Remy Briand

Following its merger with RiskMetrics, global index provider MSCI will launch a series of indexes and risk products incorporating ESG for the first time, and in doing so will propel ESG factors into the mainstream. Amanda White spoke to managing director, global head of index and applied research at MSCI, Remy Briand.

With more than 120,000 indexes and 2,400 organisations subscribing to its equity index products, MSCI can reasonably argue its status as the most widely-used provider of global equity benchmarks by institutional investors.

With this in mind the decision to launch a number of ESG index and risk products in September is a revolution for the industry which has supported the need to understand the concepts, risks and opportunities of ESG, but struggled to incorporate it into investment processes.

Managing director, global head of index and applied research at MSCI, Remy Briand, acknowledges that incorporating ESG factors provides some unique challenges.

“We’re going to discuss with clients, why would you incorporate ESG, and our view is that for asset owners ESG is taking into account externalities generated by companies which may affect the whole portfolio – traditional finance looks at companies in isolation. It is interesting for pension funds to look at those negative externalities,” he said.

“It’s an area that is difficult to measure sometimes but this year there’s been a number of very high profile cases such as FoxConn and BP which have been great examples.”

MSCI is working on an “extensive lineup” of indexes that will incorporate ESG, including country and industry indexes, as well as some specific indexes that cover SRI or the environment more specifically, and all will adopt the best-in-class methodology.

MSCI is also currently under way into how to include companies’ carbon footprints into an index, which will be done by adjusting the weights of companies in the index according to their carbon footprint.

The genesis for the ESG indexes comes from MSCI’s acquisition of RiskMetrics which was completed in June.

The RiskMetrics stable includes a wealth of ESG-related businesses including: Institutional Shareholders Services, the proxy voting service bought by RiskMetrics in 2007; Innovest Strategic Value Advisors which specialises in analysing companies’ performance on ESG factors groups and was bought in February 2009; and KLD which published the first research designed to evaluate the risks and opportunities associated with corporate social and environmental performance and was bought as recently in November 2009.

Of the top 50 institutional money managers worldwide, about 30 use KLD’s research to integrate ESG into their investment decisions. And the KLD 400 index, launched in May 1990 as the Domini 400 Social Index was the world’s first benchmark index built using ESG factors. MSCI will incorporate the history of that index into its new series.

(The suite of KLD indexes is currently calculated and licensed by FTSE).

With a rebranding, and a tweaking of the underlying core index to be consistent with the MSCI methodology, existing clients will be transitioned to the new index by the end of August.

“We plan to change the underlying index so that is consistent with the other MSCI indexes. It will use the best in class methodology, and the parent index will be an MSCI one, they will be part of the family and use the same criteria,” Briand said. “As far as ESG factors, we want to leverage the wealth of knowledge, experience and research of the existing ESG research group. RiskMetrics has built a very large research organisation and (has) about 60 people in ESG research.”

Briand says the best in class notion is defined by targeting 50 per cent of market cap by sector – and includes those with the highest ESG rating.

“The structure of each sector which will dictate how many stocks are included, but we are targeting 50 per cent. The major indexes will be the best-in-class, we will change some aspects of the methodology, but it is more of an evolution than strict criteria at the outset,” Briand says. “The timing will be to transition existing clients by the end of August which is when the quarterly rebalancing at MSCI is conducted, and from September 1 all those clients will have transitioned and we will then have a formal announcement.”

He says there has definitely been an increasing demand in ESG in general, and in particular MSCI sees a trend to integrate ESG into the mainstream investment process, rather than as a separate product. And, importantly, according to the data (see performance figures in the graph below) there is a performance pay-off as well.

“From that perspective for us we want to provide clear ratings and benchmarks to reflect those ratings, so there is alignment with the methodology of the rating and a benchmark.”

One of the benefits of bringing the indexes into the MSCI fold is that a direct comparison will be possible with the general index used by most institutional investors.

“We don’t have a direct comparison, but will be able to do that relatively easily when we have both series,” he says. “One thing we are communicating is that the ESG dimension takes into account aspects that may have a long-term effect and the stock market is discounting short-term factors. And this has performance analysis considerations for institutional investors.”

MSCI is also considering incorporating ESG factors into its risk products.

“It is definitely worth investigating and we are looking at it with Barra but it is at a very early stage,” he said.

Index performance at March 2010 1 year 3 year 5 year
 10 year
KLD400 52.94 -2.21 2.68 -1.05
FTSE All World US 50.07 -3.77 2.43 -0.51
S&P 500 49.77 -4.17 1.92 -0.65
MSCI 49.09 -7.45 0.84 -1.75

Source: FactSet Research Systems, Inc, FTSE Group, MSCI

MSCI Global Investable Market Indices Methodology (pdf)

Fer Amkreutz
Fer Amkreutz

As part of an increasing focus on emerging markets, APG Asset Management, has an increasing interest in emerging markets. As part of that strategy an office in Hong Kong employs 28 staff to cover the Asian region. Amanda White spoke to the president of APG Asset Management Asia, Fer Amkreutz, about the perils and profits of a life in Asia.

The Hong Kong office of APG Asset Management, one of only two offices outside of The Netherlands, is part of a wider strategy to manage the move away from developed market equities.

Over the past six years, APG which manages assets for Dutch pension funds, including the giant €208 billion ($274 billion) Dutch pension fund ABP, has decreased the allocation to developed market equities by nearly 8 per cent, while the emerging markets exposure has increased to the current level of 7 per cent in the recently completed 2010-2012 strategic plan.

The office was set up in 2007, well after there was a significant allocation in the region, with assets in Japan, India, Australia and wider Asia.

“We already had investments here but realised if you don’t have your feet on the ground you won’t fully understand the region. You need to speak the language and be part of the network,” President of APG Asset Management Asia, Fer Amkreutz says.

Amkreutz, who has only been in the Hong Kong office for the past nine months, can’t emphasise enough the role that relationships play in doing investment management business in Asia.

“It goes back to Confucius, it is absolutely important, and if you’re new it’s harder,” he says.

But Mike Friedlander, COO/CFO of the APG Hong Kong subsidiary, says it is not unlike any other emerging market.

“It’s identical to other parts of emerging markets, being on the ground permits you entry into transactions you wouldn’t be part of if you were sitting in New York or Amsterdam,” he says.

Similarly Brett Gordon, a Brit who has worked in Asia for the past 17 years and now heads up the listed real estate business for APG in Asia, says business partnerships in Asia are very much a two way street.

“From a western view we are coming in and selecting partners, but really it is also about them selecting us as well.”

Unlike other parts of the world, where money talks, Gordon says investing in Asia can often be as much about a transfer of skills or knowledge as capital.

“There is no shortage of capital in Asia, so if someone needs your capital then you should think twice about investing,” he says.

“It’s about bringing an additional benefit, not just about the money, for example in a real estate context if we are able to bring a certain skill or green technology, we become a much more attractive partner.”

“But who you invest in is often more important than the opportunity itself.”

Like any emerging market, there are unique country risks and Friedlander warns investors to fully understand the risks with the opportunities.

“Due diligence is a must, it must be calculated and that includes due diligence of asset consultants. There must be a very tangible alignment of your strategic interest,” he says.

“There is a great “soft” factor in due diligence that – next to financial/economic factors – needs to be reviewed thoroughly.”

APG’s asset liability management study looks at the determinants of investing according to sectors, but also regions, and there is about 10 per cent invested in Asia (about €20 billion) across listed and non-listed real estate, infrastructure and emerging markets equities.

APG has more than 600 investment staff globally and there are 28 people in the Hong Kong office, 16 are investment professionals and 12 of those are local, with an increasing focus on bringing assets in house.

“Without localisation being on the ground it is not getting you there,” Amkreutz says. “We choose the people that work here but they choose us too. We have a responsibility as an employer as well as an investor. We take a bit of a European approach as well, in the development of skill and balance of life, but that doesn’t necessarily apply easily.”

Trust is a big part of doing business in Asia, the APG executives concur, with the Dutch proverb roughly translated that “trust comes on foot and goes on horseback” a close ally.

“We send the local staff to Holland to help them understand what a pension fund is and is not. It’s a mixed cultural office, but it is also an Asian office and we are cognisant of feng shui. And keep in mind that what you where used to “as a westerner”, or thought to be true, might not work out well in an Asian context.”

The balance between east and west business cultures as well as managing misconceptions are enduring aspects of conducting business in Asia.

Friedlander says there is a popular misconception about the management of environmental, social and governance issues in China.

“People get it here and are moving in that direction, it’s a complete misconception that they are not,” he says.

For example APG recently had engagement with a South East Asia company over a governance issue, and that company responded positively.

“They said no one has ever discussed this with us. They said we understand and will change. So they are willing to change. There is a sense that there is a lot of first generation money that has been made and they understand to hand it on to the second generation they have to make changes.”

There is an element of protecting reputation and the transfer of wealth.

While APG invests in all asset classes, there is a focus on real estate and infrastructure-type projects, which are constantly being assessed. Opportunities such as energy efficiency in China are of particular interest.

“The Chinese Government is completely committed as an economic imperative and have energy efficiency goals, we see this as a good opportunity,” Friedlander says.

And Gordon stresses economic impact is assessed alongside social and environmental impact.

“But it needs to stack up against other business opportunities,” he says.

One of the big lessons from three years in the region, is scale and patience.

“The trend to emerging markets is strong and will continue, but it is a gradual process. There is a strategic shift but it is not quick. It is estimated by 2040 India and China will be 50 per cent of GDP, so you need to be here,” Amkreutz says.

ABP strategic investment portfolio

Investment mix 2009 2010-2012
Government bonds 10% 10%
Price indexed bonds 9% 12%
Corporate bonds 21% 16%
Alternative inflation 7% 7%
Global TAA 2% 3%
Equities, developed markets 24% 20%
Equities, emerging markets 5% 7%
Private equity 5% 5%
Real estate 8% 9%
Infrastructure 1% 2%
Commodities 0% 1%
Opportunity fund 4% 4%
Hedge funds 4% 4%

Note: APG Asset Management client’s have discretion over their asset allocation

Chris Ailman
Chris Ailman

CalSTRS will explore the potential of risk-oriented strategic allocation management and wider asset class ranges, as it sets out its investment business plan for 2010-11, which also includes collaborating with UC Regents and CIC about improvements to Barra One – its risk management system – and potentially further insourcing.

Each fiscal year CalSTRS sets out an investment business plan, with this year’s theme of “continuous improvement” on the back of last year’s “back to basics, alpha, beta, costs”.

“Pension Consulting Alliance will lead us through a discussion of how we might attempt to be more nimble in the financial markets and more actively manage risk at the extreme inflection points in the market,” said a paper to be presented at the meeting states.

The paper also says that later in the financial year, the fund will explore different levels of internal versus external asset management.

Risk measurement and management will also be a key area of continuous improvement, and all the private asset classes will be integrated into Barra One, the fund’s risk measurement system.

It has also said it will work with staff at UC Regents and the China Investment Company to improve the system and enhance reporting.

Climate change and diversity will be a key focus, which includes continuing to expand climate change investment in real estate, private equity and global equity.

The fund endeavours to consider global sustainability issues across its entire portfolio, but this year the innovation and risk unit will also be incorporating environmental factors into a quantitative screen to identify potential new strategies for incubation.

According to the business plan, to be presented at the July 9 investment committee meeting, two core objectives for the investment team this year are adding 60 basis points of value over the policy benchmark, and achieving an absolute return above the actuary assumed rate, which is currently 8 per cent.

In real dollar terms this is $10 billion in profits from the financial markets, and an extra $1 billion of return above the market.

The fund also aims to prudently diversify the portfolio and strive for lower costs.

“The big challenge before us is whether to shift our asset allocation process to make it more nimble to accommodate market dynamics,” the paper said.

In the past, themes for the business plan have included “the year of alph” and “squeezing 8 per cent out of a 5 per cent market”.

CalSTRS logoThe $130 billion Californian fund, CalSTRS, will hire a deputy chief investment officer who will oversee the new absolute-return asset class, investment operations and a majority of the day-to-day investment branch management.

This brand new position will allow the chief investment officer, Chris Ailman, to focus more on portfolio management and asset allocation.

All existing heads of departments – innovation and risk, global equities, fixed income, real estate, private equity and corporate governance – will continue to report to Ailman, as will the new deputy.

In addition to overseeing investment operations, which has about 18 staff and includes cash management, portfolio controls, reporting and performance, and administration and management, the new deputy will manage the new absolute-return asset class.

An allocation of up to 5 per cent of the fund has been approved by the board for the absolute return asset class which is made up of Treasury inflation-protected securities (TIPS) and infrastructure, although no investments have been made in infrastructure yet.

A portfolio manager was appointed this spring and will develop internal processes, portfolio construction planning and hire a general infrastructure consultant.

The three-year plan is for five staff in this business unit, reporting to the deputy CIO.

Rob Arnott
Rob Arnott

Alternative beta is catching on, with Russell Investments the latest market index builder to embrace the non-cap-weighted index trend by inking a deal with Rob Arnott’s Research Affiliates company.

Russell will launch a series of “fundamental” indices, in association with Research Affiliates, during the third quarter of this year.

Fundamental indices rank stocks according to a range of factors which the strength of the underlying businesses rather than the price multiple of all their shares (capitalisation value). Critics have suggested that it is a form of value-biased index but Research Affiliates say that more factors are assessed than price:earnings figures.

Arnott, the founder and chair of Research Affiliates, said that about US$50 billion in assets were being managed using fundamental indices around the world.

Russell’s Ron Bundy, the managing director for indices, said the firm would continue to believe that cap-weighted indices represented the best description of the market’s opportunity set and therefore the most appropriate benchmarks for investors.

However he noted the increasing demand from index investors for a “more active” approach using alternative beta.

The big quant index houses, State Street Global Advisors and Barclays Global Investors (now BlackRock), have provided various bespoke and packaged indices in recent years.

SSgA, for instance, has a “diversified” index strategy which combines low-volatility with value and size tilts.

Russell, which is best known for its multi-manager funds and asset consulting, pioneered the development of growth and value indices in the US in the 1980s. The first index in the new series is likely to be a global equities index.

Research Affiliates, based in Newport, California, also provides a range of investment services from direct asset management and sub-advisory services to licensing agreements.

Through their momentum properties, cap-weighted indices favour the emergence of speculative bubbles, according to research by EDHEC-Risk Institute, which concludes cap-weighted stock market indices offer no particular advantage.

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