Passive strategies | Sustainable investing How can passive strategies benefit from sustainable investing principles?

The trend toward passive investing and growing interest in sustainability are closely related. How so?

14 Sep 2018

1. Passive investors expect asset managers to factor in sustainability issues in their investment decisions1

Firstly, as asset owners move their equity assets increasingly toward passive strategies, they are less exposed to stock or manager specific failures. However, they are increasingly exposed to unmanaged, longer-term systemic and socioeconomic risks, which impact the long-term returns of the markets as a whole. As a result, they are placing increasing emphasis on longer-term sustainability issues.  Increasingly, they expect asset managers to take these longer-term issues into account when making their investment decisions1.

2. Passive managers can be more proactive given popularity of asset class

Consequently and secondly, the rise of passive investing has provided an opportunity for  passive managers to take a more proactive role in solving large, systemic sustainability issuesthrough stewardship, in the form of engagement and proxy voting.

As passive assets have grown, so too has the potential power to influence and shape corporate agendas.

3. Emergence of smart beta has coincided with a move toward differentiating active strategies through sustainability integration

Finally, the emergence of smart beta and rules-based strategies has coincided with a move toward differentiating active strategies through sustainability integration. Increasingly sophisticated quantitative approaches have replaced many more traditional fundamental strategies.

This in turn has created a demand for new methodologies within active asset management that cannot be replicated by rules-based approaches by focusing on longer-term drivers of performance, which inevitably overlap with sustainability issues. This entails integrating material sustainability signals in order to invest in line with the long-term value of companies.


How does active stewardship add value?

UBS Asset Management has conducted quantitative research into the impact of sustainability on returns.

Our internal back-testing has examined the UBS proprietary factor driver score which identifies the most relevant sustainability factors per industry.2 Through this quantitative analysis, we can better understand and control the inputs into our sustainability variables, as well as control how the score correlates with financial performance.

We examined the performance of an MSCI World Index strategy that is tilted using the UBS factor driver scores, where companies with higher scores are given a higher weighting while companies with poor scores are underweighted compared to the MSCI World benchmark.

The overall back-test showed a positive signal, as the portfolio outperformed the benchmark by 8% over the whole time period, or 0.39% on an annualized basis3.

While the performance was relatively neutral, to slightly negative during the 18 months leading up to the credit crisis, the portfolio began to out-perform the MSCI benchmark in June of 2008, just before the worst period of the crisis in the fall of 2008, and nine months prior to the market bottom in March 20093.

The portfolio has been generally positive since the end of 2012 as markets recovered from the European sovereign crisis of that year.4

Interestingly, these results are similar to those of recent research conducted by the quantitative research team of UBS Investment Bank (IB) which tested the performance results of various tilted portfolios using sustainability scores from Sustainalytics.5


What is UBS Asset Management’s approach to stewardship?  
We organise our stewardship activities into four pillars:

1. Thematic

1. Thematic

2. Reactive

2. Reactive

3. Proxy Voting related

3. Proxy Voting related

4. Proactive

4. Proactive

1. Thematic

Engagements on specific sustainability topics, including climate change and impact 

2. Reactive

Engagements on topical events and UNGC breaches

3. Proxy Voting related

Engagements centered around shareholder meeting research

4. Proactive

Engagement following identification of material ESG risks and opportunities

Stewardship is relevant for both active and passive strategies. In the case of active, it facilitates enhanced investment decisions for long-term value creation. For passive, it addresses broader negative externalities to the economy which could cause instability and inefficiencies within the financial markets.

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