Sydney-based Morphic Asset Management is launching a new global equity strategy on the Trium UCITS platform, employing ESG factors to generate alpha on both short and long positions.
The Trium Morphic ESG L/S Fund launches on 20 February 2018, targeting European investors. It will be managed by experienced portfolio managers Jack Lowenstein (pictured), and Chad Slater.
Both managers have a multi-decade track record in successful, sustainable investing and will apply a fundamental equity long/short approach to the fund, targeting absolute returns. Multi-level risk management is at the heart of their approach and the fund will offer investors daily dealing. Typically, the fund will hold 20-60 long and short positions.
At the core of the Morphic investment process is the belief that markets have an inability to adapt to price changes in the real world. This also extends to changes in ESG for individual companies where studies suggest improvers are rewarded the most (Statman et al).
By embedding ESG into the research process, the fund is able to find multiple new alpha sources. This includes shorting using a selection of ESG and non-ESG signals; for example, failed engagements are often a signal that a share price is likely to fall (Hoepner et al). Most of the shorts will be implemented through pair trades or as single stock shorts.
The team uses a two-stage ESG approach that, initially, applies a negative ESG screen to a universe of stocks and, then, this is used to analyse stocks to identify change.
The final portfolio consists of fundamental longs and shorts that are consistent with both the firm’s ESG charter and the portfolio construction process.
According to Jack Lowenstein, co-CIO of the Trium Morphic ESG L/S Fund, the idea that change creates opportunity is central to Morphic’s investment philosophy: “Responsible investing is having a gravitational effect on investment markets – reshaping the flow of capital to those companies demonstrating improvements in ESG and delivering sustainable returns to investors.”
“It is clear markets reward those companies making material ESG improvements. Hence, we don’t view exposure to companies with impressive ESG scorecards as a source of maximising alpha; instead, we seek companies implementing measures to improve their ESG profiles. This means accessing the future shape of change by identifying early catalysts for ESG improvements.”
Change is viewed through the lenses of evolving fundamentals and value opportunities through mis-pricing. Once an early catalyst has been identified, the team undertakes a forensic valuation and risk analysis before deciding on portfolio inclusion.
Lowenstein adds: “This process applies to both longs and shorts working from the premise that if companies outperform due to material ESG improvement, we can consequently expect stocks to underperform if they continue to exhibit poor or materially deteriorating ESG practices.”
Improving ESG factors, such as increasing boardroom diversity and the appointment of external directors, have been shown to produce better investor returns. During market crises, ESG or sustainable strategies have also been shown to outperform significantly.
Chad Slater, co-CIO of the Trium Morphic ESG L/S Fund explains why an ESG strategy can provide stronger defences against draw-down risk: “ESG offers downside protection in three key ways: from an environmental perspective, companies have less exposure to ‘green risks’ such as increases in carbon and fuel taxes – as well as diminished exposure to one-off pollution-driven disasters.”
“Secondly, companies displaying improving commitment to the ‘S’ of ESG are less likely to suffer from employee lawsuits and have constructive relationships with regulators. Finally, demonstrable improvements to governance codes mitigate fraud through stronger auditing processes, while reducing conflicts of interest, bribery and other illegal activity.”
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