Could Quants Transform ESG?

As data on environmental, social, and governance factors become more widespread, some quantitative managers are bringing systematic thinking to ESG investing.

When it comes to investing in accordance with environmental, social, and governance principles, quantitative managers have made few inroads. Now, that’s slowly changing.

Quant manager Acadian Asset Management is launching the first actively managed emerging markets strategy free of companies that own fossil fuel reserves. Others may follow now that ESG data is more widely available.

Acadian, which has $82 billion in assets, alreadyincorporates ESG research into its global and international investment process, but the fossil-free strategy is its first standalone investment.

“In the U.S., interest in climate change issues by investors has built over the last 18 to 24 months,” said Asha Mehta, senior portfolio manager and director of responsible investing at Acadian. “This fund grew out of discussions with a consultant who asked whether we could implement a fossil-free strategy and still be able to deliver an attractive alpha profile.”

Acadian was able to create the strategy in part because it has a broad universe of securities to choose from and can easily rotate from sectors like energy and utilities to others, like consumer discretionary goods. Mehta said quants have a lot more ESG data to work with, even though there are still limitations.

“There is an increasing amount of ESG data available, but not all is predictive of corporate success or returns,” she said. “Better data and regulation of that data will help the industry move forward.”

Brian Cho, portfolio manager and head of quantitative research at Chiron Investment Management, a ‘quantamental’ manager using both fundamental and quantitative methods, said there is enormous potential for quants in ESG, but the work is still in its infancy as data, the amount of which is growing, is still difficult to work with and is not frequently updated. He also emphasized that ESG factors are only useful for long-term investments, not short-term.

Although Chiron does not currently use ESG data in its process, Cho said he believes there is a strong connection between ESG factors and company success. Chiron, for example, measures management behavior, which can include how capital is deployed, balance sheet health, and the number of women on boards.

“What usually happens is that a firm that looks good on management behavior is usually good on ESG,” he said.

According to Cho, that quantitative and fundamental analysis is likely the most effective way to get at underlying ESG issues and understand how they could impact a company’s future. “You need judgment,” he said.

Acadian, which was the first quant manager to become a signatory to the U.N.’s Principles of Responsible Investment, said it won’t offer sustainable or similar funds if ESG factors don’t add to their returns. Despite the launch of the new strategy, Acadian is not pulling fossil-fuel investments from its core funds.

Still, some quants think they can fundamentally transform the ability of investors to find companies that embrace ESG principles. Gavin Smith, a v.p. and researcher for QMA, the $116 billion multi-asset manager owned by Prudential Financial, is bullish on the possibilities that unstructured data will bring to the ESG world. Such “unstructured data” can range from people’s comments on social media to data mined from online retailersand sites like Glass Door, which provides salary information and employee reviews.

Being able to systematically make sense of candid quotes and information from people who work at companies about what’s going on internally when it comes to hard-to-measure issues like corporate culture or a commitment to the environment could lead to valuable ESG insights, Smith said.

“This is a better window on the social awareness of a company than what the company formally discloses,” he said. “This could be very exciting.”