Industry Voice: Hidden fears and ESG: what's on investors' minds
Henry Odogwu, Head of the asset owner group Europe at FTSE Russell discusses
Henry, what are your clients focusing on in the current market environment?
After the dramatic risk-off in late 2018, investors may have been pleasantly surprised by the performance of equity markets so far this year. In local currency terms the FTSE All-World Index, our flagship global equity benchmark, was up 17.2% over the seven months to end-July. Within the index, US and European (ex UK) stocks have been performing particularly strongly.
As expectations of interest rate rises have receded investors have switched to worrying about an economic downturn, driving bond prices up and yields down. This has made equities look cheaper, at least on a simple yield comparison.
But it's an uneasy market. Some kinds of stock are going up strongly, while others are lagging. FTSE Russell's factor analysis, which measures the performance of the major factors in investment return, can help us see what's going on.
Equities have performed strongly so far in 2019
Source: FTSE Russell Market Maps, July 2019. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
What challenges are they facing?
A key challenge for investors is to get the right kind of equity exposure: in other words, to own the best equity factors for the prevailing market environment.
As interest rate expectations have been falling due to investors' concern about a possible slowdown, investors have been focusing on high-quality, defensive stocks within their equity portfolios. Across regional equity markets, the quality factor has been performing strongly in the past year and a half.
But other factors have underperformed, notably value. Value is typically seen as a pro-cyclical factor. Recent market moves tell us investors don't anticipate an upturn yet. But they will be watching closely for signs of an economic improvement in order to switch back into undervalued stocks.
Source: FTSE Russell Market Maps, July 2019. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
The biggest challenge for many investors is how to integrate sustainability risks while generating returns in their portfolio. Large asset owners, particularly in Europe, tell us they want to integrate environmental, social and governance (ESG) considerations into their portfolio construction processes. But they also have long-term performance targets to meet.
What solutions are your clients looking for?
A common request from our institutional clients is to modify a standard FTSE Russell benchmark to reflect a desired ESG outcome. For example, a client with a portfolio that tracks the FTSE All-World Index may want to reduce the index's carbon footprint by a certain percentage, with moderate tracking error to a global equity benchmark. We can help them with this modeling exercise.
Another type of request is to retain exposure to a particular equity market factor—say size, value, quality, low volatility or momentum—while enhancing ESG scores or increasing exposure to green revenues. We call this approach ‘smart sustainability'.
And we are increasingly being asked to produce green versions of bond indexes, for example by reducing the carbon exposure of the index. We see customized ESG bond indexes as a big future growth area, and believe that fixed income has a bigger role to play in the sustainable investment conversation.
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