages a multi-asset fund. “This has a couple of advantages. By dissecting the investment portfolio into various macro factors, one can test whether it reflects the asset owner’s underlying growth and inflation assumptions. In other words, the Macro Risk Factor Approach provides a reality check on whether the portfolio’s current positioning is in line with the macroeconomic expectations of the asset manager.”

‘This is what Alan Greenspan once famously called irrational exuberance’

“Based on these six factors, we can now explain between 75% and 90% of the variability of returns in most broader asset classes,” says Daalder. “In other words, we can now say that we have a pretty good idea where most of the returns come from.”

Dissecting a portfolio

“Secondly, traditional portfolios may look well diversified, when in fact the assets they contain may be exposed to the same underlying macro risk factor. Investing in other asset classes rather than the common combination of 60/40 stocks and bonds can reduce sensitivity to the equity factor.”

“So, by looking at factors rather than asset classes, the traditional bonds-are-from-Venus-and-equities-are-from-Mars way of looking at the world becomes less appealing. The Macro Risk Factor Approach is a relatively new, but promising development in the field of multi-asset investing.”

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SUSTAINABILITY investing

Winning by not sinning Some industries remain off-limits to many investors on ethical grounds. And this creates a dilemma, since some of the most contentious businesses are highly profitable, which means following your conscience may cost your clients money. Sin stocks are a case in point where taking the moral high ground can mean losing out on high returns; companies involved with alcohol and tobacco among other naughty industries have outperformed for many years. Nobody was sure why they did so well â&#x20AC;&#x201C; but now the mystery has been solved using factor investing. It means investors can rest a little easier by knowing that two factors and not the exploitation of human weakness are behind this phenomenon.

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Research reveals why sin stocks outperform The mystery of sin stocks’ outperformance has finally been unraveled, thanks to research that shows it is down to a theory of factor investing, rather than because human weakness makes more money.

Companies selling alcohol, cigarettes or products that cater for other human vices have historically enjoyed higher returns than the stock market indices to which they belong. Ironically, the stocks of tobacco companies have at times performed better than the pharma companies making cancer drugs to combat smoking-related illnesses. Since all active fund managers chase alpha – seeking to make higher returns than the benchmark – this in theory makes them ideal holdings. However, investors holding them can face reputational risk, particularly as lobbyists become increasingly vocal against industries known to harm human health such as alcohol or weapons. So how come sin stocks outperform, making them irresistible but shunned at the same time? Their returns were investigated by David Blitz, co-head of quantitative research at Robeco, and Frank Fabozzi, Professor of Finance at EDHEC Business School, in their article ‘Sin Stocks Revisited: Resolving the Sin Stock Anomaly’ published in the Journal of Portfolio Management.

Smoking gun Blitz and Fabozzi define sin stocks as companies directly involved in the alcohol, tobacco, gambling or weapons industries. Many are barred from portfolios on ethical grounds, though Robeco does not exclude all sin stocks, with several alcoholic drinks and tobacco companies held in global equity funds, for example.

“Various studies have investigated the historical performance of sin stocks and observed that they have delivered significantly positive abnormal returns,” says Blitz. “Despite this, many investors have composed an exclusion list of sin stocks that they do not wish to invest in because they do not want to be associated with the activities of these firms.” “A popular explanation for the observed abnormal returns of sin stocks is that they are systematically underpriced because so many investors shun them; this enables investors who are willing to invest in sin stocks, going against social norms, to earn a reputation

‘Sin industries could benefit from monopolistic returns’ risk premium. Other explanations are that sin industries could benefit from monopolistic returns, or that these stocks face increased litigation risk for which investors are rewarded.”

Quality factors In fact, the outperformance of sin stocks can be explained by the two new quality factors in the recently introduced fivefactor model by renowned economists Eugene Fama and Kenneth French, says Blitz. Their previous three-factor model

used ‘market risk’, ‘size’ and ‘value’ to explain why some stocks performed better than others. The 2015 update added ‘profitability’ and ‘investment’.

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The profitability factor maintains that stocks with a high operating profitability perform better, while the investment factor suggests that companies with high total asset growth perform worse. Sin stocks tend to have high exposure to both factors; cigarette makers, for example, enjoy high margins due to relative price inelasticity, and are restricted in how they can grow their assets. Applying this factor theory to actual stock market returns, Blitz and Fabozzi used global data right up until the end of 2016, incorporating the latest insights from the Capital Asset Pricing Model (CAPM), which calculates the relationship between risk and expected return and is used for pricing riskier stocks.

‘This alpha completely disappears when accounting for the profitability and investment factors’ “We find that, consistent with the existing literature, sin stocks exhibit a significantly positive CAPM alpha in the US, European, and global samples,” says Blitz. “However, this alpha disappears completely when accounting not only for classic factors such as size, value, and momentum, but also for exposure to the two new Fama-

French quality factors – profitability and investment.” “For Japan, sin stocks also exhibit significant exposure to the profitability and investment factors, but in this case the one-factor alpha is not even significant to begin with. So in sum, the performance of sin stocks is fully in line with their exposure to factors included in current asset pricing models, and there is no evidence of a specific additional sin premium.” This means that investors who are uncomfortable holding sin stocks but don’t want to miss out on outperformance can simply replicate them by weighting their portfolios towards the Fama-French factors including profitability and investment.

Climate change faces threat from two unlikely sources Global warming is being made worse by two surprisingly high contributors to it – the internet and natural gas. Both are generating some mind-boggling statistics in how they are contributing to climate change.

Using the internet is now generating a carbon footprint that is higher than the airline industry, while natural gas presents a paradox in that it is a cleaner fuel, but with a nasty side effect. Renewable energy offers a solution to both in the long term, Robeco’s specialists believe. The growing world wide web offers the first challenge, since many people think going online bears no environmental cost as it is essentially invisible; you’re not driving a car emitting exhaust smoke, for example. However, all those billions of computers, tablets and smartphones need energy to be

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manufactured and then powered as they draw down trillions of items of information each minute.

1.5 gigatons of gases Research by UK web hosting company Kualo reveals that all the world’s computers will generate 1.5 gigatons of greenhouse gases, equivalent to 3% of all global emissions, by 2020. This is because the world’s current tally of 3.5 billion internet users is steadily increasing, particularly as more people in emerging markets are able to get online.

its environmental impact through cleaner and more efficient engines. Every second that someone browses a simple website adds 20 milligrams of C02 to the atmosphere. More complex websites with advanced graphics can add up to 300 milligrams per second. There are currently an estimated 70 million servers in the world, most of which are powered by mainstream electricity grids, contributing 2% to greenhouse gas emissions. Data centers alone use about 30 gigawatts, or 30 billion watts of electricity, according to Green House Data. This is enough to power every house in Italy.

Datacenters going greener It means that their combined carbon footprint will exceed that of the airline industry, which has been steadily reducing

So, can this be curtailed? Many large users or owners of datacenters are aware of the environmental implications; Apple,

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Facebook, Google and Amazon all have stated targets to increase the use of renewable energy for their facilities. “In 2013, Apple said all of its data centers were now fully powered by renewable energy, including facilities in California, Texas, Ireland and Germany,” says Richard Speetjens, a portfolio manager in Robeco’s Trends Investing team. “Data centers that house computing infrastructure for services like iTunes, Siri, Maps and the App Store now get 100% of their power from a combination of renewable energy that the company buys, mixed with on-site generation capacity.” “Google recently stated that somewhere in 2017, all of its data centers around the world will be entirely powered with renewable energy sources, up from 45% in 2015. Google says its vast network of global operations will start purchasing as much renewable energy as it uses across all 13 data centers and all of its office complexes.” “Facebook is already at 30% of clean and renewable energy used in its data center

‘They all do care a lot about our planet’ electricity supply mix. The company is now aiming to have at least 50% clean and renewable energy in its total energy mix in 2018. Finally, Amazon Web Services – the cloud business of Amazon – generated over 40% of its electricity supply from renewable sources in 2016, and is targeting 50% by the end of 2017.” “So, even though these companies might have a bad image due to the number of energy-consuming facilities they own, they all do care a lot about our planet, and are increasingly becoming more dependent on renewable energy sources.”

The paradox of natural gas One energy source that is not renewable, but is seen as cleaner than most, is natural gas. It has replaced burning oil or coal in power stations, thereby cutting emissions. However, its main ingredient, methane, is also one of the biggest contributors to climate change when unburned gas

escapes during its extraction, with fracking proving a particularly large problem. Methane is so potent that its warming power is an incredible 80 times that of carbon dioxide over a 20-year timeframe, and is responsible for about 25% of global warming. Estimates suggest that energy companies are releasing at least 3.5 trillion cubic feet of methane into the atmosphere each year, equivalent to all the gas sold by Norway. Yet the contribution to global energy needs made by cleaner-burning gas cannot be disputed, accounting for 22% of world electricity production in 2014, up from under 8% in 1988, meaning we now burn much less coal and oil. So how to tackle this double-edged sword? Robeco’s Active Ownership team is engaging closely with the oil & gas industry to try to solve the conundrum of how methane can be a boon and a curse at the same time. And their message has not fallen on deaf ears – many of the oil majors participate in the Oil and Gas Methane Partnership, the industry’s own

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initiative to improve emissions reporting and cut methane emissions. Members include BP, Eni, Repsol, Statoil and Total.

Business opportunity “We see the methane issue more as a business opportunity than a risk,” says Sylvia van Waveren, who is leading Robeco’s engagement with the oil & gas industry. “What we often say to companies is that methane is a potential revenue source; it would be a waste if companies do not use it because it escapes into the air.” “When we talk about motivation at the company level, it’s still early days: European companies are talking in general terms and are only now conceptualizing methane policies. If we’re lucky, they

‘We see the methane issue more as a business opportunity than a risk’

to calculate, estimate and set targets to reduce methane. It is still a mystery to many of them. That’s where we come in with engagement. We need to keep them sharp on this issue and ask them for their actions, calculations and plans.”

have calculated how much methane is part of their greenhouse gas emissions. And if we’re more fortunate, they are producing regional and segregated figures for their carbon footprints, but the level of motivation among these companies is low, and it takes a lot to spur them into action.”

“We rely very much on the knowledge we acquire within the sector when we are in dialog with companies in our capacity as institutional investors,” she says. “We review data analyses and make intermediate reports of the scores. We find best practice solutions and we hold companies accountable. There are also times when we name names. So in that sense, that is how engagement works.”

“One issue that is particularly bothersome is that many companies do not know how

Two worlds colliding – insights from ESG integration Robeco Global Equity has been structurally integrating ESG information into its investment process for the last three years. Masja Zandbergen, Head of ESG integration, explains why it is important to use this extra lens in the research and shares some of the insights she has gained over this period.

Why should you analyze ESG risks and opportunities for a company in a different way to other business risks and opportunities? Isn’t this simply part of fundamental stock analysis? As this concept is fairly new, however, we made it an explicit step in the investment and research process by introducing the Value Driver Adjustment Framework in 2014.

we determine which ESG information is material to the investment case. Material means that it has significant impact on the financial performance of a company, such as its revenue growth, margins, required capital and risk.

The three-step Value Driver Adjustment Framework

The second step is to analyze the companies’ policies, practices and performance on these material issues. We compare companies with their peers and identify the impact (positive, negative or neutral) on the strategy and the business model.

The Value Driver Adjustment Framework consists of three steps. First of all,

Third, we quantify this impact. For every

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investment, the analyst makes an indepth investment case for the company. We look at four value drivers: revenue growth, margin development, invested capital required and risk. We first look at benchmark performance for the value drivers and then adjust these numbers based on the fundamental analysis of the company. Lastly we incorporate the ESG analysis by further adjusting the value drivers. The end result is a target price.

The numbers Over the past three years, we have written 200 investment cases incorporating ESG factors. In about 50% of these, ESG analysis had an impact on the valuation. On average, 7% of company valuations were attributed to ESG factors.

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The dispersion of the valuation impact is quite high. The companies where there was an extreme impact on valuation (positive or negative) are companies that provide products that are either a solution to a sustainability problem (e.g. specialty chemicals), or contribute to a problem (pesticides, coal etc.)

ESG opportunities outweigh risks As mentioned, on average 7% of the valuation of the companies analyzed can be attributed to ESG factors. When we simply take the average over the whole sample, we find that there is a skew to the upside as 4% extra upside is tied to ESG factors. This means that, on average, ESG factors are seen by our

analysts as having a positive impact on companies’ value drivers. This is also clear when looking at the adjusted value drivers. In over 45% of the cases, the analyst sees a positive effect on a company’s profitability, because of, for example, good human capital

Sales growth is also often adjusted upward. Good innovation management and having the right products and services in place to cater to changing customer preferences or regulation adds to the positive conviction on a company.

‘7% of the valuation of the companies can be attributed to ESG factors’ management leading to lower employee turnover; excellent operational management and energy efficiency; and good supply chain management. All of which keep costs down and boost profitability.

ESG as a measure of quality

There are a few explanations as to why we find more opportunities than risks. The first one is that we look for companies that have good cash flow generation and high returns on invested capital (ROIC). Many studies show a positive relationship between good ESG performance and traditional quality measures, such as stable profit, return on

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equity (ROE) and operational profitability. We also focus on large cap stocks. Research shows that there is a clear correlation between good ESG performance and size. With the focus that we have on large cap quality names, it is logical that we often find more opportunities than risks. The average operating ROIC for companies with high ESG valuation upside (over 10% is ESG-related) is more than four times the ROIC for companies with ESG valuation downside. We cannot say what comes first, the chicken or the egg. Do companies that have high ROICs invest more in financially material sustainable solutions, or can they invest more as they generate high returns in the first place? Either way, we know that good performance on financially

‘In half of our investment cases, ESG analysis impacted valuations’ material ESG issues is the sign of a high quality company.

The sixty-four-thousand-dollar question Our clients often ask us to show the contribution ESG integration makes to performance. It is impossible to do this accurately, however. Although we can show its impact on the valuation of the companies we research, not all companies make it into the portfolio. And for those that do, many additional factors influence the decision-

making and the stock’s performance.

What we can show is that if we build four equallyweighted portfolios based on the ESG valuation impact (negative, no impact, less than 10% impact and more than 10% impact), we find that over the 2014 to 2016 period, the portfolio with the large positive ESG impact outperformed the one with the negative ESG value by about 10%. As this is a very crude analysis, we cannot be too bold in our conclusions. Still, the result is encouraging and calls for further analysis.

Private equity managers show progress in ESG integration Private equity managers increasingly integrate sustainability into their investment process, according to an annual ESG assessment.

The results are published in Robeco Private Equity’s ESG Engagement Report 2016 which details the activities of the 66 managers that are part of its institutional products and mandates. The team introduced its ESG engagement program back in 2004 and has been one of the leaders in ESG integration in private equity ever since. “The assessment of their ESG efforts in 2016 reveals improvement in both the average and the median ESG scores for the program as a whole,” the report says. “Compared to a year ago, more private equity managers in our ESG program (95%) now have a responsible investment

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policy in place. And many of them also define ESG objectives and include ESG matters in their fund formation documents. This is an improvement compared to the score of 87% received a year ago.” “The number of managers who are monitoring whether their portfolio companies have the relevant sustainability policies in place increased further in 2016, and 74% of them now monitor ESG matters in at least part of their portfolio. While the percentage of managers that disclose information on ESG to the public remains below 15%, we have noticed that an increasing number of them are disclosing more specific and detailed information on

the environmental and social impacts of their portfolio companies.”

UN PRI tools Robeco Private Equity uses the reporting and assessment tool developed by the UN Principles for Responsible Investment (PRI) for the monitoring of the ESG activities carried out by the managers in its program. More investors in the private equity world are signing up to the PRI and its goals every year. “Public commitment to the PRI seems to have a positive impact on the ESG efforts of the private equity managers, as we again found that the PRI signatories in our program outperformed the nonsignatories,” the report says.

The future of the euro The euro has turned 18 and reached human adulthood – so what now for the European single currency? Its future is more likely to lie in further integration rather than any form of disintegration, according to Robeco’s experts. initiate steps to unilaterally leave the euro, and this would set off a number of adverse reactions.”

Speed read

Research

• Rising populism could trigger disintegration • Introducing Eurobonds may progress integration • Muddling through continues but can’t last forever

As an unprecedented common project conducted on an epic scale, the euro has never been perfect, and has not always met expectations. However, predictions for its demise have consistently been exaggerated. And commitment to maintaining it has not wavered since ECB President Mario Draghi made his famous “whatever it takes” speech in 2012.

“For one, severe capital restrictions would have to be implemented immediately, to stem the flow of capital leaving the country and try to save the banking system,” he says. “Banks would probably need to be nationalized. The new currency would probably fall sharply against the euro, so both foreigners and local citizens alike would scramble to get their money out of the country. And trade would be badly hit.” “The remains of the euro would probably be closer to what might be defined as the optimal currency – more of a German mark than the original euro, most likely even excluding France.”

Integration – enter the Eurobond? But it still faces many challenges, from the advance of populism seen in the anti-EU Brexit, to continued economic problems in euro countries such as Greece. Two options stand out as the most likely longer-term outcomes: disintegration, or further integration, according to Robeco’s new five-year outlook, Expected Returns 2018-2022.

Disintegration – exit the Italians? Partial or total disintegration is often seen as a likely outcome, though it should be avoided to prevent economic chaos, says Robeco Chief Economist Léon Cornelissen. “We can imagine a number of different ways in which the Eurozone may disintegrate,” he says. “These include the rise of populism, tensions between member states, growing economic divergence, the collapse of a national banking sector and government debt spiraling out of control.”

The extreme economic and political costs are the main reason why there will always be a drive towards the other option – moving forward with integration – says Lukas Daalder, Chief Investment Officer of Robeco Investment Solutions. “There are numerous steps that can be taken with respect to this integration process,” he says. “One idea floating around is investments financed by European bonds, which could be an embryonic form of the much debated Eurobond: bonds issued on a supranational rather than national level.”

‘One idea floating around is investments financed by European bonds’

“One country that is probably more threatening to the Eurozone’s existence than others is its third-biggest economy – Italy. The Italian economy has hardly grown since it joined the euro, its debt ratio is massive, its banking system is weak, and the Eurosceptic Five Star Movement is currently a frontrunner in the polls.” Cornelissen says the Brexit showed it is possible to leave the EU, but no nation has ever left the Eurozone. “In the case of an exitvote win, the country in question (such as Italy) could immediately

“These bonds would certainly end the possibility of speculation of a break-up. A complete banking union is another potential step, but one which is much less discussed nowadays. A European-wide deposit guaranty would prevent a bank run, if a sovereign issuer appears to be running into financial trouble.” The euro’s main problem is that as something shared by 19 disparate economies and cultures, it isn’t an optimal currency, he says. For that you need to meet four criteria: full labor and capital mobility; symmetrical business cycles; a fiscal transfer mechanism, and shared customs or language. “Ultimately, steps should be taken to enhance the Eurozone,

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‘It is also clear that ignoring the wishes of the people is not a sensible approach'

making it more of an optimal currency area,” says Daalder. “Given that we will not be able to change the wideranging differences between the financial and economic structures of the various economies anytime soon, a further fiscal and even political integration would seem to be what is ultimately required to safeguard the future of the euro project.” “It’s quite easy to identify this as the solution, but we also have to conclude that current popular and political sentiment has been moving in the opposite direction.”

Muddling through – beware Target2? So what about maintaining the status quo? “In itself, there is no real reason why we can’t continue with the current let’s-not-fix-

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anything-and-hope-for-the-best approach in the short run,” says Daalder. “If the central bank is more than committed to it, then doing nothing – although it’s not the best solution – may still be enough.”

“Having said that, there may be a limit to the ‘whatever’ Draghi has mentioned. The rising imbalances in the Target2 system which processes euro transactions mean that the financial stakes are increasing. As we have seen in the case of Switzerland, even a central bank can decide that the financial risks have become too big.” “Additionally, looking at the rise of populism we have seen in recent years, it is also clear that ignoring the wishes of the people and not changing anything is not a sensible approach either. What will eventually prove enough to ensure the Eurozone’s survival in its present form for the next five years remains to be seen.”

Behind every cloud is a data center All sectors must undergo digitization and real estate is no exception. Demand for data storage and related services is driving growth in data centers. Because of a lack of understanding, investors tend to underestimate their potential. Portfolio manager Folmer Pietersma considers data centers the best value/growth proposition in the Real Estate Investment Trust space.

Speed read

Trends

• Digitization drives demand for third-party data centers • Data centers connecting companies become a one-stop platform • Investors underestimate data centers’ value creation potential

In the past, data was only a side effect of business operation. The size or structure of databases meant they were unsuitable for analytical purposes and the computing expense was too high. Data was stored in an in-house cost-creator data center.

Retail centers occupy smaller spaces measuring less than 10,000 square feet. Contracts typically last between one and three years, with an option to extend. Given the smaller size, the type of tenant varies greatly, ranging from smaller enterprises to larger ones to all sorts of network related businesses which are a part of digital data ecosystems. Interestingly, the large number of tenants per data center has been an enabler of cost-effective interconnection possibilities, whether on a one-to-one or a one-to-many basis. Hence, retail data centers have evolved into platforms, as part of highly interconnected digital ecosystems.

A data center is still property, so location, location, location!

‘Data centers can be viewed as a physical location where IT infrastructure hardware is stored’

Technological progress has completely transformed the situation. Data has become the most valuable asset. Digitization is driving immense growth in data volumes. It is estimated that by 2020, the data universe will exceed 44 zetabytes, which would be a tenfold increase from the 4.4-zetabyte universe of 2013. The more data we consume, the cheaper it becomes, which in turn leads us to consume more, and so on.

Data has become a valuable asset, a key business driver. The need for improved data storage facilities has driven the emergence of third-party data centers. For companies, outsourcing data centers has clear benefits, such as cost savings, scalability, data security and flexible adjustment to new technological developments.

Two types of data centers Data centers can be viewed as a physical location where the IT infrastructure hardware is stored. There are two types: wholesale and retail (colocation) data centers. Wholesale data centers typically lease out large areas of space, measuring over 10,000 square feet. They are estimated to be economically viable for enterprises requiring more than 1 MW of power for IT. This is much more than is typically required by the average enterprise. Hence, the tenants tend to be large enterprises, content providers, cloud players and social media platforms.

It should not be forgotten that despite their focus on hardware and IT development, data centers are still physical property. Hence, the location is of utmost importance. In our view, the ideal location varies depending on the type of data center, but all of them share certain features. Regardless of type, a data center must have access to redundant and cheap energy, preferably from renewables. For cooling purposes, a location should be in a cooler climate or have access to cooling sources such as large water reservoirs. And it must be possible to access dark fiber easily and reliably.

One-stop platform Besides data storage, companies need access to other services, such as cybersecurity and cloud computing. These are not offered by the data center providers themselves but by individual service providers that are also customers of the data center. Therefore, interconnectivity is a key growth driver of retail/ colocation data centers. They have evolved into one-stop platforms. We believe that the platform aspect of retail data centers is not yet fully appreciated by the wider market. This clearly creates investment opportunities, since platform firms typically provide strong investment returns on a consistent basis. Facilities that provide a wide range of interconnection services

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‘Data privacy legislation has become increasingly strict’

are extremely valuable and difficult to replicate given their size and density (the industry leader offers a mind-blowing 230,000+ interconnection possibilities). Hence, we believe that the value of retail data centers lies in the broadbased selection of providers and interconnection capabilities which underpin the ‘one-stop’ platform business model. In an increasingly interconnected world, we expect the value of interconnection to grow as more parties are forced to join in order to fully utilize their business opportunities.

Data privacy Data privacy legislation has become increasingly strict. Some investors see this as a business risk as it will likely drive capital outlay to ensure regulatory compliance. We acknowledge that this is a potential risk. However, the technology creates opportunities to turn the compliance challenge into a business opportunity for colocation data centers. An increasing number of data centers are able to deliver compliance advice services to a wider range of businesses, which is mutually beneficial. This relieves companies of the burden of conducting research into compliant solutions to their individual

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needs, which reduces costs and mitigates compliance risks. As for the data centers, they are able to provide additional value to their services, ensuring ‘stickier’ revenue.

Investment opportunities So far, the investor community has all but ignored the newest additions to the real estate universe. Understanding their business models requires at least basic technology literacy and the information available is often highly technical and full of IT jargon. Historically, these factors have caused IT-related shares to be under-owned. However, given the high growth and good profitability profile, we see real estate investors gradually warming up to these stocks. IT-related real estate shares typically show much higher revenue growth (for instance data centers show an industry average revenue growth of 10%) than traditional property-related shares (which tend to be more GDP related). We consider data centers the best value/growth proposition in the Real Estate Investment Trust (REIT) space. We particularly like interconnection-focused retail data centers, which are part of unique ecosystems that are difficult to replicate.

Net alpha is not a measure of a manager’s skill Some pricing anomalies in financial markets have harmful consequences on economic activity. Hopefully investors, particularly active ones, can help eliminate persistent anomalies and therefore potentially add a lot of value to the broader economy, says Jules van Binsbergen, who holds the Nippon Life Professorship of Finance at the Wharton School of the University of Pennsylvania. they do not beat passive benchmarks,” he says. “Think of it this way: if everybody invests passively, who will make sure that the price is right?”

Speed read

Research

• Active managers can add value to the economy • Consistently achieving positive abnormal returns is very difficult • Management skill should be measured in the right way

Over the last few decades, numerous so-called financial market ‘anomalies’ have been documented in the academic literature. But is a potential mispricing of stocks harmful to the economy as a whole? And what can investors do about it? To answer these questions, it is important to establish first whether a given anomaly represents a robust phenomenon or a statistical quirk, says Jules van Binsbergen, whose research focuses on issues related to both asset pricing and corporate finance.

In recent years, active managers have been heavily criticized for charging excessive fees while achieving poor performance. This has led to a sharp rise in the amount of passively managed assets that follow market indices. But such criticism may not take the whole picture into account. According to Van Binsbergen, the key to understanding the often disappointing performance of active mutual funds is to frame the issue as an economic equilibrium. “Suppose an active mutual fund manager runs a 100-milliondollar fund, and has delivered a 2% extra return to investors. What do you think will happen? Well, many investors will jump at this amazing opportunity.”

‘If everybody invests passively, who will make sure the price is right?’

“We should worry about the persistent anomalies such as the value premium or the profitability premium,” he says. According to him, transient anomalies, like momentum for example, while potentially interesting for some investors, are not particularly important for the economy. According to Van Binsbergen, in this context, it is important to underscore that financial intermediaries, in particular active mutual fund managers, can help eliminate persistent anomalies and therefore potentially add a lot of value to the economy. “This holds true even if

But as more money flows into the fund, the manager will find it harder and harder to identify good investment opportunities for this new money. As a result, the fund’s average performance per dollar invested will decline. “The inflow will only stop when the net alpha is driven down to zero,” says Van Binsbergen. “This explains why net alpha does not persist and why it is not an accurate measure of the manager’s skill.” To establish whether active managers are skilled or not, one must measure the level of this skill in the right way. When we measure skill based on the amount of money a manager makes or loses in markets for asset owners and for himself – which is the fee he charges plus the positive or negative alpha that he achieves, all multiplied by the amount of assets under management – instead of using a return measure, we do find persistent evidence of skill,” says Van Binsbergen. “So, yes, at least some active managers can be considered skilled.”

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LAST BUT NOT LEAST

Trends investing: hype or trend? Trends investing is popular because of all the exciting stories about robo-advice, self-driving cars and other new technologies that transform entire industries. But it goes beyond story-telling. Trend investors need to deliver just like any other investor. In their quest for alpha, they aim to understand the dynamics of secular change better than anyone else, and take advantage of behavioral biases engrained into investorsâ&#x20AC;&#x2122; brains. Trend analysts Steef Bergakker and Jeroen van Oerle explain how they do this, presenting the investment philosophy behind trends investing.

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The rationale behind trends investing Steef Bergakker and Jeroen van Oerle – Robeco Trends Investing Everybody loves a good story. Trends investing derives an important part of its appeal from story-telling. However, a solid investment strategy needs more than a seductive narrative. In this article, Steef Bergakker and Jeroen van Oerle set out their trends investing philosophy, laying the foundation of a conceptual and analytical framework for trends investing that goes beyond mere story-telling. Before we can explain the trend approach to investing, we have to define what a trend is. We define a trend as a profound change in the prevailing secular or, more specifically, economic status quo, which generally challenges incumbent companies and business ecosystems to maintain their market positions. At the same time, the trend provides opportunities for new and upcoming companies and business ecosystems to establish new markets or conquer existing ones. The trends we identify can be characterized as high-level secular changes that, usually, play out over long time frames. These trends are driven by either socio-demographic shifts, government policies, technological innovation, or a combination of all three. Examples are, respectively, population aging, renewable energy policies and increasing digitization of products and services. Having identified the trends, we translate them into a portfolio of companies that are significantly exposed to those trends and are wellpositioned to create economic value from them.

The quest for alpha In today's investment world, the added value of portfolio managers is measured by the outperformance, or alpha, they can deliver. In a landmark paper, Fuller (2000) suggests that there are three sources of alpha: • Acquiring superior (private) information to get an analytical edge • Using better ways (quant models) to process information for an informational edge • Taking advantage of behavioral biases to acquire a behavioral edge Trends investing aims to exploit the analytical edge by thoroughly understanding the dynamics of secular change, and to take

advantage of the systematic behavioral biases displayed by people.

Behavioral biases

Behavioral biases tend to be consistent sources of alpha as they are more or less hardwired into our system and therefore do not change much over time. The challenge when trying to take advantage of them is that there are many behavioral biases, some of them diametrically opposed in their effect. For instance, both over- and underreaction bias have been documented in academic literature. Investors who aim to profit from behavioral biases need to develop a deep understanding of which biases are to be expected in which circumstances. Fuller makes a useful distinction between two broad categories of behavioral biases: 1. Non-wealth-maximizing behavior: in contrast with the economist's classification of wealth maximization as rational behavior, people may strive to maximize other pursuits that they deem more important. Window dressing is a well-known example of non-wealth-maximizing behavior. 2. Heuristic biases and systematic cognitive mistakes: using mental shortcuts or rule-of-thumb decision making is often subject to bias and may result in the incorrect processing of available information. Anchoring, overconfidence, representativeness and saliency are well-documented heuristic biases, which we will explain below. As the vast majority of investors are incentivized to optimize risk-adjusted returns, non-wealth-maximizing behavior is not very common in the financial industry. Heuristic biases, however, affect the majority of people, irrespective of their incentives. These can consequently be exploited, provided that we understand which biases tend to occur in which circumstances. Anchoring, overconfidence, representativeness and saliency are well-documented heuristic biases. Anchoring is the tendency to be heavily influenced by previous (quantitative) values when making quantitative estimates. Overconfidence is the tendency to anchor onto

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Figure 1 | People systematically underestimate exponential growth

Quantity

Continued exponential growth

People’s extrapolation

previous values or estimates, reinforced by overconfidence in our own knowledge of the subject matter. Representativeness is the tendency to overemphasize the importance of recent events when forming expectations about future events. Finally, saliency is the tendency to put too much weight on recent events that are vivid or have a high impact, such as a stock market crash. The key to successful exploitation of behavioral biases is knowing in which circumstances certain biases are likely to crop up. As a general rule, people are not very good at recognizing whether changes in their environment represent a significant departure from the status quo or not. As we have seen above, people tend to overreact to recent, high impact events, which may turn out to be unrepresentative noise, but underreact to seemingly small, but significant, deviations from the quantitative values they have anchored on to. Typical situations in which overreaction takes place in financial markets are profit warnings or market crashes, while typical cases of underreaction occur in accelerating end markets or when a company's competitive advantage is growing.

An excellent tool: Gartner’s hype cycle In the context of trends investing, people have a tendency to overreact to new, exciting technologies that promise to revolutionize entire industries, especially when the media, acting as a huge amplifier, picks up on them. When these new technologies fail to live up to the unrealistically high expectations, disappointment sets in and expectations are pared back drastically. However, when these technologies have taken root, overcome their teething problems and when customer uptake starts to accelerate, people, in classic under-reactive fashion, are slow to pick up on this new information and tend to be positively surprised by it.

Source: Wagenaar & Sagaria; Robeco Trends Investing

Law and forms the basis of Gartner's hype cycle. This is an important tool in our investment process. People also have a tendency to grossly underestimate exponential growth. This is well-documented, for example, in a widely cited experimental study by Wagenaar and Sagaria (1975). Apparently, we have great difficulty in calibrating non-linear processes, even when we are instructed about their nature or deal with non-linearity regularly. This is strong evidence that conservatism in extrapolation is more or less hardwired into our brains and that underreaction can be a source of persistent alpha generation, especially when we are dealing with non-linear phenomena. These behavioral biases are sources of alpha, as they may lead to unrecognized longer-term growth opportunities.

‘Behavioral biases are consistent sources of alpha as they are hardwired into our system’

This empirical pattern of overreaction to early-stage new technologies and subsequent underreaction to later-stage acceleration of the acceptance of these technologies, is sometimes referred to as Amara's

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Future

Present Time

Two sources of alpha in trends investing

If we tie all the strands together, we can identify two main sources of alpha stemming from a trends investing approach. First, there is potential benefit in studying the dynamics of secular change and consequently better understanding these change processes (analytical edge). Second, it is possible to exploit systematic behavioral bias which manifests itself in a tendency to underweight longer-term information and to structurally underestimate the effect of compounding over longer time periods (behavioral edge). Both edges may lead to unrecognized

Figure 2 | Portfolio construction in line with the hype cycle Expectations

longer-term growth opportunities or an extension of a company’s competitive advantage period.

Technology Trigger

Peak of Trough Inflated Disillusionment Expectations

Slope of Enlightenment

Plateau of Productivity

There are three main drivers of secular Time Short-term overreaction Investment chasm Long-term underreaction change. It is either driven by government – Basket approach – Shake-out – More concentrated policies/regulatory changes, socio– Picks and shovels – Do not invest – Long-term winners demographics or technology. Technologydriven change is most interesting for Source: Gartner, Robeco Trends Investing trends investing. The speed and extreme rise of the software giants in the eighties and nineties (value shops) to specialization make it hard to predict the exact way in which new the recent swift ascent of platform companies (value networks), these technology will proliferate. Examples are automation, digitization and shifts all tell us a lot about where and why business success occurs and hyper-connectivity. provide clues as to where it will move next.

Monetization is the key to investability The previously described sources of change are a necessary, but not sufficient, condition for value creation. Monetization choices and extraneous conditions ultimately define how change will be translated into monetary flows and investment returns. An example of how monetization choices can affect outcomes is the differing paths of East and West Germany after the Second World War. Both countries had similar access to technology, similar population traits and similar infrastructure, yet different choices about the organization of the economy resulted in hugely different economic performance. Equally, competitive conditions and strategic choices largely determine whether companies can monetize opportunities arising from secular change. Research has shown that the distribution of equity returns has, historically, been very skewed. Only a tiny fraction of all common stocks have produced super returns; the rest have just produced mediocrity. Clearly, it matters greatly whether extraneous conditions and deliberate choices allow for monetization. We believe that companies that successfully capitalize on trend shifts have a better shot at making it to the select group of super performers than the modal company. An important tool we use to gauge monetization is observing shifts in business model success and deployment. From the dominance of large manufacturers in the sixties and seventies (value chains) to the

The maturity of the change determines the portfolio approach Identifying the trends and dominant drivers of change is half of the equation. The portfolio construction step, including bottom-up analysis of the underlying stocks that have good exposure to the topdown trend, makes up the other half. The Gartner hype cycle is a very helpful tool at this stage, providing insights into the best portfolio construction strategy. This is illustrated in Figure 2. In the first two stages of the hype cycle (technology trigger and peak of inflated expectations) it is often not yet clear who the winners will be. As the investment community gets excited about a trend and the media picks it up, momentum increases and it enters the stage in which the tide raises all boats: every company that can be associated with the trend increases in value. Expectations are very positive and overreaction can result in bubble-like valuations. Our investment approach during this first stage is twofold. First of all, since there are no clear winners yet, we believe it is best to construct broad baskets of companies with good (preferably pure) exposure to the technology in question instead of focusing on a few companies. Especially since at this stage valuation models can produce practically any outcome as a result of the wide range of expectations for value

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drivers making it very hard to determine true intrinsic value. A second approach is to invest in companies that facilitate the new technology. This is the ‘picks and shovels’ approach. Instead of trying to invest in a (presumed) star gold miner during the gold rush, our approach is to invest in the shop in town that is supplying the picks and shovels. A practical example of this approach is the self-driving car. We do not yet know who will be the winner in the self-driving car segment or how business models will exactly evolve, but we do know that self-driving cars require a lot of sensors and software, irrespective of the eventual winners. Hence, the investment focus would be on companies that benefit from their supply position. After the hype has peaked, the next phase is difficult from an investment perspective. During the ‘trough of disillusionment’ and part of the ‘slope of enlightenment’, sentiment is still very negative, some companies cease to exist and merger & acquisition activity peaks. During this shake-out, winners will emerge, but it is hard to invest during this period, which we have dubbed the ‘investment chasm’.

certain periods. Furthermore, we believe in long holding periods of typically three to five years. As it is very hard to pin-point when a trend will start to perform, we position for the long run.

Conclusion: Beating the market through inspired trends investing Financial markets process new information almost instantly and in the vast majority of cases produce unbiased expectations about future events. To consistently produce investment alpha, logic therefore dictates that investors either persistently produce more accurate expectations than the market through better analysis or better information processing, or find the limited number of situations in which expectations are predictably biased. We believe that a trends investing approach can generate better understanding and, consequently, better expectations of the implications of secular change. In this way, trends investors can exploit the predictable biases that occur during the non-linear transformations that often characterize secular change.

‘People have a tendency to grossly underestimate exponential growth’

The second stage of investment opportunity comes along halfway up the ‘slope of enlightenment’ and continues onto the ‘plateau of productivity’. This is where we find the companies that have survived the shake-out period and are able to continue developing the technology. The big difference with the hype period is that this time companies actually implement and use the new technology and are able to monetize this development with a sound underlying business model. The best investment opportunities occur during the ‘slope of enlightenment’ phase, when sentiment is still negative because many investors also witnessed the crash period. The portfolio approach during this phase is to identify long-term winners and concentrate portfolio holdings into these names as opposed to the basket approach in phase one.

Based on the premise that trends investing can generate alpha through analysis of secular change and the exploitation of behavioral biases that occur in dealing with non-linear change, we believe the following elements are key in our trends investing approach: • Identifying those trends where non-linear change takes place and where we can apply useful models or theoretical frameworks that help us understand the dynamics of the change process • Examining the potential for monetization based on established insights from financial and management theories • Constructing portfolios in a way that is consistent with the insights of the analysis and that consist of more than one narrowly defined trend in order to generate more stable returns through time

The Robeco trends approach combines multiple, low-correlated trends in one portfolio. This allows for substantial diversification benefits, making the portfolio less vulnerable to trends that fall out of favor in

Trends investing is a viable investment strategy that needs to, and definitely can, evolve further than just relying on the appeal of a few good stories.

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Arnout van Rijn

‘In many ways Asia has left the West behind’ Interview

Invest in Asia for high economic growth? That was once upon a time. These days, Asia is primarily attractive due to vibrant business dynamics, says Arnout van Rijn, CIO Asia Pacific.

You've lived for over a decade in Asia. What have you learned in those years? “It's very important to realize that Asia is not lagging, but in many ways has already left the West behind. Perhaps it's my age, but I sometimes struggle to keep abreast of developments here. Internet technology has made huge leaps forward in China. You no longer need to take your wallet with you when you go out. You simply pay using your smartphone. In the past, Western dignitaries would go to Hong Kong to learn from the ‘Octopus card’, but these days they'd be better taking a look at China.” So what does this say about China? “It is a sign that China has weathered the crisis very well indeed. The Chinese government has thought very carefully about economic developments. They apply a sort of laissez faire policy, but where necessary – when the economy is threatening to flounder or the government's dominant position is under threat – they always intervene strongly and skillfully in the macroeconomic process. They are able to cool down economic developments or nudge them in the right direction. Naturally the success of the planned economy is in its execution, but China has so far proven remarkably skillful agile in this regard.” So what about the debt issue or the housing market bubble, which dominate economic reporting on China? “The Chinese look at this with a great deal more nuance. Not that they deny any of the problems – these are obviously on the radar – and they take appropriate measures just in time. And that really impresses me. Chinese policymakers are extraordinarily shrewd. The expertise of the central policymakers is grossly underrated outside China.”

So how does a value investor continue generating returns in an environment in which momentum is demanding the limelight? “Markets here are momentum driven due to the conduct of local investors – there's lots of herd behavior. As a value investor, you've got to operate cautiously. Momentum can be stickier than you might think. If you sell out too soon, you can get hit hard. Real estate is expensive here, but the shorters in local project developers often burn their fingers, led by people like Jim Chanos. Real estate is the best-performing sector in China this year. And yes, it has become expensive, but local investors like tangible investments. They want to ‘cling’ to their possessions. You can't cling to equities and equity investors are not always treated very well either.” Is corporate governance a good example of something still in its infancy? “Yes, it is. Our message to companies is: take equity investors seriously. Many companies think that stock issuance is cheaper than debt paper. Equities are often seen by companies as toys for speculators. Companies are used to investors that only hold for a few months. But we invest for a period of three to five years in equities and try to create value together with the company. And yes, that sometimes surprises managers.” “Incidentally, governments today put pressure on companies, for example to lower their carbon footprint. The smog problem is a serious issue and, partly under the influence of social media, the government is tackling this very hard. But that pressure is fully topdown, while in Europe companies are competing among themselves to become ‘greener than green’. And although there is now relevant regulation, enforcement remains questionable. To what degree do companies make a real effort, or do they prefer to just enjoy a glass of wine or two with the local official to settle things?”

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But how are things economically in Asia? “China is emerging from an (unofficial) recession and is now in a better place than the last three years. Naturally, in such a large economy there are always problems – the debt quota is high, but not unacceptably so. Growth is lower than the official growth numbers, but that's a good thing: 6-7% growth is not sustainable. China needs to return to a lower growth track and finds that difficult to accept. But businesses are doing better than in recent years. In Japan we don’t see any great growth, but corporates there too do notice an improvement. However, households do not really benefit yet.”

‘Chinese policymakers are extraordinarily shrewd’

“The tragedy of Asia (outside Japan) is that income inequality tends to worsen. Non-skilled labor remains cheap, and skilled labor is increasingly well-paid. That's why families in China and Korea spend so much on education. So Asia has no shortage of problems, but if I have to give the economy a grade one a scale from one to ten, we've gone from a six to a seven.” Does that mean Asia is ‘the place to be’ for investors? “The growth numbers will be lower in the future. This is a classical fallacy investors make when asserting that you need to be in Asia because of GDP growth. Although that may have applied in the past, it's certainly not a valid reason any longer. Japan, China, Taiwan and Korea are all interesting due to the business dynamic (earnings power and better governance), not for their economic growth. And markets are cheap due to a weak governance discount. If that improves, we could see the 20-30% discount close. But that's a long-term view.”

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Column

The vision thing “The wind is back in Europe’s sails,” declared European Commission president Jean-Claude Juncker in his latest State of the Union before the European Parliament. And he took advantage of the opportunity to push for the European Union taking a more federalist direction. It is easy to underestimate Juncker and to pass him off as just an eccentric, antediluvian and largely irrelevant touchy-feely drunkard or an old-school Europhile and an unlikely agent for change. Who knew the old man had so much spunk in him? Some of Juncker’s more outrageous proposals, like merging the offices of the president of the European Commission and the European Council were immediately and predictably dismissed by the usual suspects, Denmark and the Netherlands. Dutch Prime Minister Mark Rutte has declared Juncker a romantic. “I am more of a ‘when you have visions, go see a doctor’-kind of guy.” This reminds me of when former US President Bush was said to lack “the vision thing”, that is, clear ideas and principles that could shape public opinion. It’s not exactly a compliment, I’d say. But since Brexit, the Dutch have clearly been on the defensive: they fear almost complete domination by France and Germany in a political union and are mourning the loss of Britain with its free market instincts as a counterbalance. Their political punch (the

largest of the smaller members) has diminished since the incorporation of eastern European countries in the Union (Poland is the ‘rising star’). No one is excited about the inevitable expansion of the EU to include the troubled countries of the western Balkan, a topic also addressed by Juncker. Reminiscent of their usual criticism of ECB policies, the Dutch are behaving as anxious rentiers. The dogs bark, but the caravan moves on. Merkel’s chief of staff called it an “important and great” speech. Change is in the air. The new French president Macron has won his first battles on the street to push through labor market reform: the unions were divided. Supply side reform in France is a necessary condition for German approval of initiatives to strengthen the architecture of the euro. A definite solution remains elusive: for example, Germany continues to resist approving a Eurozone-wide deposit guarantee system and a sufficiently large central Eurozone budget (a couple of percentage points of Eurozone GDP as suggested by Macron would be the minimum amount required, but they are still resisting). Some suggest that the German push for a kind of European IMF will be used as an excuse to oppose any fiscal transfer by other means should the need arise. Not that it matters in the shorter run. The cyclical recovery in the Eurozone is even lifting the Italian boat. Though Forza Italia’s Berlusconi (speaking of antediluvian figures) has reintroduced his older proposal for a parallel currency system, other parties are downplaying their Euroscepticism, as they are no longer eager to make it a major issue in the upcoming elections, now that the economy is recovering and the problems in the banking sector have disappeared from the headlines. The Five Star movement has now called its earlier proposal for a referendum on the euro a measure of last resort. The Lega Nord has also toned down its rhetoric. A eurocrisis in this cycle has become highly unlikely, but Europe and the Eurozone remain a work in progress.

Léon Cornelissen, Chief Economist

Robeco QUARTERLY • #5 / SEPTEMBER 2017

Important Information Robeco Institutional Asset Management B.V. has a license as manager of Undertakings for Collective Investment in Transferable Securities (UCITS) and Alternative Investment Funds (AIFs) (“Fund(s)”) from the Netherlands Authority for the Financial Markets in Amsterdam. This document is solely intended for professional investors, defined as investors which qualify as professional clients, have requested to be treated as professional clients or are authorized to receive such information under any applicable laws. Therefore, the information set forth herein is not addressed and must not be made available, in whole or in part, to other parties, such as retail clients. Robeco Institutional Asset Management B.V and/or its related, affiliated and subsidiary companies, (“Robeco”), will not be liable for any direct, indirect, special, incidental or consequential damages arising out of the use of any opinion or information expressly or implicitly contained in this publication.The content of this document is based upon sources of information believed to be reliable. Without further explanation this document cannot be considered complete. It is intended to provide the professional investor with general information on Robeco’s specific capabilities, but does not constitute a recommendation or an advice to buy or sell certain securities or investment products and/or to adopt any investment strategy. Nothing in this material constitutes investment, legal, accounting or tax advice, or a representation that any investment or strategy is suitable or appropriate to your individual circumstances, or otherwise constitutes a personal recommendation to you. Any opinions, estimates or forecasts may be changed at any time without prior warning. If in doubt, please seek independent advice. All rights relating to the information in this document are and will remain the property of Robeco. This material may not be copied or used with the public. No part of this document may be reproduced, saved in an automated data file or published in any form or by any means, either electronically, mechanically, by photocopy, recording or in any other way, without Robeco's prior written permission. The material and information in this document are provided "as is" and without warranties of any kind, eiwther expressed or implied. Robeco and its related, affiliated and subsidiary companies disclaim all warranties, expressed or implied, including, but not limited to, implied warranties of merchantability and fitness for a particular purpose. Investment involves risks. Before investing, please note the initial capital is not guaranteed. The value of the investments may fluctuate. Past performance is no guarantee of future results. Investors should ensure that they fully understand the risk associated with the Fund. Investors should also consider their own investment objective and risk tolerance level. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline or other expectations which involve assumptions, risks, and uncertainties and is only as current as of the date indicated. Based on this, there is no assurance that such events will occur, and may be significantly different than that shown here, and Robeco cannot guarantee that these statistics and the assumptions derived from the statistics will reflect the market conditions that may be encountered or future performances. Historical returns are provided for illustrative purposes only. The price of units may go down as well as up and the past performance is not indicative of future performance. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. The performance data do not take account of the commissions and costs incurred on the issue and redemption of units. The prices used for the performance figures of the Luxembourg-based Funds are the end-of-month transaction prices net of fees up to 4 August2010. From 4 August 2010, the transaction prices net of fees will be those of the first business day of the month. Return figures versus the benchmark show the investment management result before management and/or performance fees; the Fund returns are with dividends reinvested and based on net asset values with prices and exchange rates of the valuation moment of the benchmark. Please refer to the prospectus of the Funds for further details. Performance is quoted net of investment management fees. The ongoing charges mentioned in this document is the one stated in the Fund's latest annual report at closing date of the last calendar year. This document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, such as US Persons, where such distribution, document, availability or use would be contrary to law or regulation or which would subject the Fund and its investment manager to any registration or licensing requirement within such jurisdiction. Any decision to subscribe for interests in the Fund must be made solely on the basis of information contained in the prospectus which information may be different from the information contained in this document. The information contained in this document is qualified in its entirety by reference to the prospectus, and this document should, at all times, be read in conjunction with the prospectus. The prospectus and the Key Investor Information Document for the Robeco Funds can all be obtained free of charge at www.robeco.com. Additional Information for US offshore investors The Robeco Capital Growth Funds have not been registered under the United States Investment Company Act of 1940, as amended, nor the United States Securities Act of 1933, as amended. None of the shares may be offered or sold, directly or indirectly in the United States or to any US Person. A US Person is defined as (a) any individual who is a citizen or resident of the United States for federal income tax purposes; (b) a corporation, partnership or other entity created or organized under the laws of or existing in the United States; (c) an estate or trust the income of which is subject to United States federal income tax regardless of whether such income is effectively connected with a United States trade or business. Additional Information for investors with residence or seat in Australia This document is distributed in Australia by Robeco Hong Kong Limited (ARBN 156 512 659) (‘Robeco’) which is exempt from the requirement to hold an Australian financial services license under the Corporations Act 2001 (Cth) pursuant to ASIC Class Order 03/1103. Robeco is regulated by the Securities and Futures Commission under the laws of Hong Kong and those laws may differ from Australian laws. This document is distributed only to “wholesale clients” as that term is defined under the Corporations Act 2001 (Cth). This document is not for distribution or dissemination, directly or indirectly, to any other class of persons. In New Zealand, this document is only available to wholesale investors within the meaning of clause

3(2) of Schedule 1 of the Financial Markets Conduct Act 2013 (‘FMCA’). This document is not for public distribution in Australia and New Zealand. Additional Information for investors with residence or seat in Austria This information is solely intended for professional investors or eligible counterparties in the meaning of the Austrian Securities Oversight Act. Additional Information for investors with residence or seat in Brazil The Fund may not be offered or sold to the public in Brazil. Accordingly, the Fund has not been nor will be registered with the Brazilian Securities Commission - CVM nor have they been submitted to the foregoing agency for approval. Documents relating to the Fund, as well as the information contained therein, may not be supplied to the public in Brazil, as the offering of the Fund is not a public offering of securities in Brazil, nor used in connection with any offer for subscription or sale of securities to the public in Brazil. Additional Information for investors with residence or seat in Colombia This document does not constitute a public offer in the Republic of Colombia. The offer of the Fund is addressed to less than one hundred specifically identified investors. The Fund may not be promoted or marketed in Colombia or to Colombian residents, unless such promotion and marketing is made in compliance with Decree 2555 of 2010 and other applicable rules and regulations related to the promotion of foreign Funds in Colombia. The distribution of this document and the offering of shares may be restricted in certain jurisdictions. Prospective applicants for the Fund should inform themselves of any applicable legal requirements, exchange control regulations and applicable taxes in the countries of their respective citizenship, residence or domicile. Additional Information for investors with residence or seat in the Dubai International Financial Centre (DIFC), United Arab Emirates This material is being distributed by Robeco Institutional Asset Management B.V. (Dubai Office) located at Office 209, Level 2, Gate Village Building 7, Dubai International Financial Centre, Dubai, PO Box 482060, UAE. Robeco Institutional Asset Management B.V. (Dubai office) is regulated by the Dubai Financial Services Authority (“DFSA”) and only deals with Professional Clients or Market Counterparties and does not deal with Retail Clients as defined by the DFSA. Additional Information for investors with residence or seat in France Robeco is having the freedom to provide services in France. Robeco France (only authorized to offer investment advice service to professional investors) has been approved under registry number 10683 by the French prudential control and resolution authority (formerly ACP, now the ACPR) as an investment firm since 28 September 2012. Additional Information for investors with residence or seat in Germany This information is solely intended for professional investors or eligible counterparties in the meaning of the German Securities Trading Act. Additional Information for investors with residence or seat in Hong Kong Investment returns not denominated in HKD/USD are exposed to exchange rate fluctuations. Investors should refer to the Hong Kong prospectus before making any investment decision. This Fund may use derivatives as part of its investment strategy and such investments are inherently volatile and this Fund could potentially be exposed to additional risk and cost should the market move against it. Investors should note that the investment strategy and risks inherent to the Fund are not typically encountered in traditional equity long only Funds. In extreme market conditions, the Fund may be faced with theoretically unlimited losses. The contents of this document have not been reviewed by the Securities and Futures Commission (“SFC”) in Hong Kong. This document has been distributed by Robeco Hong Kong Limited (‘Robeco’). Robeco is regulated by the SFC in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. Additional Information for investors with residence or seat in Italy This document is considered for use solely by qualified investors and private professional clients (as defined in Article 26 (1) (d) of Consob Regulation No. 16190). If made available to Distributors and individuals authorized by Distributors to conduct promotion and marketing activity, it may only be used for the purpose for which it was conceived. Additional Information for investors with residence or seat in Panama The distribution of this Fund and the offering of shares may be restricted in certain jurisdictions. The above information is for general guidance only, and it is the responsibility of any person or persons in possession of the prospectus of the Fund and wishing to make application for shares to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. Prospective applicants for shares should inform themselves as to legal requirements also applying and any applicable exchange control regulations and applicable taxes in the countries of their respective citizenship, residence or domicile. Additional Information for investors with residence or seat in Peru The Fund has not been registered before the Superintendencia del Mercado de Valores (SMV) and are being placed by means of a private offer. SMV has not reviewed the information provided to the investor. This document is only for the exclusive use of institutional investors in Peru and is not for public distribution. Additional Information for investors with residence or seat in Shanghai This material is prepared by Robeco Investment Management Advisory (Shanghai) Limited Company (‘Robeco Shanghai’) and is only provided to the specific objects under the premise of confidentiality. This material must not be wholly or partially reproduced, distributed, circulated, disseminated, published or disclosed, in any form and for any purpose, to any third party without prior approval from Robeco Shanghai. The information contained herein may not reflect the latest information on account of the changes and Robeco Shanghai is not responsible for the updating of the material or the correction of inaccurate or missing information contained in the material. Robeco Shanghai has not yet been registered as the private fund manager with the Asset Management Association of China. Robeco Shanghai is a wholly foreign-owned enterprise established in accordance with the PRC laws, which enjoys independent civil rights

Robeco QUARTERLY • #5 / SEPTEMBER 2017

and civil obligations. The statements of the shareholders or affiliates in the material shall not be deemed to a promise or guarantee of the shareholders or affiliates of Robeco Shanghai, or be deemed to any obligations or liabilities imposed to the shareholders or affiliates of Robeco Shanghai. Additional Information for investors with residence or seat in Singapore This document has not been registered with the Monetary Authority of Singapore (“MAS”). Accordingly, this document may not be circulated or distributed directly or indirectly to persons in Singapore other than (i) to an institutional investor under Section 304 of the SFA, (ii) to a relevant person pursuant to Section 305(1), or any person pursuant to Section 305(2), and in accordance with the conditions specified in Section 305, of the SFA, or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. The contents of this document have not been reviewed by the MAS. This document is not intended as a recommendation or for the purpose of soliciting any action in relation to Robeco Capital Growth Funds or other Robeco Funds and should not be construed as an offer to sell shares of the Fund (“Shares”) or solicitation by anyone in any jurisdiction in which such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such an offer and solicitation. Any decision to subscribe for interests in the Fund must be made solely on the basis of information contained in the prospectus (“Prospectus”), which information may be different from the information contained in this document, and with independent analyses of your investment and financial situation and objectives. The information contained in this document is qualified in its entirety by reference to the Prospectus, and this document should, at all times, be read in conjunction with the Prospectus. Detailed information on the Fund and associated risks is contained in the Prospectus. Any decision to participate in the Fund should be made only after reviewing the sections regarding investment considerations, conflicts of interest, risk factors and the relevant Singapore selling restrictions (as described in the section entitled “Important Information for Singapore Investors”) contained in the Prospectus. You should consult your professional adviser if you are in doubt about the stringent restrictions applicable to the use of this document, regulatory status of the Fund, applicable regulatory protection, associated risks and suitability of the Fund to your objectives. This document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or which would subject the Fund and its investment manager to any registration or licensing requirement within such jurisdiction. Investors should note that only the sub-funds listed in the appendix to the section entitled “Important Information for Singapore Investors” of the Prospectus (“Sub-Funds”) are available to Singapore investors. The Sub-Funds are notified as restricted foreign schemes under the Securities and Futures Act, Chapter 289 of Singapore (“SFA”) and are invoking the exemptions from compliance with prospectus registration requirements pursuant to the exemptions under Section 304 and Section 305 of the SFA. The Sub-Funds are not authorized or recognized by the Monetary Authority of Singapore and Shares in the Sub-Funds are not allowed to be offered to the retail public in Singapore. The Prospectus of the Fund is not a prospectus as defined in the SFA. Accordingly, statutory liability under the SFA in relation to the content of prospectuses would not apply. The Sub-Funds may only be promoted exclusively to persons who are sufficiently experienced and sophisticated to understand the risks involved in investing in such schemes, and who satisfy certain other criteria provided under Section 304, Section 305 or any other applicable provision of the SFA and the subsidiary legislation enacted thereunder. You should consider carefully whether the investment is suitable for you. Additional Information for investors with residence or seat in Spain The Spanish branch Robeco Institutional Asset Management BV, Sucursal en España, having its registered office at Paseo de la Castellana 42, 28046 Madrid, is registered with the Spanish Authority for the Financial Markets (CNMV) in Spain under registry number 24. Additional Information for investors with residence or seat in Switzerland This document is exclusively distributed in Switzerland to qualified investors as such terms are defined under the Swiss Collective Investment Schemes Act (CISA) by Robeco Switzerland AG which is authorized by the Swiss Financial Market Supervisory Authority FINMA as Swiss representative of foreign collective investment schemes, and UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zurich, postal address: Europastrasse 2, P.O. Box, CH-8152 Opfikon, as Swiss paying agent. The prospectus, the key investor information documents (KIIDs), the articles of association, the annual and semi-annual reports of the Fund(s), as well as the list of the purchases and sales which the Fund(s) has undertaken during the financial year, may be obtained, on simple request and free of charge, at the head office of the Swiss representative Robeco Switzerland AG, Josefstrasse 218, CH8005 Zurich. The prospectuses are available at the company’s offices or via the www.robeco.ch website. Additional Information for investors with residence or seat in United Arab Emirates Some Funds referred to in this marketing material have been registered with the UAE Securities and Commodities Authority (the Authority). Details of all Registered Funds can be found on the Authority’s website. The Authority assumes no liability for the accuracy of the information set out in this material/document, nor for the failure of any persons engaged in the investment Fund in performing their duties and responsibilities. Additional Information for investors with residence or seat in the United Kingdom Robeco is subject to limited regulation in the UK by the Financial Conduct Authority. Details about the extent of our regulation by the Financial Conduct Authority are available from us on request. Additional Information for investors with residence or seat in Uruguay The sale of the Fund qualifies as a private placement pursuant to section 2 of Uruguayan law 18,627. The Fund must not be offered or sold to the public in Uruguay, except in circumstances which do not constitute a public offering or distribution under Uruguayan laws and regulations. The Fund is not and will not be registered with the Financial Services Superintendency of the Central Bank of Uruguay. The Fund corresponds to investment Funds that are not investment Funds regulated by Uruguayan law 16,774 dated September 27, 1996, as amended.

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