Style Analysis of Japanese SRI funds: Looking for sustainable alpha


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Akihiro Tokuno, Research Centre for Financial Engineering - NomuraSecurities Co., Ltd - Japan.

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Style Analysis of Japanese SRI funds: Looking for sustainable alpha

  1. 1. TOKUNO, Akihiro Financial & Economic Research Cent re , Nomura Securities, Co. , Ltd. E-mail: [email_address] m May 200 7 Style Analysis of Japanese SRI funds Looking for sustainable alpha TBLI Asia 2007 : Fund Performance
  2. 2. AUM of Japanese SRI Funds : increasing but still a small fraction
  3. 3. <ul><li>Style -adjusted performance of Japanese SRI Funds </li></ul><ul><li>( open-end investment trust s) </li></ul><ul><li>Analysis based on Three-Factor Model by Fama and French (1992) </li></ul><ul><li>22 SRI funds and 97 other “Active” funds examined </li></ul><ul><li>Calculated using daily data </li></ul><ul><li>Looking for “sustainable” alpha </li></ul>Can you find statistically significant alpha in Japanese SRI Funds? Return Spread: Small minus Large Return Spread: Value minus Growth
  4. 4. Well, actually…bad news for Japanese SRI
  5. 5. <ul><li>After correction for style biases, alpha is not statistically significant </li></ul><ul><ul><li>“ Sustainability” does NOT seem to create value-added </li></ul></ul><ul><li>All funds are very similar to the market: market beta is nearly 1.0 </li></ul><ul><li>(except for Eco7, a balanced fund) </li></ul><ul><ul><li>Status quo: Differentiating strategy needed </li></ul></ul><ul><li>Mostly large cap biased and growth oriented </li></ul><ul><ul><li>Low risk and low return, in the long run </li></ul></ul><ul><li>However, do these hold true only for Japanese SRI funds? </li></ul><ul><li>Among 97 funds whose name includes the word “active”, only four funds have statistically significant alpha, of which only one has positive alpha </li></ul>Style-adjusted performance of 22 Japanese SRI Funds
  6. 6. “ Active” f unds in Japan also show the same style properties: Mostly l arge cap biased and growth oriented
  7. 7. Even major SRI Indexe s shows the same style-adjusted performance: A stylised fact about SRI performance?
  8. 8. Nikkei Opinion Poll on “Good/Bad Board” by Equity Fund Managers Note: (1) The impact of such things as changes of stock code and company name has been taken into account (Bank of Tokyo-Mitsubishi, Sanwa Bank, Mizuho Holdings, Daiwa Bank, Liquid Audio Japan, Nichiei) (2) The survey covers members of the Japan Securities Investment Advisers Association, and fund managers at companies authorized to conduct discretionary investment business, and at leading life and nonlife insurance companies. (3) The survey targets are asked to compile a list, from among all listed Japanese companies, of their top ten “good boards” and “bad boards”, based on criteria including: emphasis on shareholder interests, improvement of management transparency, introduction of external directors, strengthening of the board of auditors, establishment of supervisory committees such as advisory boards, drawing up of plans for successor officers, etc. Rankings are produced by awarding 10 points for the top place in a respondent’s list, nine points for the second place, and so on. Source: Nomura, from Nikkei Business Publications materials
  9. 9. “ Good/Bad board ” companies’ subsequent ROE Source: Nomura, from Nikkei Business Publications materials
  10. 10. “ Good/Bad board ” companies’ subsequent share price Source: Nomura, from Nikkei Business Publications materials
  11. 11. Investment Style Characteristics : Property of “ G ood/ B ad boards ” portfolio is large-growth / small-value. Note: This graph illustrates the results of time series analysis of each portfolio using the “Style Manager”. Based on the Russell/Nomura index series. As of the end of August 2004. g, b, and TPX indicate “good board” portfolio, “bad board” portfolio, and TOPIX index, respectively. Y axis position is recalculated so as to locate TPX’s near the centre of graph. Source: Nomura, from Nikkei Business Publications materials
  12. 12. If you invest in “ G ood/ B ad” companies … Biased in Large-Growth Financially sound Well-known, famous “ Good Boards” Portfolio “ Bad Boards” Portfolio Biased in Small-Value Financially unstable Unknown, infamous High-end accountability Low risk, low return Potential, possibility of change High risk, high return
  13. 13. Why don't fund managers make use of ESG ? ( regardless of whether or not it matters ) I. UNIVERSE (Benchmark) Major Market Indices TOPIX S&P 500 Russell 1000 Index etc Status Quo Bias III. PORTFOLIO CONSTRUCTION <ul><li>Select the top ranking companies for potential inclusion in the portfolio </li></ul><ul><li>Simultaneous Effect </li></ul><ul><li>Causation issues </li></ul><ul><li>Utilize a proprietary optimization to match the risk characteristics of the benchmark   </li></ul><ul><li>Neutralises, to the extent possible, the inherent biases introduced by a screened universe of securities </li></ul><ul><li>Incorporates risk factors (e.g., Barra ) to minimize tracking error </li></ul><ul><li>Nearly identical to the market </li></ul><ul><li> (Status Quo Bias) </li></ul>II. SCREENS Negative Eliminate companies with certain business operations or products Sector Bias (Growth oriented) Positive Rank the companies versus their sector peers on a range of environmental, social and governance (ESG) factors Research targeted mainly large companies Growth oriented Or may be irrelevant SRI Indices Morning Star SRI (Japan Equity) DJSI FTSE4Good etc Style Biases Mostly Large-Growth
  14. 14. <ul><li>Benchmarking and tracking error management leads to the status quo bias </li></ul><ul><li>(Market beta equals to 1.0) </li></ul><ul><li>More active and unconfined way of managing the portfolio </li></ul><ul><li>Research on ESG tends to ingenerate some style biases, mostly, large-growth </li></ul><ul><li>(Low risk low return, in the long run) </li></ul><ul><li>Discussion on the style-adjusted performance </li></ul><ul><li>Research results on ESG issues does not play a significant role </li></ul><ul><li>(Alpha is not statistically significant) </li></ul><ul><li>Revisiting materiality and relevance, simultaneous effect and causations </li></ul><ul><li>In general, these are also true in active fund management (e.g. investment trust) </li></ul>A study on Japanese SRI Funds : Implications
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