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Monica:
Hello, I'm Monica Fan Bradley, Head of Global Consulting Relations at UBS Asset Management based in London.  Today, I'm delighted to be here with Rodrigo Dupleich, a Senior Portfolio Manager and quantitative researcher in UBS’s systematic and index investments team. We're here to talk about rules based investment strategies.

Monica:
Rodrigo, first of all, what are managers' proprietary rules based strategies? We've heard a lot about them, many managers produce them, how are they different from the plethora of index strategies we see?

Rodrigo:
Thanks, Monica, rule based strategies. I think the key difference is that the investment process is generated in-house, it allows us for example, to use multiple data providers, select the best in class data sets, for example, we know which data providers are, the quality of the data that they produce in terms of carbon emissions, or for example, in terms of governance we know which data providers they are best in class. 

Monica:
So you and your team have been managing index strategies for a very long time. What prompted you to start creating ESG orientated and sustainable rules based strategies in 2016?

Rodrigo:
I mean, we review what was available in terms of index solutions at that time, for particular and trying to aim for climate, climate strategies. At that time, most of the solutions were reducing the carbon footprint of a given benchmark, for example, FTSE developed, and I think when we start to analyse the problem, we realise that for example, you can have a company that tends to have high emissions with respect to another company. However, this company, it looks not good in terms of emissions however, for example, they are disclosing their data, they are increasing the investments on renewable energy or they are putting efforts to reduce their carbon footprint.

So we realise that the problem is a multi-data problem. You have to consider different data points in order to say okay, this company is a leading company in terms of climate or this company, it's a laggard with respect to the industry in terms of climate.

Monica:
What we've seen, particularly amongst clients across institutional, retail, consultants, advise, clients, their demand for rules based strategies has evolved. It's become more sophisticated. They've demanded more from rules based strategies. How have you responded?

Rodrigo:
We have seen clients where they say okay, reducing the carbon exposure is one of our objectives, however human capital, and overall ESG exposures are equally important. We consider climate components in our strategy. However, in order to mitigate the potential social effects that the climate transition can have, we include information on socially related data or Sustainable Development Goals, SDGs, in order to balance the strategy such that we have a group of climate objectives, but at the same time, we aim to mitigate the potential social impacts that the climate transition can have. 

Rodrigo: 
Monica, you are at the forefront of the discussions with our clients. What do you see in terms of trends or objectives of clients they want to translate into strategies?

Monica:
So Rodrigo net zero is a key priority for clients right now. So, countries’s Net Zero commitments, the financial industry is committed to net zero, the Alliance amongst asset owners. I think there's a real urgency for us now.

Rodrigo:
That has been an interesting evolution of the industry. If you see it, maybe three years ago, the key objective was to reduce the carbon footprint with respect to our global equity market, for example, but I think the industry has moved, sort of saying: okay, well, it's not good enough this approach, one has reduce their carbon footprint with respect to yourself, let's say, picking up let's say 2019, and gradually start to reduce the carbon emissions of our portfolio such that this reduction enters a trajectory, which could be for example, a 1.5 degree scenario that is well discussed in climate scenarios.

Monica:
Rodrigo, what we've seen more recently is that clients want to combine their risk premia factors with sustainable factors. How do you think they should go about building this into their portfolio? 

Rodrigo: 
We see clients for example, that they want to harvest risk premia, that they are well documented in academia, for example, valuation, quality, or other type of factors, but at the same time, make these portfolios aware of sustainable strategies like carbon reduction or human capital and so on.

Monica:
What are some of the challenges of incorporating this into a portfolio? 

Rodrigo:
If we go on the Net Zero camp I think we see three key challenges in terms of implementation of net zero strategies.

The first one is related to data. I think, again, rules based strategies are in the key pillar of our strategy’s data and data quality, data integrity, I think it's really at the core of the implementation of these portfolios, for example, you see scope one and two emissions, still, there is a level of disclosure of 40%, so only 40% of companies, they put the effort to disclose their carbon emissions. So you see that there is a level of uncertainty on this data.   Recently it came on the discussions to add scope three, which is basically their supply chain related emissions, it’s very important these emissions in the outdoors oil and gas sector. But you see that the level of reporting is even much lower, it’s less than one quarter of our equity benchmark the level of reporting of this data.  In some cases, scope three accounts 90% of the emissions. So one challenge is data, I  think it  has improved significantly over the years, but we still need to see further improvements, to improve the accuracy if you want to put it like that, of rules based strategies.

The second challenge is is whether actually, these net zero strategies can be achieved, but more from a global point of view. I think the IPCC, which is an entity that runs different scenarios related to climate, recently they analysed the 1.5 degree scenario, yes, and for example, in terms of the carbon budget that is available nowadays, we actually have consumed 82% of the carbon emissions that we should be able to release till the end of the century. And that leaves with 400 billions of tonnes of carbon budget that we can emit till the end of  the year.  We are more or less emitting 40 billion tonnes of carbon emissions, that sort of shows that in 10 years, pretty much, we are going to use all this carbon budget. Therefore, there is strong evidence that the world is not moving towards net zero. And therefore it's much challenging for portfolios that they have net zero strategies that align with a world that is not moving towards status scenarios. 

The third point is a little bit more technical, but it's worth mentioning, if you see for example, global benchmarks, especially in the equity side in the last five years, they wait on tech companies have increasing over time, say Amazon, Apple, Google.  I think in general the weight of these companies in benchmarks have been increasing. And you have seen the oil and gas sector reducing their weight over time. So the tech industry tends to be a low emitter, at least relatively to the oil and gas sector. Therefore, if you estimate the carbon footprint of the portfolio has been reducing over time, but mainly driven by this push of less weight on the oil and gas sector, and more index weights, if you want to put it like that, on the tech sector.  However, this year we have seen a significant change in this trend. 

We have seen that with the energy crisis, the equity prices on the oil and gas sector have been increasing and therefore their weights have been increasing. And therefore you see pressure to increase the carbon footprint of global equity markets and if you implement a net zero strategy that translates that you have to take more risk or deviate more from these benchmarks if you want to keep on decarbonizing your carbon footprint with respect to yourself over time, that is between these net zero strategies. 

Monica: 
What about the challenges of implementing the risk premia factors.

Rodrigo:
The key challenges that we have seen on implementing these strategies is the interaction between risk premia factors and sustainable factors. In some cases, there is a positive correlation, for example, you see, governance metrics on the sustainable side are very highly correlated with quality metrics, so you tried to increase the exposure in one portfolio one and, to a degree for free, if you want to put it like that, you get all the governance. 

However, there are cases in which it's not as simple as that, for example, if you see couple of years ago coming back to the oil and gas sector, they used to score quite well on valuation metrics, they look cheap, if you want to put it like that, and if you want to build up a portfolio that is exposed to value, we'll try to get exposure on these companies. But at the same time you want to reduce the carbon footprint, there is a trade off that you have to take into account.

Monica:
Looking ahead now, what do you see is two drivers or two key trends that you're watching in the rules base strategy space? 

Rodrigo: 
Probably the key one is related to technology. I think the industry, I think technology has been a key driver of of developing in our industry. I mean, farther developments on technology will allow us to address, and add in the objectives that we see in our clients in terms of customization. Yes, we have seen through sustainable risk premia that the diversity of objectives, risk, budget, targets, and so on is quite broad. And we believe that technology will allow us to bring solutions to our clients that they met their objectives and requirements. 

So that's one, probably on the the sustainable side, the move towards simplicity that has to happen at some point, I think, again, coming back to the data uncertainties that we still see across different sustainable metrics, having that sort of, maybe lean towards an approach that we can gradually taking the industry to say, okay, well, probably let's go back to simple portfolios, that they address the specific objectives of our clients, and they don't take unintended risks. They manage the risk of the portfolio in an efficient way, and they help the clients to address their objectives. 

Thank you for sharing your insights today. Rodrigo. It's always a pleasure to speak to you and thank you to our listeners for joining us. Thanks, Monica. It's always a pleasure to discuss with you.

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