Investors are taking an increasingly sophisticated view of their passive equity allocations, aiming to capture the benefits of a range of risk premiums, while also lowering the volatility and improving the risk/adjusted returns – all at a considerably lower cost than active management.

Wyoming Retirement System (WRS) turned to risk-premium mandates as part of a broad-ranging restructure of its equity portfolio that began three years ago.

Chief investment officer John Johnson explains that the investment team decided to target 70 per cent passive allocations across major classes. It was a radical about-turn for the $6.5-billion fund, which previously had a preference for active management.

While reducing costs was a benefit of the move to passive, the fund also had the overarching objectives of lowering volatility and improving risk-adjusted returns.

To this end it looked at how to capture different risk premiums – including size, value, momentum and volatility – through tilts to value and risk-weighted indexed mandates.

“We have ranges, so typically between 50 and 70 per cent will be passive in all of the asset classes, with the idea of trending towards 70 per cent,” Johnson says.

Previously, WRS had actively managed all of its equity investments but adopted its passive-management target when revamping its equity portfolio, which currently stands at 53 per cent of the overall portfolio.

WRS decided to use the MSCI risk-premium indexes, focusing on products that would capture the risk premiums of size, value and volatility.

 

An age of indexes
Large investors are increasingly looking to use these strategy indexes in their passive allocations.

The $42-billion Taiwan Labor Pension Fund (LPF) announced this month that it would allocate $1.5 billion to two MSCI low-volatility indexes tracking global equities and emerging markets.

Other investors to recently adopt MSCI’s risk-premium indexes include St James’s Place and Credit Suisse AG.

MSCI’s New York-based executive director of index-applied research, Raman Aylur Subramanian, says these risk-premium indexes can be used in both active and passive investing.

The multiple risk-premium index mandates can be used to capture a portion of excess return normally associated with active management, leaving active managers to concentrate on stock selection and rotating portfolios to take advantage of market cycles, according to Aylur Subramanian.

Passive investors can use these indexes to either add value to a traditional passive portfolio or access systematic excess returns at a lower cost to traditional active management.

Aylur Subramanian says that investors like Wyoming can make a strategic allocation but the indexes can also be used tactically.

He cites examples of investors who have wanted to de-risk portfolios by adding volatility protection to their portfolio, without the need to increase allocations to fixed income.

They can then rotate between a minimum-volatility index and a traditional cap-weighted index as market conditions change.

For WRS, the passive part of the equity portfolio was split between a 70 per cent allocation to a portfolio tracking MSCI All Country World Index Investable Market Index (ACWI IMI), with the remaining 30 per cent evenly divided between portfolios tracking the MSCI ACWI Value Weighted and MSCI ACWI Risk Weighted indexes.

“What I really wanted to do was capture all of them [risk premiums] without changing the overall portfolio’s factor exposures,” Johnson says.

“If we went and bought a value risk premium, it could change other factors within the total portfolio. MSCI ran various analyses of the portfolio’s risk factors that we were being exposed to. We had an iterative process of what we wanted to allocate to: initially it was one half to market weight and one half to risk premiums, and then of those risk premiums it was split evenly between size, value and volatility.”

Johnson says that the fund ended up incorporating the MSCI ACWI IMI, which encompasses large mid and small-capitalisation segments of the global equities universe, with a 10-per-cent strategic overweight to small caps as a way of capturing the size risk premium.

WRS did not forgo return opportunities via momentum risk premiums, with Johnson saying that allocations to a passive-market cap-weighted index provides a proxy exposure.

“We chose not to use momentum because it was the least understood factor. I think momentum is actually a very good risk premium to incorporate because it is negatively correlated to the other risk-premium strategies, so is useful in a portfolio,” he says.

“But the way we thought about is that, just like we are incorporating the MSCI ACWI IMI to capture the size premiums, effectively the market cap-weight index is a momentum index by definition because, as companies are getting larger and larger caps, they are being included in the index and you are capturing them on the way up.”

Correlation and keeping it Sharpe
Johnson explains that the passive allocation to a typical market cap-weighted index will capture the typical market beta. Hence, correlation will be 1 and the Sharpe ratio will be around the market Sharpe ratio of between 0.2 and 0.25.

Risk premiums aim to increase the Sharpe ratio that would otherwise be expected from a traditional passive allocation. The aim is to generate a Sharpe ratio of between 0.33 to 0.44, [thus] improving the risk-adjusted returns of the passive-equity allocation.

The remaining 30 per cent of the equities portfolio is actively managed, with two-thirds earmarked for long-only managers, Johnson says.

The remainder will be allocated to an “alpha pool” of five-to-seven hedge fund managers tasked with achieving returns that are uncorrelated to the broader market.

“What we have been trying to do is eliminate direct equity exposure and create more nuanced risk exposures across the portfolio,” Johnson says.

In its active equity allocation there is an expectation that the portfolio will have a lower correlation of between 0.75 to 0.8, with a Sharpe ratio of between 0.5 and 1.5, thus generating a higher return per unit of risk than the broader portfolio, he says.

In the alpha pool, zero (plus or minus 0.5) with a Sharpe ratio greater than 1.5 for the total portfolio, will add “an incremental return per unit of risk for the entire portfolio”.

 

Passivity brings beta
The exposure to risk-premium indexes should only cost 4 to 5 basis points more than the cost of a typical market-cap index, according to Johnson.

The tightly focused approach to active management comes from the investment team’s belief that they should only be paying for more for exposure to areas of the market where there is persistent evidence managers can achieve excess returns over the benchmark.

“If all you are trying to get out of that asset class is beta, then we internally can capture the beta as well as an active manager out there by going the passive route,” he says.

“What we did was that we decided to incorporate the MSCI IMI to capture the size premiums and then allocate 30 per cent, split evenly to volatility and value. So what that did was still kept the overall portfolio-factor exposure very similar to the market-cap index, but it also enhanced the return per unit of risk, which is what we were trying to get to.”

 

The rest of the revamp
As part of its revamp of the overall portfolio, the investment team has strongly focused on managing and ongoing monitoring of the correlations both within an asset class and between asset classes.

“Because correlations are not static, they change over time, we need to be constantly vigilant on monitoring,” Johnson says.

The restructure of the portfolio has resulted in a 53-per-cent exposure to equities with a target exposure of 50 per cent and a range of 40 to 60 per cent.

Fixed income is 24 per cent of the overall portfolio with a heavier exposure to credit. Fixed income is split 6.5 per cent interest rates, 11.4 per cent credit and 6 per cent to mortgage/opportunistic.

The investment team also added a global tactical-asset allocation (GTAA) that includes global macro hedge funds, risk parity and long-only global tactical allocations.

“GTAA is a strategy to exploit short-term market inefficiencies [in order to] to profit from relative movements across global markets,” he says.

“The managers focus on general movements in markets rather than individual securities within markets. The purpose for our portfolio is to provide a low-correlated asset that will provide high risk-adjusted returns and minimise the volatility of the portfolio.

Real-return opportunities make up 8.5 per cent of the portfolio, with the balance held in tactical cash.

Investments in private equity were recently approved by the board, and keeping with its overarching view on correlations are included as part of the active-equity exposure, as it is essentially capturing equity returns.

The fund also includes private equity-like structures throughout the portfolio with mezzanine and distressed debt forming part of the credit allocation.

Johnson says the fund has not yet set a target range on the amount of private-equity investment.

Infrastructure (1.5 per cent) and real estate (3.5 per cent) form part of the real-returns stream, as will a planned allocation to a resources/commodities, inflation-linked product slated for launch this year.

The fund should complete its equity restructure by mid-way through this year, Johnson says, with the overall portfolio build out being finalised by the end of the 2013.

 

Norway’s 3496 billion kroner (US$582.7 billion) sovereign wealth fund could suffer significant losses in a range of climate-change scenarios if it fails to hedge its risk by investing in climate-sensitive assets, the release of a confidential report shows.

Norway’s Ministry of Finance recently released an extensive study by asset consultant Mercer on the effects of climate change on the Government Pension Fund Global’s (GPFG) portfolio of investments.

The world’s second biggest sovereign wealth fund has a portfolio that is heavily weighted to the traditional asset classes of equities and bonds.

GPFG is the only one of 12 large institutional investors that participated in Mercer research conducted in 2011 to release the confidential report looking at the specific impact of climate change on each of the funds’ portfolios.

If the recommendations of the report, currently with the Ministry of Finance, were adopted, the fund would make it a priority to increase its allocation to assets such as low-carbon-intensive infrastructure, real estate and private equity with a focus on alternative energy and venture-capital technologies.

The fund currently has no allocation to infrastructure, private equity, timberland, agricultural land and other alternatives.

GPFG has a strict investment mandate that limits investments to financial instruments (mainly listed equities), fixed income, real estate and cash.

The fund has a new investment mandate that came into effect on January 1 this year, but has recently announced it will increase its allocation to emerging markets and decrease its exposure to European assets.

As part of its risk management processes, Norges Bank Investment Management – the fund’s asset manager – has already taken measures to build in climate-risk considerations into its investment decision making.

Since 2009 NBIM has included water among its key risk focus areas (see here).

Based on the current positioning of the fund and its unique characteristics, Mercer grouped potential climate-sensitive assets into three priority groupings:

Priority 1: Infrastructure (low-carbon assets), real estate (improve existing standards and seek new opportunities in energy efficiency), private equity.

Priority 2: Sustainable equity (continue to build on integrating into core processes), energy efficiency (listed and unlisted).

Priority 3: Timberland, agriculture, green bonds and carbon (consider building exposure to a carbon market as it matures and liquidity improves

 

The report recommends that GPFG introduces a climate-sensitive asset-allocation plan over a long-term horizon.

“In particular, develop a plan to cover what asset classes will be relevant and beneficial for the fund over a 1.3.5 or 10/20 time period,” Mercer advises in the report.

“This could include creative leadership in developing approaches to deploy capital to new areas of opportunity where institutional-investment frameworks are still nascent (for example, energy efficiency).”

This multi-asset class process would also take into account various regional sensitivities to climate risk.

The report does not prescribe specific target allocations for climate-sensitive assets.

 

Basic framework and scenario forecasting
Mercer’s Climate Change Scenarios Tailored Report takes the basic framework used in its landmark 2011 Climate Change Scenarios ‑ Implications for Strategic Asset Allocation study, which found that climate change could slash up to 10 per cent off portfolios in the next 20 years.

The potential effects of four potential climate-change scenarios ranging from divergent regional action to mitigate climate change, delayed action, comprehensive and coordinated action similar to that advocated by Nicholas Stern, and climate breakdown are analysed.

The cumulative gains or losses the fund could experience are modelled relative to a baseline case, where the fund would achieve a nominal return of 7.3 per cent with risk (standard deviation of return in absolute terms) of 12.1 per cent until 2030.

Mercer found that GFPG could suffer a cumulative loss of approximately 8 per cent of its portfolio by 2030, relative to the baseline, if the current asset allocation was maintained and delayed action on climate change occurred.

Delayed action is the second most likely scenario Mercer forecasts.

The fund could potentially lose between 1 and 2 per cent of its portfolio under the most likely scenario: regionally divergent action on climate change.

Under the “Stern action” scenario where there is comprehensive and coordinated action, the fund is forecast to enjoy 2-per-cent cumulative growth relative to its baseline over the next 20 years. This is primarily caused by lower policy risk positively impacting the returns on most assets.

A cumulative loss of between 5 and 6 per cent of the portfolio is predicted to occur if climate breakdown was to occur.

The report notes that most of the more significant macroeconomic outcomes of climate change would be modest up until 2030, with the effects considerably magnified after 2050.

Built into its analysis is the impact of technology, the physical impacts of climate change and policy changes, what Mercer calls the (TIP) risk-factor framework for examining investment uncertainty around climate change.

Mercer also takes into account the sensitivity of various asset classes to these TIP factors, as well as which regions might be better placed to lead the push to change economies to a low-carbon future.

The report notes that the fund’s portfolio – currently approximately split 60 per cent equities, 35 per cent fixed income and 5 per cent real estate – was reasonably positioned in the event of climate breakdown.

However, it was more exposed to climate risk in the other more likely scenarios of regional divergence and delayed action.

The report recommends that the fund build a process for monitoring climate risk and opportunities, which could complement efforts to gradually build out a hedge against climate risk through diversification of the portfolio.

Mercer also advocates the fund establishing engagement with active managers so that it gains the advantage of being strategically prepared, rather than attempting to enter asset classes late on the back of market events when it would be more costly.

The report notes that listed equity markets were unlikely to price long-term climate risk and were, in fact, more likely to respond to climate related events as and when they take place.

“Against this backdrop, the headline macroeconomic impact of climate change is unlikely to be a driving force behind any changes to beta assumptions for listed equities within our horizon,” Mercer notes in the report.

“Rather, we expect the degree of economic transformation that will take place under the different scenarios to produce varying impacts in terms of sectors and regions.”

 

Uncertainty is risky
Policy uncertainty is also identified as one of the greatest sources of risk, and Mercer advises the fund, which is the second biggest sovereign wealth fund in the world, to engage on both a domestic and international level with policy makers. This engagement activity should form part GFPG’s risk management processes, according to Mercer.

The report also recommends GFPG build into its potential climate-risk hedging activities consideration of which regions will be better prepared to deal with climate change.

The European Union and China/East Asia are identified as regions where government policy is aiming to reduce emissions and attract investments.

In the case the fund does not adopt the recommendations of the report regarding specific allocations to climate-sensitive assets, Mercer advocates GPFG builds proactive management of climate risk into its existing assets.

This would include reducing the operating costs around carbon by improving the sustainability practices and energy efficiency of its real-estate portfolio and consideration of the overall equity portfolio’s exposure to TIP risk factors.

Global equities are the least sensitive to TIP risk factors, followed by emerging markets and sustainability-themed equities.

Norges Bank Investment Management (NBIM), the manager for the fund, was contacted for comment but directed enquiries to Norway’s Ministry of Finance. The ministry did not respond prior to publication.

To read the report click here

EDHEC-Risk Institute research associate Hilary Till looks at the risk management of commodity derivatives trading and the lessons that can be learned from recent high profile trading debacles.

Till, a principal, at Premia Capital Management, LLC, analysed several case studies and looks at risk management at large institutions, proprietary trading firms and at hedge funds. The research is a chapter dealing with commodity derivatives trading risk management in Risk Management in Commodity Markets: From Shipping to Agriculturals and Energy.

View this research here: Case Studies and Risk Management Lessons in Commodity Derivatives Trading

Advocating the use of financial models a six-year-old could understand and warning that the dogmatic belief in overly complex and unrealistic models contributed to the financial crisis were some of the challenging views put to the attendees of the recent CFA Institute’s annual conference.

Throwing down the gauntlet was GMO asset-allocation team member James Montier, who outlined what he saw as the key flaws of finance to members of the institute.

The fallout from the financial crisis was a point debated throughout the recent 65th Annual CFA Institute Conference in Chicago. Opinion was divided on whether the key building blocks of financial theory remained intact or had been fundamentally undermined by the events of 2008.

Montier told delegates that the four bads – bad behaviour, bad models, bad policies and bad incentives – explained the causes of the financial crisis and warned that the many of these key failings remained.

Montier honed in on the widespread use of risk measured by value-at-risk as an example of where investors were lulled into a false sense of security and/or ignored clear signs of growing risk due to an overdependence on finance modelling and theory.

“Using VaR is like buying a car with an airbag that is guaranteed to fail just when you need it, or relying on body armour that you know keeps out 95 per cent of the bullets,” Montier says.

“VaR cuts off the very part of the distribution of returns we should be worried about: the tails.”

He points to systemic problems if VaR is widely adhered to, with investors locked into pro-cyclical behaviour.

This would occur when the commonly used trailing correlation and volatility inputs to the model indicate lower risk or lower VaR, encouraging investors to increase leverage. Similarly, when VaR rises, investors are likely to collectively deleverage, further amplifying the market cycle.

The adoption of VaR by regulators encouraged bad incentives, according to Montier.

On the back of intense lobbying from powerful banking interests, VaR was extensively used as a means to determine capital adequacy and drove a surge in leverage in the banking sector.

Montier says volatility was a poor measure of risk, and pointed out the build-up of leverage in the financial system was also one indication of increasing risk.

In finding solutions to the causes of the financial crisis, Montier calls for investors to abandon their obsession with the concept of optimality. Rather than trying to construct optimal portfolios, investors should instead aim for robust portfolios.

He advised investors to treat financial innovation with suspicion and be mindful of the limits of financial models.

“All financial-model underpinnings and assumptions should be rigorously reviewed to find their weakest links or the elements they deliberately ignore, as these are the most likely source of a model’s failure,” he says.

To watch  Montier’s presentation to the the recent 65th Annual CFA Institute Conference in Chicago, click here.

In its most simple form, CalPERS defines sustainability as the “ability to continue”. This year CalPERS turns 80 and clearly “continuing” is something it wants to do.

The strategy paper, presented to and endorsed by the board, explains the fiduciary framework the fund has adopted to integrate sustainability across the entire fund and sets out the themes and visions for the future.

Anne Simpson, director of corporate governance at the fund, says one of the interesting questions for a fund as big and complex as CalPERS is “how do you actually get this done?”

“This is a new strategy for a total-fund approach with practical impact. It has been a two-year project, it takes time, so be patient,” she says.

In developing a total-fund approach, it was essential to get buy-in from all aspects of the fund at the outset.

The fund’s corporate-governance program has been overseen by a working group that has representatives from all the key constituents in the business, including the chief executive, the president of the board, the chief operational officer and head of external affairs.

“This allows the fiduciary, investment and all aspects of the business to be across it. This is critical to develop this new strategy,” she says.

“There is a question in the industry about whether the governance people sit in the investment team, legal or in a separate division, the answer is yes, in all of them.”

The outcome of the report is that implementing environmental, social and corporate governance (ESG) is now a strategic goal for the investment office, and it is a board commitment, she says.

“This won’t work if we can’t get the F into ESG,” she says. “It sounds like I’m swearing.”

Until Christmas, Simpson’s corporate-governance group of around 20 people sat within the global equities asset class. That has now changed and they work across asset classes.

“Previously we were in global equities, but that didn’t allow us to connect on issues across other asset classes, such as private equity. This move was made just before Christmas, and it is one of the moves we’ve made internally to implement the sustainability plan.”

At the same time the sustainability plan was being formed, the fund conducted its triennial asset-liability-modelling review.

 

External matters

It now manages assets in three buckets: growth, which includes public and private assets; income; and inflation hedges. The management of ESG is done within these different buckets and the appropriateness of the strategy assessed on each.

“The working group across asset classes had a representative from each, and the commitment of each asset class and a critique of the vision was done on economic grounds. They assessed the vision and how to link that on to an investment strategy,” she says.

“We have an economic view that wealth creation is through financial, human and physical capital and that became the intellectual framework for ESG.”

Each of these three elements – financial, human and physical capital – was then assessed in each asset class.

CalPERS still faced the enormity of how to prioritise these forms of capital in ESG implementation, and for clarity it benchmarked the fund through an international group of peers.

It communicated directly with 11 funds, all of which had more than $200 billion, including Norges Bank, Government Employees of South Africa, Previ, Ontario, PGGM and BT.

From that process clarity of how to implement a strategy became clearer, it prioritised one mission for each of the different areas.

Climate change became the theme for the environmental consideration. The reasoning was it affects all asset classes and CalPERS believes as a mega-fund with long-term liabilities, it will be impacted by climate change.

For social issues, priorities and human capital, talent management and rewards, human rights and fair labour practices across the entire supply chain will be a focus.

And for governance, alignment of interest is the key focus.

“It’s not everything, but we can’t do everything. We had to do something that speaks to our size, global exposure and the long-term nature of our liabilities,” Simpson says.

“Each asset class developed a couple of specific things before now and the end of the financial year.”

 

Internal considerations

In addition, another project is underway, a “manager’s expectation” document across the total fund.

“We have a complicated structure with internal management of public assets as well as external managers. If we think ESG has the potential to effect risk then we need to be consistent with expectations of internal and external experts. An expectations document is the next project to start next week.”

“CalPERS is in a leadership role. Rather than small portions of capital to the space, we want managers to look at risks and opportunities,” Simpson says.

CalPERS will also issue a request for proposals next month to review the “evidence” of the effect of ESG on risk and return. This will set the scene to commission new research, which ultimately will identify data and create a matrix to integrate into financials.

The fourth project, in what Simpson describes as a “mighty amount of work to do”, is to review the more than 110 initiatives and statements across the CalPERS portfolio.

This will be developed into a unified statement of principles for the entire portfolio.

“We have been doing a lot of rethinking about the long term, the fear of sustainability of returns, and the fundamental ability to pay pensions,” Simpson says.

Simpson says CalPERS has been proactive in leading by example internally.

It has cut its own greenhouse gases by 30 per cent between 2008 and 2010, more than 90 per cent of its printing and writing paper come from recycled sources, and it has conducted a governance overhaul, which includes in an external-board evaluation this July.

“We are willing to take those things on,” she says. “Asset owners need to act and engage intelligently on market level reforms. We need a broader vision.”

More than 1000 asset owners and service providers have signed up to the United Nations Principles for Responsible Investment, and yet the question on everyone’s lips remains how to actually integrate sustainability into the investment process and ultimately add alpha. Bill Mills, managing partner of Highland Good Steward Management, has an idea and a platform for such a solution.

As with any integration process, empowerment is crucial; for integrating environmental, social and corporate governance (ESG) into investment processes it is no different.

Mills is working on the premise that ESG information can be turned into alpha and it rests with empowering the investment decision-makers.

His solution is a labyrinth of players which are involved in a continuous multi-directional loop of information. But the secret, he says, is to leave the responsibility for decision making, with the fund manager.

The Highland Good Steward Global Bond Fund, which uses Pimco as the sub-advisor, has an emphasis on changing the behaviour of borrowers in a long-term sustainable way, but also to remain flexible enough to maximise short-term opportunities.

The key, Mills says, is to provide ESG signalling to the underlying manager in order to guide its long-term decision-making in sustainable companies without limiting its shorter term investment discretion.

The philosophy is that the outcome will be achieved by collaborating with the manager rather than replacing the manager’s judgement.

“Philosophically, we do want a sub-advisory based on traditional asset management with a track record. But we want to stimulate their thinking, not change their thinking, for ESG, but ask them to think deeper,” Mills says.

“What underpins all of this is that you don’t tell managers what to do. You hire the best managers, listen to them and work with them.”

There are a number of differences in this approach that distinguish it from simply overlaying a process with ESG information on a company.

 

How data signalling and engagement work
Highland Good Steward Management (HSGM) has developed a consortium of research firms that provide company ESG and socially responsible investment (SRI) information. This is fed to the manager as additional information for securities selection, of which the manager retains ownership.

The research consortium includes ECPI, Eco-Frontier, MSCI, CAER, EIRIS, and SocioVestix Labs, and produces a grading on 7000 companies for the individual elements of environment, social and governance, as well as a consolidated ESG rating.

“The data from these providers acts as a signal for the portfolio managers to use, alongside financial and other data used for analysis.”

“Highland will not limit Pimco’s investment choices by negative screening. Instead the aim is to collaborate with the manager in their search for additional alpha by integrating ESG considerations into their investment analysis.”

But it doesn’t stop there. Another element of the process is the use of a service, provided by Hermes EOS, to engage with corporations before and after the investment decision.

Colin Melvin, managing director of Hermes EOS, says engagement is a way of looking at longer term decisions and aligning the client.

“We have an engagement indicator that measures the quality of the company and its responsiveness to engagement. If you are considering it as part of the normal decision-making, then you want fund managers to do it as they do other things. But you can also use it to challenge managers on their decisions,” he says.

“For many, these issues have been taboo for funds managers. They have been overly impressed for too long by short-term decisions.”

Hermes engages this way with about 500 companies globally.

For this relationship, the engagement starts with investors suggesting themes. These currently include climate change, access to and utilisation of water, operations in troubled regions, supply chain, and access to medicines.

Hermes then suggests to HGSM certain companies that may have potential for engagement breakthroughs. This list is then taken to Pimco for the manager to analyse as possible portfolio holdings on the basis of their investment thesis.

If Pimco invests in these companies, which is at their discretion, then Hermes engages in focused impact engagement in order to accelerate the corporate and potential changes in share value.

It also works the other way: if Pimco invests in companies outside the HGSM research-consortium database, then HGSM can request that a research report on the company be performed by one of the research companies, and Hermes may also engage with that company.

“It is incorporating the manager in the process. We can take all the holdings in the fund and download them into research,” he says. “Over time we can see how the portfolio is moving towards E,S,G or not.”

 

Case studies on the HGSM platform
Mills points to the example of two companies as to how the process may work. On a corporate level, the companies would be analysed on a theme and how they engage with Hermes, and then ranked.

Say, for example, company A has improved its water management, which will be reflected in a good environmental score, but it has a tight yield spread. Compare this to company B, which historically hasn’t taken Hermes seriously on water engagement and has a low environment grade, but its yield spread is higher.

In recent times when Hermes engages with company B, it now wants its senior management to be involved, which is sending a different signal about how it is approaching the issue. HGSM sends the information to Pimco, instructing that it is a signal to be fed into the analyst’s process.

“They love that,” he says. “Everyone wants to prove ESG works. It entirely depends on the time frames, the same way for example value and growth does. We have been attaching the wagon to the wrong thing and setting ourselves up. The ideal way is corporate engagement – it is the only way to determine a company’s DNA.”

“You can be more explicit in engagement than data providers can be on performance. But the engagement partners are selected not with an eye to embarrassment but effective engagement.”

“We would go back to Hermes and say that water engagement is important to my client and Pimco bought 500 bonds on that basis. We will also share with the company we’re engaging with.”

“This is a long-term monitoring process that makes sense, it’s better than trying to prove alpha exists,” he says.

Mills is now transferring all the data from this platform to Microsoft Cloud, which makes it immediately customisable.