Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
‘Profound changes that won’t happen overnight’: Funding climate transition of the real economy
Allspring Global Investments has a patent pending on its proprietary broader ESG scoring process, which it supplements with a forward-looking Climate Transition Framework. Henrietta Pacquement (photo above), who has a master’s in astrophysics from Cambridge University, as well as a CFA designation, says the manager’s proprietary scoring system was developed because of the issues with third-party data, such as lack of standardisation and collection inconsistencies.
The quant process is used in conjunction with fundamental analyses of companies and can be used for both equity portfolios and her chosen field of fixed income.
Pacquement joined Wells Fargo Asset Management in 2006. The firm became the independently owned Allspring in November, 2021, after the bank sold most of its holding, including to the current leadership team and management. She is the head of Allspring’s global fixed income team, based in London, and senior portfolio manager on the popular ‘Climate Transition Credit’ strategy.
She spoke about the strategy last week (September 19) on a trip to Australia visiting clients with Martha Delgado, Allspring international business development manager based in San Francisco. It was developed in conjunction with the UK pension fund provider NEST (National Employment Savings Trust), which also seeded the strategy.
For Australian investors, one unintended consequence of the widely criticised Your Future Your Super (YFYS) performance test for super funds which is actually a positive is that it tends to support the trend for super funds and their managers to favour engagement with carbon emitters over divestment.
The past six months on world markets have provided a clear example of the benefit to investment returns in taking this approach. Most of the big energy companies are moving as quickly as they can to transition to a clean energy business model, with or without pressure from investors. And, because of their size and experience in the energy field, you would have to think that most will be successful in that transition over time.
But following the Russian invasion of Ukraine early this year, energy prices have soared, especially oil and gas prices, meaning that market conditions have hurt divesting investors more than those favouring engagement – at least in the short-medium term.
For Australian super funds this also means that those which engage rather than divest have tended to have a lower tracking error against the main indices deployed by APRA for its test. In the case of fixed income, this is the Bloomberg Global Agg, which contains about 15,000 securities. Allspring does divest, too, but only after assessing a company’s ESG prospects and its ability to significantly reduce its carbon emissions. For that, it takes into account its analysts’ level of conviction about those prospects.
For example, with the broad ESG rating given to one of Australia’s largest banks by the Allspring credit team, a high quant score, obtained by standardising data from third-party providers, is blended with a much lower qualitative score driven by the analysts’ recommendation, including their assessments from interviews with management. The outcome is a score of three out of five, with a minus attached for a trend towards the negative direction as the team had a high conviction in its fundamental assessment.
“What we’re trying to do is to facilitate the decarbonisation of the real economy, not just our portfolios,” Pacquement says. “We want to bring the economy along. These are profound changes that won’t happen overnight. For example, we might want to find out why this might be taking a company too long.”
In the Ukraine invasion example a lot of companies were bringing older polluting power plants back online to ease the immediate supply problems, and Allspring is looking to balance out its decisions to see whether this will only be a short-term issue.
“The setback in timing may be temporary and explainable by current circumstances,” Pacquement says.
Martha Delgado says that there is some dispersion with regard to targets, with the majority of investors aiming for decarbonization by 2050 while others have set ambitious targets for as early as 2030.
“You can certainly achieve the ambitious targets from a portfolio perspective, by divesting and/or mapping to a decarbonization target using off-the-shelf data from providers like Trucost,” Delgado says. “But we find that most investors are actively researching more pragmatic approaches. Our framework offers investors a glide path to measure their decarbonization progress in a concrete way while retaining the focus on achieving financial objectives.”
She says Allspring’s climate transition strategy should be viewed as a core strategy for an investor for inclusion in broad investment-grade portfolios. “It’s therefore compatible with the YFYS test. We’re looking to outperform the broad benchmark by 75bps with an information ratio above one. The portfolio’s duration range is plus-or-minus 15 per cent,” she says.
Allspring has developed a forward-looking ‘Climate Transition Framework’ for the qualitative part of its securities ratings. This has four components of a company’s assessment: its strategy and governance; the assets it has, operating position and skill set; the balance sheet strength to see if it can fund a transition; and the macro conditions in which it operates, including geographically and politically.
“This allows us to get a comprehensive picture of each company and also gives us a sense of whether the trend is positive or negative,” Pacquement says.
The framework was developed by Tom Lyons, a senior analyst and the head of climate investment research, with Jamie Newton, the head of global fixed income research. San Francisco-based Lyons is also a member of the standards advisory group for the Sustainability Accounting Standards Board and previously on the fixed income advisory committee for the UN’s PRI.
