ESG Momentum Strategies and Active Manager Concentration
Week Ending 26 July

Another week deep in the heart of 2Q earnings season – the IR summer ritual when the junior sell-side analysts dial into the call from the office, but you can hear the sound of crashing waves for a split second whenever a senior analyst is unmuted for Q&A.  We’re all at our desks of course, and we’d recommend streaming the album Calming Sounds of the Ocean over your headphones to get you through earnings to your next holiday. 

Here’s the latest news in the IR world.

Buy Side
- First and foremost, this FT piece covers a meeting between the SEC, major banks and asset managers on background, but leads with the suggestion that the SEC is likely to extend the 30-month no action letters that allow US broker-dealers to receive payments from MiFID-regulated asset owners without fully “unbundling.” Note that there’s no official SEC comment, either on the policy or the possibility of the timing being a three-year extension, but it’s worth keeping a close eye on as the official exemption runs out in July 2020, meaning it’s likely a decision that will happen late this year to give investors and banks certainty.

- Last week’s angle on buy-side M&A from Deloitte has a counterpoint in this week’s Institutional Investor news flow, from a UK group called the New City Initiative that’s advocating for regulation to limit asset management M&A in order to preserve investor choice. Research from NCI suggests asset owners that allocated to only boutiques have generated more wealth than those allocating only to larger firms, and an Affiliated Managers Group study also suggested that smaller asset managers generated an average of 62 bps of outperformance versus larger managers. Either way, even excluding passives, scale does benefit active managers on the cost side, but the jury may still be out on the revenue side.  A smaller manager that generates strong performance is still able to grow its asset base today, and smaller managers produce diverse shareholder bases…but in the long run it may take some level of regulation to keep the active community from excessive concentration.

IR Best Practices 
- IHS Markit’s Sam Pierson keeps a close eye on the securities lending market, with data sourced from stock borrowing and lending programs flowing through the Markit Securities Finance product suite.  His 2Q summary shows the weighted average fee to borrow equities declining by 7% vs Q1 to 61 bps, with utilization of shares available for loan falling sequentially by 10% to 4.1%. Lending is often a leading indicator of interest in particular sectors – for example, the retail sector’s average % of shares on loan rose to 5.8% from 5.1% as negative bets increased, while semiconductors % of shares on loan fell sharply, to 3.2% from 4.2%. 
Pierson’s wrap also points out the impact of a stronger IPO market on lending – newly-issued IPOs with low floats that aren’t yet part of major indices are generally the priciest borrows in any lending program. For companies in the process of transitioning from newly-public to fully-floating, expect to naturally see higher short interest as the company enters new index funds and becomes progressively cheaper to borrow… that rise in your short interest may be a result of the changing market structure, not anything company-specific. 
- We are not shocked that CFA Institute’s membership opposes any move by the SEC to shrink quarterly reporting requirements; this blog post highlights some of its membership-wide survey’s responses to questions on quarterly reporting, and as you might guess, it shows a strong majority of professional investors preferring retaining the existing quarterly structure.  However, CFA Institute’s survey also covered additional tangent topics to quarterly reporting that didn’t make the headline bullets...41% of respondents agreed with the statement “companies should cease releasing quarterly guidance as it creates an undue focus on short-term results.”  In a similar vein, 42% of respondents disagreed that “companies should issue quarterly guidance, because if they don’t market participants will make and disclose their own estimates of future earnings.” 
And, in a pivot to ESG, 67% of respondents stated that they incorporate governance factors into investment analysis, and 51% said they incorporate environmental and social factors into their analysis. In terms of disclosure, 52% of respondents answered that sustainability disclosures should be a regulatory requirement of public companies and 34% said supporting ESG disclosures should be “updated more than annually.”  (Emphasis ours). If you’re planning any changes to your disclosure regime going forward, these data points might be important inputs in your decision-making process.

- Plenty of chatter over the last couple weeks stemming from an SEC/U.S. Chamber of Commerce event, with Chairman Clayton and Corporate Finance Director Bill Hinman both speaking about the regulator’s roadmap on corporate governance.  We’d encourage any company that often receives 14a-8 shareholder proposals to review this Cooley post summarizing the staff’s comments – most importantly, there’s consideration within the SEC as to whether every no action request to exclude a proposal needs to have an individual response from Corp Fin.  Clayton and Hinman also both spoke about issuers’ favorite topics in this area, resubmission thresholds and minimum ownership standards, but the possibility of uncertainty around proposal exclusion is something many issuers will need to think about in advance.  Clayton’s comments around creating greater dialogue with shareholders around proposals may adjust the way you think about engaging with investors on potential proposals, even in this coming offseason. 

- As investors add more ESG investment products based on the available data and research, you could argue we should start to see ESG overlays of the standard investment strategies appear.  For example, imagine taking a “carbon value” approach in holding a high emissions company with aggressive targets to lower usage…or a “carbon growth” strategy for a company that’s already achieved such targets. IHS Markit partner Factset’s research team coversESG Momentum,” a strategy originally proposed by UBS’ Wealth Management team in 2018, and shows the ability to generate alpha through a strategy of investing in the highest decile of S&P 500, Russell 1000, and MSCI World companies that show recent improvement in Sustainalytics ESG scores. (Canaccord just announced its own set of Canadian ESG improvement picks this week as well, with many in sectors you wouldn’t normally think of as housing strong ESG stories).

Factset points out that the top performers on ESG momentum do also tend to show better operating metrics, including higher revenue growth / ROE / operating margins than lower ESG scorers.  From the article: ”There has long been a stereotype that businesses concerned with ESG operate at a disadvantage when trying to win new business. These historical growth numbers suggest the opposite.”

Questions? Comments? Have at least a quarter acre back yard, and up for hosting Woodstock 2019? Reach out to your IHS Markit team, or