Dr. François Chevallier-Gravezat, PhD, Portfolio Manager, Machine Learning Strategies [email protected]
The first quarter of 2022 threw a daunting number of curves at investors. The confluence of higher inflation brought about, in part, by the lengthy pandemic, the Russian war with Ukraine and the January tech meltdown producing a sharp spike in market volatility. Markets took a beating, and ESG stocks were no exception. In its wake, there is a good amount of hand-wringing among ESG supporters and finger-pointing from others about the limitations of ESG investing.
Reflecting back on the quarter I’d like to point out two factors that may have contributed to this circumstance, and how Welton ESG Advantage’s design differs from others. I’ll then describe our outperformance during this challenging quarter and the reasons that contributed to this success.
First, the majority of ESG product offerings have an overreliance on equity securities. This concentration may lead to outperformance during optimal market conditions, but it also subjects investors to periodic systemic market risk too — like that experienced during Q1. This concentration was particularly painful for tech-heavy ESG programs as the Nasdaq experienced steep losses during January. By contrast, Welton ESG Advantage was conceived as a multi-asset ESG program to diversify risk in pursuit of an all-weather performance profile. Welton ESG Advantage’s holdings include single equity securities like others, but this is diversified with other ESG-screened assets including currencies, agriculturals, emissions, metals, bonds and STIRS. For more information, we have written elsewhere (here and here) explaining both the deficiency of the long-only equity approach as well as the intended benefits of multi-asset ESG.
The second issue at play is that single stock ESG metrics typically focus solely on stock issuers with little consideration for external factors. One such factor includes home country / country of origin, and few events brought this issue to the fore quite like the war in Ukraine. For example, before the Russian invasion of Ukraine it is likely that equivalent US and Russian companies may have shared similar ESG scores. After the invasion, however, everything changed in a matter of days. Entities or assets with a significant link to Russia likely experienced a rapid decline from an ESG score standpoint. Rather than radically change one’s view after such an event, however, we believe ESG scoring frameworks would benefit by inherently weighing sovereign entity/asset risk factors at all times. Welton’s proprietary ESG scoring framework does just this by using sovereign ESG score inputs. We further innovated by applying this capability to non-equity assets as well.
So, after weathering a quarter dominated by systemic market risks, how did Welton ESG Advantage fare? Suffice to say that Welton ESG Advantage continues to outperform the benchmark S&P 500 Index and that this differential widened meaningfully after Q1.
PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
We believe there are three reasons for this outperformance:
- Multi-asset strategies offer greater protection to investors in choppy markets. Because we prefer a more evenly weighted sector allocation (not concentrated) our strategy was more insulated from sector-driven gyrations like the tech rout this past January. Additionally because we have no energy exposure the portfolio was inoculated from recent energy volatility as well.
- We deliberately incorporate derivative strategies into the portfolio design to diminish systemic equity downside risk, and these uncorrelated strategies have contributed to our outperformance.
- A rigorous risk management framework.
In short, Welton ESG Advantage is doing what it was designed to do: produce a similar upside to a stock market investment, but with less downside and ESG risks through the efficient use of diversification and dynamic sustainability filtering.
We very much hope that Welton ESG Advantage will inspire others to innovate new products to help scale ESG investing. The bottom line is that if we want ESG to gain broader acceptance across the institutional investor landscape, then we must offer investors more sophisticated products that are capable of withstanding a variety of market environments.