Robeco Quarterly March 2019

Robeco

QUARTERLY Intended for professional investors only

FACTOR INVESTING Old data meets modern research

QUANT investing SUSTAINABLE investing #11 / March 2019

“…over the next six years institutional investors expect to shift their portfolios toward more active strategies and smart beta products — all at the expense of traditional passive” ‘The traditional passive fund is a dying species’ Institutional Investor, March 2019

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Robeco QUARTERLY • #11 / MARCH 2019

10 | Against the tide of passive 11 | Active duration management shines as bond markets jitter

13 | Implementing EM quant strategies the smart way

15 | The case for strategic allocation to Momentum

And MORE

QUANT investing

CONTENTS

OUTLOOK Recession indicators are overrated for stock returns

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TRENDS Changing consumer tastes: from smart speakers to well-being

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OPINION Earnings growth is not a prerequisite for higher equity prices

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INTERVIEW – MARLIES VAN BOVEN ‘Educating clients on smart beta is still important’ 28 RESEARCH How ESG integration aids outperformance

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LONG READ The long-run value of Conservative Equities

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INTERVIEW Guido Baltussen – ‘Factors are a permanent feature of markets’

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COLUMN The undercover MMT practitioner

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SUSTAINABLE investing

Masja Zandbergen – page 23

19 | The palm oil paradox 21 | Integrating ESG into China A-shares 23 | Another record year for SI at Robeco

25 | Investing in the SDGs to tackle snake bites

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Podcast

Tune in now – Robeco launches podcasts Podcasts – an audio interview streamed over the internet – have made a remarkable comeback in recent years.

They can reach areas that other forms of media cannot reach.

People often don’t have the time or space to scroll down a screen to read all of the content of an article. And they cannot necessarily watch a video, particularly if travelling to work on a crowded train. This is where podcasts provide an answer. Just plug in your earphones and the topic in question can be explained with great clarity, within 20 minutes or less.

Wild is the co-CEO of Robeco’s affiliate, sustainable investing specialist RobecoSAM, where he has long served as Head of Research among other roles. Wild explains why embracing SI is “a good sort of selfish”, as it enables the investor to enjoy superior risk-adjusted returns while also addressing a range of environmental, social and governance (ESG) issues.

Blitz is the Head of Quantitative Research at Robeco and the author of many research papers on the field of quant and factor investing. In the second podcast, Blitz discusses the latest trends and issues in factor investing, in which investors chase factors such as low volatility, value

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or momentum to get the best picks for their funds.

Future podcasts will include our two other

investing pillars of credits and emerging markets, along with a wide range of subjects of interest to the modern investor.

Stay tuned for future developments!

SDGs are entering the investment arena, slowly Infographic

Robeco will produce a monthly podcast about a topical subject. The interviews are being conducted by British financial journalist and podcast specialist Sam Shaw, with the aim of producing lively, engaging interviews which are interesting and in-depth, but also fun and engaging to listen to. For the first two, we have rolled two of Robeco’s investing titans, Daniel Wild and David Blitz.

Institutional investors talk about SDGs...

SDGs are on the agenda of pension funds’ boards

17%

48%

Not discussed

More than once a year

...but most have not integrated SDGs in their investments 35% Once a year

66% No formal policy on SDGs Source: VBDO survey among Dutch pension funds (2018)

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New times, new skills

Gender equality and diversity are important issues for Robeco’s Active Ownership team, which regularly engages with companies on these issues. To mark International Women’s Day on 8 March, engagement analyst Laura Bosch gave an update on the work done in this field.

Research shows that a gender-balanced workforce positively supports corporate performance in relation to profitability, risk reduction or its share price. A gender

Editorial

Diversity

Working towards gender equality

Sustainability is permeating every layer of the financial industry. A welcome side effect of this is greater diversity in the sector.

Once characterized by hard data, percentages and numbers – which held a strong appeal for alpha males in particular – the industry’s embracing of sustainability is attracting a wholly different type of person. It is no coincidence that the male to female ratio in, for instance, Robeco’s Active Ownership team is a far cry from that in the more traditional investment teams. These teams are now also more engaged with each other than ever before, which also helps to drive diversity.

Yet workplace diversity goes so much further than keeping a tally of the number of men and women.

It is much broader than that and also encompasses diversity between people with a short-term vision and those with a long-term one. There are now increasing opportunities for the latter in a world where the former have long ruled the roost.

diverse workforce at all levels of the organization, with equal opportunities for all employees, supports business and financial performance while improving human capital management practices.

In 2017, an engagement program focusing on this topic was initiated in collaboration with RobecoSAM, framed around the guidelines used to determine the eligibility of companies in its Gender Equality strategy. This specifically focuses on companies that are making a difference in this area, and can reap the rewards in terms of enhanced future returns.

Topics such as female representation within the workforce and equal remuneration opportunities are covered in the engagement dialogues. We follow up regularly on our discussions while actively tracking their progress.

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Integrating sustainability, and thus changing the way the industry is perceived, is increasing the size and quality of the talent pipeline. Asset managers are moving from ‘investing in a company’ to ‘coowning a company’ – which appeals to people with a completely different mindset. Therefore, those in key positions need to have an affinity with sustainability.

This won’t happen in the next two or three years, but as an industry we are moving away from what can be generalized as the traditional stronghold of the alpha male towards an industry where engagement goes hand in hand with competitiveness, and where the skill of communication is just as important as that of financial analysis.

Peter Ferket, Head of Investments

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The impact of central banks should not be underestimated. And I don’t just mean the impact on economic growth and interest rates. Central banks are a driving force of financial markets, too. The size of G4 (US, Eurozone, UK and Japan) central bank balance sheets as a percentage of GDP has grown relentlessly over the last 20 years, from just 2.5% to the current level of more than 35%, and global equities have more or less followed

Three megatrends shape business and society today Trends

Column

The far-reaching effects of central bank policy

As our economy and society are constantly changing, the world as we know it is being transformed by three powerful megatrends. They are transformative technology, ‘preserving the Earth’ and changing sociodemographics. In our new trends investing booklet, Robeco trends investors Henk Grootveld and Steef Bergakker show how these megatrends and the changes that drive them create investment opportunities.

Those firms that are able to benefit from the changes, while minimizing the risks, often grow exponentially, and in a winner-takes-all fashion.

The booklet explains the key tools that help investors separate longterm investment opportunities from short-term hypes. One such tool is the analysis of behavioral biases, or filters, through which people look at trends. Due to these biases, investors typically underestimate the exponential growth potential of

Jeroen Blokland Senior Portfolio Manager

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One striking example that the booklet looks at is the disruptive megatrend of digitalization, which has changed a variety of industries, from financial services to manufacturing. Along with this, has come a set of new winning business models that have emerged amid several waves of digitalization. Two examples of such new business models are ‘Everything as a Service’ and online marketplaces that connect sellers and buyers.

For investors, understanding trends is crucial, because they are a key factor in the industry’s profitability over time. They explain both the persistence of and abrupt changes in relative industry profitability.

Data-driven services move today’s proptech industry Trends

its path. The correlation has become especially strong since the financial crisis, not coincidentally a period of unprecedented stimulatory monetary policy. Over the last 20 years, there have only been two episodes in which equities staged significant rallies that were not accompanied by significant increases in global central bank liquidity: during the dot-com bubble (2000-2001) and the housing bubble (2006-2008).

Definitely something worth thinking about for a minute.

trends. Another tool is the analysis of stages of the Gartner Hype Cycle.

Understanding these stages helps investors find long-term winners and build a portfolio.

With 6,000 firms and counting, the proptech sector is revolutionizing tenant services. It offers the real estate industry ways to embrace the digitalization trend. The new services offered by proptech to residential and business tenants were the key theme of last month’s ‘Bricks, Bits & Investment’ event organized by Robeco and PropTechNL. The services include energy-saving options, communication platforms and food

delivery options. From an investor’s point of view, one promising area of proptech is the automation of mortgage processes and legal procedures related to property transactions for both residential and commercial space.

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Recession indicators are overrated for stock returns Credible recession indicators like the US bond yield curve have little forecasting power for future stock market returns, and investors should be wary of linking them, says multi-asset specialist Jeroen Blokland.

Speed read

Outlook

• S&P 500 usually peaks just six months before the start of a recession • Peaks occur long after other recession indicators signal a slowdown • Investors triggered by inverted yield curves miss out on stock gains

However, the dynamics suggest that stocks tend to hit new records just before a recession, but only tend to peak long after other indicators such as inverted yield curves have signaled a slowdown.

This means investors who use indicators to try to time when to pull out of markets miss out on returns, at a time when a US recession is currently unlikely anyway.

“The US yield curve showing the difference between long-term and short-term bond yields is one of the best – if not the best – recession indicators out there,” says Blokland, senior portfolio manager with Robeco Investment Solutions. “The yield curve has correctly predicted all of the last seven US recessions since

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December 1969. As a rule of thumb: whenever the yield curve inverts, meaning when short-term rates move above long-term rates, a recession will occur somewhere within the next year or two.”

“However, an inverted yield curve has not stopped the S&P 500 Index from rising (see Figure 1 on page 6); in the past seven recessions, stock prices have kept rising after each time the yield curve inverted, except for in 1973. In fact, the S&P 500 Index continued to grind higher for another 11 months, or almost a year, on average, before it reached its peak.”

“So, while the yield curve is perhaps the ultimate recession indicator, it does a poor job in predicting stock market peaks. You would have missed a significant amount of return if you had based your investment strategy on the yield curve.”

Valuations are unreliable So, what about using equity valuations? “Some investors believe that high valuations precede recessions, and that stocks fall during them as normal valuation levels are restored,” Blokland says.

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Outlook

“The rationale behind this is that most economic cycles end in bubbles. For example, if monetary policy is too loose for too long, companies over-invest, driven by the prospect of ‘never-ending’ growth, or because growth is financed to an increasing extent by debt. All of these scenarios result in a stellar rise in stock market valuations, which at some point must be corrected.”

“A couple of things should be considered, however. First, the number of recessions, fortunately, is limited... but this also decreases the significance of past-return data. In addition, recessions are often defined months or sometimes even years after they occur. At the time of a market peak, investors did not know yet when the recession would officially start.”

“While it is true that numerous recessions are the result of the bursting of a bubble, this does not automatically involve high stock market valuations. Recessions can happen at any level of valuation, and price/earnings (P/E) ratios of the S&P 500 Index have varied greatly just before the start of past recessions. If anything, P/E ratios were somewhat below the longterm average ahead of a recession.”

“Yet, this does not take away from the fact that equity markets tend to peak long after renowned recession indicators signal one. This in turn explains why these indicators have little forecasting power when it comes to stock market prices.”

‘Equity markets tend to peak long after renowned recession indicators signal one’

Peaking equity markets In fact, equity markets tend to peak just before recessions begin, as shown in the chart. However, investors should be wary of this old chestnut as well, since the peak usually occurs long after other indicators signal a recession, Blokland says.

“If we look at the last seven US recessions, the S&P 500 Index on average recorded a peak just six months before the official start of the recession,” he says. “On two occasions, in 1980 and 1990, the peak in the equity market actually coincided with the start of the recession. In general, equity markets tend to perform solidly up to 12 months before a recession, then show a mixed but positive picture 12 to six months before a recession, and then tend to turn south within six months of the next recession.”

Figure 1 | S&P 500 Index & recessions 2,500

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1965

1970

1975

S&P 500 Index (log scale)

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1980

1985

1990 US recessions

1995

So, when is the next recession?

In all, it’s pretty difficult to pinpoint exactly when the next US recession will hit, Blokland says. “Having said that, based on the latest macroeconomic data it could take a while before a new recession occurs. The US labor market remains extremely strong, creating a significant number of new jobs each month. At the same time, people are re-entering the labor market, reducing inflation risks. Wages are rising faster than inflation, which increases the purchasing power of US consumers.”

In addition, the ISM Manufacturing Index unexpectedly rose to a healthy 56.6 in January, suggesting above-average GDP growth going forward. All of this is happening with the Federal Reserve clearly on hold with its tightening cycle, limiting the drag on the economy and supporting financial conditions.”

“China remains the most important external factor for the US economy, especially since the trade dispute between the two countries remains unresolved.

China too, however, feels the negative impact of slower trade, and is stimulating its economy. Together, these developments reduce the probability of a US recession this year. Therefore, given the limited forward-looking ability of equity markets when it comes to recessions, the odds favor higher stock market 2000 2005 2010 2015 prices over lower stock market Source: Bloomberg prices for now.”

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QUANTinvesting Against the tide of passive On paper, passively tracking the S&P 500 index has many advantages. It’s a relatively cheap way to gain exposure to liquid large-cap stocks from different sectors that represent over 80% of the total market capitalization of US equities. In addition, investors don’t need to perform extensive and expensive manager due diligence. In a time of increased cost awareness on the part of investors, it’s no wonder this kind of strategy has been gaining considerable traction over the past decade. But is replicating the S&P 500 really the best way to invest in US stocks? We don’t think so. And while trying to ride the wave of passively tracking the S&P 500 might be tempting, investors should be brave and go against the tide, instead.

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Rising up against passive S&P 500 strategies Many equity investors have been giving up on active management over the past decade. In the US, a very popular approach is to settle for a passive strategy based on the well-known S&P 500. But while replicating this index clearly has its merits, we think factor investing provides a much more compelling alternative, say Robeco’s Jan de Koning and Bart van der Grient.

In recent years, going passive seems to have become the default option for many equity investors, in particular in the US. As the largest and most liquid equity market in the world, the US stock market is also often perceived as the most efficient one, making it very difficult for active investors to consistently outperform the market.

formidable opponents when competing for assets. And given the steep fees active managers sometimes charge, they actually start at a disadvantage. At Robeco, however, we argue that investors should definitely not settle for the S&P 500 Index and that factor-based investing can provide a much better alternative.

Four key characteristics In this context, passive investment strategies that replicate the popular S&P 500 Index have thrived, commercially speaking. Currently, a total of over USD 3.4 trillion is invested in passive vehicles that track this well-known index, according to the latest Annual Survey of Assets by S&P Dow Jones Indices. Vehicles that track the S&P 500 are widely available at low costs, sometimes as low as just a few basis points.

Settling for the S&P 500 Index?

The appeal of passively tracking the S&P 500 is clear: the index offers exposure to liquid large-cap stocks from different sectors that represent over 80% of the total market capitalization of US equities.

Moreover, investors don’t need to engage in extensive and expensive manager due diligence. Given its transparency, the passive portfolio does not hold any surprises in terms of sector or individual stock weights.

With such characteristics, it is not surprising that active managers face

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To beat the S&P 500 after costs,

‘To beat the S&P 500 after costs, consistently over time, a strategy should feature four key characteristics’ consistently over time, a strategy should feature four key characteristics. First, it should expose to low relative risk, by only allowing small deviations from the reference index. This enables long-only investors to capture a manager’s skill in the most efficient way. Back in 2003, Barton Waring and Laurence Siegel demonstrated that, whenever a long-only constraint is applied, the amount of alpha per unit of active risk goes down as the active risk level goes up.1 The second condition is that a strategy should have low costs, as costs can soon cancel out potential relative gains from

such small deviations. This is definitely possible. As Joseph Gerakos, Juhani Linnainmaa and Adair Morse showed in a 2016 paper, actively managed accounts of institutional investors outperformed strategy benchmarks by 0.42% after fees and costs. Since institutional fee levels are much lower than retail fee levels, these results imply that active management can add value provided fees are competitive enough.2 Third, the strategy should provide efficient exposure to academically proven factors of return such as value, momentum and quality. Over the past four decades, academics have not only shown that equity returns could largely be attributed to systematic factors, they have also demonstrated that investors who allocate to factors perform better than those who don’t. Eduard van Gelderen and Robeco’s Joop Huij studied the returns of US mutual funds over the period from 1990 to 2010 and found that mutual funds adopting investment strategies based on factors consistently earn positive abnormal returns.3 Finally, there should a disciplined quantitative implementation process, as the portfolio manager will have to continuously assess the potential of hundreds of stocks. Managing a lowtracking error strategy entails investing in hundreds of different stocks, from various sectors, with the implicit objective of keeping deviations from the index at a minimum. Having a group of analysts

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continuously monitor the prospects of hundreds of stocks would pose a real challenge for these professionals, making quantitative screening and ranking processes a much more viable alternative.

Stable and sustainable alpha Robeco’s Enhanced Indexing strategies feature these characteristics, while also integrating sustainability criteria. Our investment process has three steps.

First, an integrated multi-factor stock selection model assesses the value, quality, momentum and analyst revision characteristics of each stock using enhanced factor definitions such as residual momentum.

Next, top-ranked stocks are overweighed, while bottom-ranked stocks are underweighted. To further increase the breadth of our strategies and prevent

‘Our Enhanced Indexing strategies also work in narrower investment universes, even in the very efficient US stock market’ index arbitrage, these Enhanced Indexing strategies can also invest a maximum of 5% in off-benchmark stocks.

Finally, since the factor characteristics of stocks change over time, we rebalance the portfolio periodically, while keeping a close look at turnover and transaction costs. Most of these portfolios are customized and tailored to fit our clients’ risk-budgets (tracking error ranging from 0.5% up to 4%), universe criteria or needs in terms of sustainability criteria.

Since 2004, these strategies have proven their ability to deliver stable and sustainable alpha after costs when applied to broad investment universes such as global developed and emerging stocks. But carve-outs of their realized performance show that our Enhanced Indexing strategies also work in narrower investment universes. This holds true even in the very efficient US stock market, making them a compelling alternative to passive S&P 500 strategies.

1 Waring, M.B. and Siegel, L.B. (2003) “The Dimensions of Active Management”, The Journal of Portfolio Management, Spring 2003, 29 (3) 35-51 2 Gerakos, J., Linnainmaa, J.T. and Morse, A. (2016), “Asset Managers: Institutional Performance and Smart Betas,” NBER Working paper 22982 3 Van Gelderen, E. and Huij, J. (2014), “Academic Knowledge Dissemination in the Mutual Fund Industry: Can Mutual Funds Successfully Adopt Factor Investing Strategies?”, The Journal of Portfolio Management, Summer 2014, Vol. 40 (4) 157-167

Active duration management shines as bond markets jitter Robeco’s Dynamic Duration strategies lived up to their promise in 2018. They offered protection against rising yields as the year got underway but also benefited from the government bond rally as it came to an end. Moreover, as part of our continuous effort to improve the duration model that determines the duration position of these strategies, we recently started implementing a new, ‘longer-term’ trend variable, say Olaf Penninga and Martin Martens.

Government bond markets experienced sharp moves in 2018. As a result, investors could add value through bond market timing, gaining protection from rising yields and benefiting from declining ones.

In this context, the positioning of our Dynamic Duration strategies was indeed truly dynamic.

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Active duration management once again proved to be an effective way to avoid human biases and benefit from outof-consensus positions. Systematically sticking to proven bond market drivers without any bias allowed the fund to embrace government bonds and take a maximum overweight in the last months of the year.

Last year, our Global Dynamic Duration and Long/Short Dynamic Duration strategies both generated strong positive total returns, significantly outperforming their respective benchmarks. In this difficult period for risky assets, the two strategies delivered valuable diversification just when investors needed it most.

Proven duration model The duration positions taken in the Dynamic Duration funds are based on the outcome of our duration model. This model was developed in the early 1990s and has been the sole instrument to systematically determine the duration

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Figure 2 | Cumulative performance for the old and the new trend variables the year by signaling that US bonds would underperform. The trend and seasonal variables detracted from performance in the first part of 2018 but recovered in the rally in the last months of the year.

25% 20% 15% 10%

Improved trend variable

5% 0% -5% 1982

1986 1990 1994 Former trend variable

1998 2002 2006 Enhanced trend variable

positioning of our Dynamic Duration strategies since 1998. Thanks to its pronounced active duration positions and lack of inherent bullish or bearish bias, the model has delivered both attractive absolute returns as yields have fallen and downside protection as they have risen, therefore providing strong diversification benefits.

The model forecasts changes in interest rates for the main developed government bond markets: the US, Germany and Japan. This is done using financial market data to extrapolate expectations

2010

2014

2018

Source: Robeco

‘We carry out additional screening in EM to ensure that the quality of the data used as input for our models is sufficient’ concerning the fundamental drivers of bond markets. There are six variables: three fundamental variables relating to macroeconomic drivers of bond markets such as economic growth, inflation and monetary policy; one valuation variable to assess to what extent these expectations are already discounted in bond prices and two technical variables (trend and season) to improve the timing of the model.

Four out of the six variables contributed to the strong relative performance in 2018, while the other two made a neutral contribution. The economic growth and inflation variables contributed positively, as they signaled both the rise in yields at the start of the year and the bond market rally at the end. The inflation variable gave up part of its performance in the Italian turmoil, while the growth variable had a weaker period in the summer. The monetary policy and valuation variables contributed quite consistently for most of

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In a continuous effort to improve the duration model, our researchers recently analyzed whether the trend variable could be further enhanced. The trend variable is combined with a seasonal variable to optimize timing in the model. These variables complement the information gleaned from financial market data analysis to capture expectations on the key drivers of bond markets, as well as the valuation variables used to assess how much these expectations are already discounted in bond prices.

Specifically, our researchers analyzed the consequences of replacing the existing trend variable with a somewhat ‘longer-term’ one. They also looked at ways to improve the variable design to avoid short-term mean-reversion effects.

The idea behind these adjustments was twofold. First, the trend variable used until now in the duration model has been much shorter-term than those applied in Robeco models for other asset classes. Second, bond markets have changed in the way they operate over the past quarter-century, for example due to the rapid rise in passive fixed income strategies. As a result, it made sense to analyze whether a better trend variable could be set.

The main finding from simulations of the 1982-2018 period is that the enhanced trend variable would have generated a slightly better result over the full research period, due to better performance in

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the last two decades. Meanwhile, the turnover of the strategy would have been consistently lower during the research period thanks to this ‘longer-term’ trend variable, in particular in the ten years from 2008 to 2018. As a result, Robeco recently decided to enhance its duration model with this new trend variable.

Changing global bond markets Bond markets, like equity markets, have

changed over the past decades due to the emergence of index-based products such as futures, ETFs and index mutual funds.

For equity markets, Guido Baltussen and fellow researchers Sjoerd van Bekkum and Zhi Da show that while serial dependence in daily to weekly equity index returns around the world has traditionally been positive, since the emergence of indexbased products it has turned significantly negative.

We find that the emergence of indexbased products has affected bond markets in a similar way. This explains why the performance impact of the adjustment to avoid short-term reversals, which would have been negative in the first decade of the backtest period, becomes increasingly positive from the mid-1990s onwards.

Implementing quant strategies in EM the smart way Quantitative stock selection models work as well in emerging markets (EM) as they do in developed ones (DM). However, their implementation in the former requires additional expertise. Arlette van Ditshuizen and Tim Dröge from our quant equities team explain what makes quant investing in EM slightly more complex and how we address this challenge.

In terms of practical implementation, what are the main differences between DM and EM for quant equity investors?

Tim Dröge: “Well, there are, in fact, many differences. Trading is different, regulation and corporate governance standards are different, capital gains taxes can be very different and currency conversion also needs to be handled differently. And that’s to name just a few examples.”

Arlette van Ditshuizen: “On the trading front, for example, there tends to be less liquidity in EM than in DM, while trading costs tend to be higher, which obviously has an impact on returns. But this is by no means the only difference. Another important aspect has to do with block trading. Unlike in the US or Japan, where there is almost no block trading, stocks in many EM countries are frequently traded in such significantly large numbers.”

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compensate for these within a quantitative approach?

Dröge: “Yes, governance is clearly an area in which EM-listed companies are not always on a par with their DM counterparts. Therefore, we carry out additional screening in EM to ensure that the quality of the data used as input for our models is sufficient and to identify any issues the model cannot detect. This is especially true for Chinese A-shares. Within Robeco’s quant equities team, portfolio manager Yaowei Xu is responsible for this extra step for two of our dedicated A-shares quantitative strategies: Active Quant Chinese A-shares, which is aimed at delivering stable outperformance, and Conservative China A-shares, which is aimed at delivering lower volatility.”

‘We carry out additional screening in EM to ensure that the quality of the data used as input for our models is sufficient’ “This is especially the case in countries such as Brazil, Mexico, Chile or Colombia, where large institutional investors like to trade blocks and therefore tend to be liquidity seekers. As investors, we like to provide that liquidity. This helps us bring down trading costs. For that purpose, Robeco has two EM trading desks – one in Hong Kong, for all Asian shares, and one in Boston, for shares from Latin American countries.”

You mentioned the differences in corporate governance, but how do you

“These issues can range from simple ‘back-door listings’1 to potential fraud.

For example, in recent years, a number of companies have seen their share

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‘For approximately 10% of our quant EM portfolios, we prefer to buy ADRs and GDRs instead of the local shares’ costs. They also usually involve lower custody and broker costs and are not subject to potential restrictions in terms of capital controls. All of these elements explain why for approximately 10% of our quant EM portfolios, we prefer to buy ADRs and GDRs instead of the local shares you’ll find in the index. In rare cases ADRs can also have disadvantages, like unclaimable dividend taxes or premiums. In such cases we aim to avoid the premium and buy the local shares instead.” prices plummet when informed market participants raised red flags after studying suspicious trading patterns and accounting reports.”

You also mentioned taxes. Is there anything investors can do about these?

Dröge: “Yes, taxes are another very important issue. Broadly speaking, there are two main types of tax: exchange tax and capital gains tax. In India, for example, there is a 10% capital gains tax, while in South Africa they have a stamp duty. But you can avoid these by buying alternative instruments such as ADRs (American depository receipts) or GDRs (global depository receipts) instead of locally listed stocks.”

“What’s more, ADRs and GDRs offer many other advantages compared to locally listed stocks. Being listed in US dollars, in New York or London, they are generally easier to access and trade for foreign investors than locally listed stocks and don’t involve high currency conversion

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OK, but doesn’t the use of ADRs and GDRs complicate matters when it comes to processing corporate actions, or index additions and deletions?

Van Ditshuizen: “Yes, but bear in mind that corporate actions such as mergers, spin-offs and delistings are generally more complicated to handle in EM anyway.

The same goes for index additions and deletions, because a significant amount of money invested in EM is being managed relatively passively – either following index-based strategies or using a simple buy-and-hold approach. Compared to DM, the lack of arbitrageurs exacerbates the price moves triggered by addition and deletion announcements in EM.” “To address this, Robeco’s teams follow a process that predicts whether a stock will be removed from the EM index. If that is the case, we aim to avoid buying it for our Conservative, Enhanced Index and Active Quant portfolios in the period between one month before the announcement date and the actual day of rebalancing.

Additions to the MSCI EM Index are already included in the universe by including MSCI EM IMI small caps (and FTSE / S&P IFCI off-BM stocks) in the eligible universe. If these stocks are not yet in the MSCI EM Index, top-ranked companies can already be bought outside of the index and our strategies can therefore profit from MSCI additions. If countries are promoted from frontier to emerging market, we prefer to include the upgraded country as an offbenchmark opportunity six months before the effective date to benefit from expected upward market movements.”

Dröge: “Furthermore, with our Enhanced Indexing strategies, if a MSCI EM index deletion is ranked at the bottom according to our stock selection model, we aim to sell it before it is removed from the index.”

You said ADRs and GDRs are listed in US dollars and can therefore be used to lower currency conversion costs. That’s because emerging currency conversion costs are generally higher, right?

Dröge: “Currency conversion costs are indeed another difference. It is relatively straightforward to trade DM currencies like the euro, the US dollar and the British pound. These currencies are being traded efficiently by our FX trading desk. On the other hand, currencies like the Korean won, Indonesian rupiah, Brazilian real or Thai baht are not freely tradeable or may carry trading restrictions, so we need to outsource this to our custodian. To make sure conversion costs remain low, we have negotiated low spreads with our custodian and we ask them to net equity buy and sell transactions as much as possible, to minimize currency conversions.”

1 A ‘back-door listing’ usually occurs when a privately held company purchases a publicly traded one, thereby avoiding the public offering process and securing an automatic stock exchange listing

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The case for strategic allocation to Robeco’s Momentum factor For equities, Momentum is the tendency of stocks that have delivered above-average returns in the recent past to continue to do so, and of stocks with below-average returns to follow suit, as well. Historically, the return associated with Momentum has been high and has had a low correlation with other factors. Yet investors tend to overlook this factor – wrongly so, say Daniel Haesen, Matthias Hanauer, Georgi Kyosev and Laurens Swinkels.

‘Momentum is a global phenomenon that can be documented over different sample periods, including the most recent one’

Why do so many equity portfolios lack a systematic exposure to the momentum factor? We believe that there are three main reasons.

First, despite convincing historical evidence, investors doubt whether the equity momentum premium will persist in the future. Second, investors are worried that the factor’s theoretical performance may not be replicable in real-life portfolios due to the high turnover and associated trading costs. Third, for investors willing to add momentum exposure to their portfolio, there are hardly any funds with a momentum focus available in the market.

Global and persistent But while we consider these valid concerns, we also believe they can be dispelled. For one, there is overwhelming empirical evidence of a strong and persistent momentum factor premium in equity markets, that has a low correlation with other proven factors. According to our research,1 the outperformance of momentum in global developed equity markets is 3.90% per year on average (see Figure 1). It is more modest for Japan (1.17%), and particularly strong for Europe (5.08%) and emerging markets (6.06%).

Japan’s lower performance can partially be attributed to frequent market reversals.

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Our empirical results confirm that momentum is a strong factor that should not be ignored. They also indicate that evidence of the existence of the momentum factor is not limited to the US stock market, where it was first reported.

Momentum is a global phenomenon that can be documented over different sample periods, including the most recent one. Our results also show even long-only investors can benefit from avoiding losers, which essentially equates to an underweight relative to the index, although the underweight of each stock is constrained by its index weight.

This selects stocks with the highest stockspecific returns, which are by definition unrelated to their betas, and thus largely eliminates unrewarded beta tilts from the portfolio. The result is a return pattern similar to that of a generic momentum strategy, but with about half the risk, which doubles the information ratio.

As regards transaction costs, our extensive experience in real-life quantitative portfolio management has helped us to develop a quantitative portfolio construction methodology that limits turnover without significantly affecting the return potential of the strategy. Three examples are our sell-driven portfolio construction process, the inclusion of our proprietary transactions cost model, and the use of a short-term stock selection model to time trades more efficiently.

Moreover, while it is true that trading on generic momentum signals pushes up trading costs – due to the high turnover – and can lead to severe momentum crashes, we argue that these challenges can be addressed efficiently. For the latter, Robeco has developed a ‘residual momentum’ technique which isolates the momentum that is really stock-specific.

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Figure 3 | The Momentum factor premium 6% 5% 4% 3% 2% 1% 0%

Global developed

United States

Europe

Japan

Global emerging

Largest 500

Source: Robeco. Annualized returns in US dollars. The winner portfolio contains the 20% of stocks with the highest past 12-month returns, excluding the last month. The stocks in the portfolio are equally weighted, and the portfolio is rebalanced monthly. We report the excess returns of the momentum portfolio versus the universe, which is indicative of the outperformance that a long-only momentum investor may earn. The sample period starts in January 1986 for developed markets and January 1993 for emerging markets. The largest 500 stocks are from developed markets and compared each month based on their free-float market capitalization.

We do not constrain the portfolios by trying to replicate the industry or country composition of the universe.

Efficient factor exposures In addition to these techniques for avoiding crashes and limiting costs, our definition of the momentum factor has been designed to avoid negative exposures to other proven factors wherever possible.

For instance, we take into account value to

avoid expensive momentum stocks, low risk to avoid high-risk momentum stocks and quality to avoid stocks with poor earnings power. In this way, we can achieve efficient factor exposures with high expected returns by selecting.

In contrast, a combination of generic factor strategies is inefficient because stocks that rank high for momentum may rank low for, for example, value.

If we were to combine these generic strategies, the growth exposure of some momentum stocks cancel out some of the value exposure the investor wants to obtain through a value fund. This also explains why a combination of generic smart beta indices is inefficient. As a result of the generic definitions used in these indices, exposures are offset when combined, leading to severely reduced factor exposure at the portfolio level.

In turn, lower factor exposure leads to lower expected returns. Another weakness that holds specifically for momentum indices is that rebalancing can be problematic. For those that rebalance only twice a year, the momentum exposure is substantially reduced after a few months. A policy that combines frequent rebalancing and the careful management of turnover and transactions costs ensures a more constant and deeper momentum exposure throughout the year.

The combination of robust multidimensional momentum signals and our proprietary portfolio construction methodology and short-term stock selection model is at the heart of the Robeco QI Global Momentum strategy.

This strategy was launched over five years ago and has since delivered attractive returns. Its unique features, described in this article, mean it can be a worthwhile and profitable addition to any existing equity portfolio with a fundamentally or quantitatively managed value style.

1 For a comprehensive discussion of these results, see our recent publication: Haesen, D., Hanauer, M., Kyosev, G. and Swinkels, L., 2019. “The case for a strategic allocation to Momentum�.

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Changing consumer tastes: from smart speakers to well-being Steady as she goes? As investors reassess the prospects for the world economy in 2019, trend investors Jack Neele and Richard Speetjens consider how secular growth trends reflect changing consumer styles. They look at China and a new growth market: India.

Speed read

Trends

• Digital consumers are turning to voice-controlled devices • Emerging consumer markets in India offer attractive growth • Strong brands: the growing emphasis on health & well-being

Digital consumers: switching on to smart speakers While some short-term investors took fright at the fourth-quarter sell-off in the IT sector, and across growth stocks generally, longer-term investors can see lower valuations as opportunities to increase exposure to their favored stocks. As such, the Robeco Trends team’s focus has been on technology companies that are capitalizing on consumers’ insatiable appetite for voice-controlled devices.

Smart speakers such as Google Home and Amazon Alexa form a key element of the Internet of Things, which connects devices across the home, including smart TVs, fridges, central heating thermostats and home security systems. Voice control is the latest step in facilitating easy access to technology systems, being easier, quicker and much more intuitive than typing on a keyboard.

Neele and Speetjens fully anticipate ongoing regulatory scrutiny as to how the big players handle information from devices such as always-on smart speakers. Hence, to fully capitalize on the growth potential, companies will need to maintain, and in some cases, raise investment in areas such as data security. Nevertheless, even in the face of a push for tighter regulation over the use of data, they believe that the growth story for voice-controlled technologies remains compelling.

Emerging consumer: warming to India as China cools Even as the economic slowdown in China plays out, emerging consumer classes offer huge growth potential, according to the Robeco managers. While China has been the big growth story over the last decade, consumer markets there have become much more developed, and very competitive. However, Neele and Speetjens have become increasingly interested in the growth of the consumer space in India.

Having lagged China, perhaps by up to ten years, in terms of

Consumers are flocking to the technology – around 25% of US households now have at least one smart speaker. Neele and Speetjens expect this trend to gain momentum in other countries, initially led by English-speaking markets. In time they foresee similar levels of penetration as in the US. Chinese platforms are already replicating the technology with a view to capitalizing on its growth potential.

The investment case for companies enabling voicecontrolled technologies is not without risk, including regulatory factors such as growing regulation in the EU and the Digital Services Tax based on revenues.

‘Having lagged China in terms of consumerization, India now offers exciting prospects’

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Strong brands matter to the more healthconscious consumer

urbanization and consumerization, they believe that India now offers exciting prospects, helped by rapidly growing population – in contrast to China, where the population has largely plateaued.

In fact, many of the developments seen in China over the last decade are now playing out in India, driven by factors such as urbanization and the rapidly growing consumer classes’ appetite for both premium food products and basic necessities as retail channels increasingly commoditize.

Neele and Speetjens have built exposure to companies geared to the long-term growing trend of awareness of health and wellbeing among consumers. The surging popularity of health-based smartwatches such as FitBits and growing consumer interest in the composition and origin of the food they eat are two examples of this trend.

Neele and Speetjens have therefore built exposure to companies similar to those their team bought into in China a decade ago.

These include firms with unique, efficient distribution channels, category leaders in areas such as supermarkets and, in particular, food producers (such as biscuit manufacturers). Distributors with a distinctive presence – such as several high-street outlets and stores with a dominant online position – also have caught their attention.

Although this is not limited to any one demographic, many young people in particular now pay more attention to the ingredients and composition of the food they eat. They are also willing to pay a premium for more natural, ethically sourced and organic foods, including foods that meet specific dietary requirements. As well as specialized food producers selling direct to more health-conscious consumers, opportunities can also arise among specialized ingredient suppliers and even larger food producers.

While the Chinese consumer market has become crowded, the Robeco fund managers recognize that it’s still a huge market with some interesting opportunities, although they are scarcer nowadays. India is at an earlier stage of growth, a factor that can present both higher risks and opportunities. While China’s been trying to rebalance its economy away from exports towards the rapid growth of domestic consumption, India remains more of an internally focused economy. It has relatively high levels of domestic consumption, a factor that underlines the growth potential given the ongoing emergence of the domestic consumer class.

Such suppliers that fit the Robeco Trends team’s theme are, however, becoming more difficult to identify as the biggest food producers are also mindful of the health and wellness awareness trend amongst consumers and engaging in M&A activities. For example, in 2017 French multinational food giant Danone bought US-based WhiteWave Foods, a supplier of organic dairy products and plant-based dairy substitutes, with a view to better meeting consumers’ changing preferences.

Assessing valuations in the context of underlying growth trends The fourth-quarter sell-off saw 2018 calendar year returns brought back down to earth, and market returns for the year turning negative. Yet the fund retained its good relative performance as the companies Neele and Speetjens invest in have continued to enjoy double-digit earnings growth. Valuations are now back towards the lower end of our longer-term range, making them more attractive, even on a timescale stretching back three or four years.

‘Many of the developments seen in China over the last decade are now playing out in India’ 18

For the stocks the Robeco managers like, the expected price/earnings to growth ratio has become more favorable, giving them strong grounds for optimism about their potential returns. Looking ahead, Neele and Speetjens are prepared to look beyond short-term market fluctuations as they aim to capitalize on powerful underlying global growth trends in consumer markets.

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SUSTAINABLE investing The palm oil paradox Palm oil is a paradox for sustainable investors. As a highly efficient cash crop that is an essential ingredient in a wide range of consumer goods, it provides a vital source of income for farming communities in emerging markets. Yet it is subject to huge sustainability issues, from deforestation in Malaysia and Indonesia to poor labor standards. Due to its significant prevalence in the supply chain for goods ranging from foods to detergent, excluding it from the investment process is not an option. So, what’s the answer? Robeco has long believed in engagement to improve sustainability in problem areas, and palm oil is no exception. It tops our four engagement themes for 2019, as our lead story explains.

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Sustainable palm oil leads engagement themes Robeco has stepped up its engagement with producers of palm oil to address sustainable issues in the industry. The issue of sustainable palm oil tops the Active Ownership team’s engagement themes for 2019, along with tackling plastic pollution, the social impact of artificial intelligence, and digitalizing health care.

Palm oil is a highly-efficient edible oil and a vital commodity that is an essential ingredient in many consumer goods. However, the industry continues to face significant problems related to deforestation, its large carbon footprint, and human rights and labor standards.

“Our new approach to palm oil is three-fold,” says Carola van Lamoen, Head of the Active Ownership team. “Robeco, in collaboration with RobecoSAM, conducts a sector screen

that benchmarks companies according to the amount of land that has been certified by the Roundtable on Sustainable Palm Oil (RSPO). Companies that do not comply with the minimum standard of 20% RSPO-certified plantations are excluded from Robeco funds.”

“For palm oil producers who have 20-80% of RSPO-certified land, Robeco has started an enhanced engagement program. The main goal of this three-year program is to

‘We expect the companies supported by our engagement to meet the 50% RSPO threshold within three years’

In a separate but related campaign, Robeco has begun a partnership with City to Sea, an award-winning British company which aims to prevent marine plastic pollution at source through its Refill initiative. This aims to make refilling reusable bottles easy, convenient and cheap, by installing refilling stations at more than 17,000 sites.

“Producers who have not reached this threshold at the end of the engagement program will be excluded. We expect these companies supported by our engagement to meet the 50% threshold within three years.”

The second theme will address the issue

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“Currently, 95% of plastic packaging material is only single use. We aim to get these companies to move towards a circular economy model, focusing on innovation management, plastic recycling, and plastic harmonization. Plastic producers should work towards harmonizing plastic manufacture to make recycling easier and decrease ocean littering.”

“We recently became a member of the Plastic Solutions Investor Alliance and also have signed up to the Ellen MacArthur initiative, started by the former roundthe-world yachtswomen, on moving to a circular economy.”

support companies in improving material sustainable issues. Upon completion of the enhanced engagement program in December 2021, Robeco expects the selected palm oil producers to achieve at least 50% of RSPO-certified land.”

Plastic and waste

of single-use plastic. Engagement will focus on food and beverage producers, along with the plastics manufacturers themselves.

“Today, almost everyone comes into contact with plastic packaging, and there are a lot of benefits, but also drawbacks in using it,” says Van Lamoen.

Artificial intelligence The third theme, focused on engaging on the social impact of artificial intelligence will target IT companies, including social media platforms whose core business entails collecting personal data from individuals. The chief concern is

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that the technological development and application of AI outpaces the development of principles to use the technology responsibly.

“Artificial intelligence technologies create opportunities for companies, but at the same time we note that AI poses several risks to human rights, specifically the right to privacy,” says Van Lamoen. “The main aim of this engagement is to safeguard human rights in relation to the application of AI. For instance, AI-driven consumer products and autonomous systems (such as automated online assistants) generate and collect vast amounts of data without the knowledge or effective/informed consent of the users.”

“We’re also looking at the corporate governance aspect of this and how the board is dealing with it. Sufficient technological knowledge and awareness of the public debate on AI at board level is key

‘AI poses several risks to human rights, specifically the right to privacy’ for companies using the technology.”

Digitalizing health care Finally, engagement with health care companies aims to lower spiraling medical costs through digital innovation, as well as combatting aggressive drug pricing. “High costs are a barrier to access to health care, and drug pricing is a specific component of this,” says Van Lamoen. “It’s a financially material sustainable concern, and the focus will be on digital innovation, as we believe this can reduce healthcare costs, and so increase access to health care.”

“There are several key trends: preventative medicine, to steer patients towards a healthier lifestyle; developing monitoring

tools for patients; and the electronic harmonization of patient data between doctors, service providers and pharma companies. There are a lot of inefficiencies that can be resolved with better data exchange in receiving consultations from medical experts.”

Ongoing engagement Engagement remains an ongoing activity at Robeco. “In addition to our new engagement themes, we will also step up our efforts in 2019 with regard to shareholder meetings,” says Van Lamoen.

“If there are controversial agenda items, then we might engage with the company on such topics like its board composition, to dividend approaches. That is no typically three-year engagement but a more focused approach to deal with specific problems when they arise.”

The challenges of integrating ESG into Chinese A-shares Growing interest in sustainable investing is driving changes in markets – but it faces distinct challenges in China. It can still be done through a systematic and thorough approach, say Hong Kong-based investors Victoria Mio and Jie Lu.

Stricter regulation on issues such as climate change, or changing consumer preferences with respect to food and electric cars are changing the entire investing environment. sustainable concerns are subsequently directly affecting companies and investors, a trend that is particularly relevant for the A-share market of domestic Chinese equities.

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Against the backdrop of China’s slowing economic growth and the government’s shift of focus from seeking GDP growth in absolute terms to a higher quality of it, there is increasing spotlight on the environmental impact and social implications of this growth. Corporates are being steered towards pursuing sustainable growth, both for the national interest and their own good.

At the same time, their corporate

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governance mechanisms are under increasing international scrutiny, as the A-share market opens up to more foreign capital.

‘Chinese companies have a relatively lower awareness of the ESG concept’

Structured approach needed A structured approach to assessing the risks and opportunities that come with these changes can help investors make better-informed decisions and spot risks and opportunities at an early stage. This is becoming increasingly important, as the pace of opening up China’s stock market has accelerated in the past 12 months. MSCI and FTSE Russell, two of the world’s leading index providers, have stepped up A-share inclusion in their mainstream indices.

This will drive a long-term fundamental change in the participation dynamics of the A-share market. Unlike its counterparts in developed markets, the Chinese A-share market is dominated by local funds, and by domestic retail investors in particular. Overseas investors tend to have better ESG investment discipline, which will push local institutional investors to follow suit. It means that ESG use in China has become an irreversible trend,

and companies or investors who fail to embrace it will get left behind.

Integrating ESG as standard As a pioneer in sustainable investing, Robeco has long believed in the usefulness of applying ESG principles to fundamental equity investments. We have integrated ESG into the investment process for choosing stocks for the Chinese A-shares strategy from the very beginning. We have ESG profile coverage for 100% for our portfolio holdings, and for more than 70% for our broader Chinese stock universe.

We do much more than just scratch the surface by only looking at ESG scores from external data providers. Our ESG analysis is based on Robeco’s global framework and tailored to the specific characteristics of the Chinese stock market.”

But there remain hurdles to overcome in

applying it fully to investing in China. First, listed Chinese companies have a relatively lower awareness of the ESG concept, and a limited appreciation of the importance of sustainability to their business operations. This leads to a misalignment of mindsets that can be frustrating for western investors who want to tap the Chinese market, but also want to stick to their sustainable principles where possible.

Second, although more than half of Chinese listed companies now publish annual sustainable or corporate social responsibility reports, most of them treat this as a box-ticking exercise, and do not provide adequate disclosures about ESG management. Third, there is lack of a comprehensive regulatory framework to promote sustainable investing. By contrast, in Europe, many national laws or stewardship codes exist to regulate it.

In the absence of a top-down push, ESG disclosures by Chinese companies are often sporadic and non-standardized.

Fourth, a lack of information, especially in the form of structured data, makes forming a one’s ESG performance and crosscompany comparison challenging. Finally, the community of investors in Chinese companies does not have a collective voice to demand more ESG-oriented management and disclosures. International associations such as the UN Principles for Responsible Investment or the International Corporate Governance Network tend to have little influence on Chinese businesses or domestic investors. This in part contributes to the slow-moving process at the regulator and company level.

Taking the first step Despite these hurdles, a number of institutions have taken the first step

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in assessing Chinese companies’ ESG performance. The leading ESG rating providers who partly base their assessment on company disclosures tend to score Chinese A-share companies lower than their counterparts in western markets because of the lack of transparency.

Based on the limited assessments of the ESG performance of Chinese companies conducted by RobecoSAM, it is no surprise to find that on average, Chinese companies score lower on all aspects of sustainable than their global peers.

‘Although more than half of Chinese listed companies now publish sustainability reports, most of them treat this as a boxticking exercise’ It is worth pointing out though that ESG coverage for A-shares is currently

limited, mainly due to the inaccessibility of information.

This situation is bound to improve as China’s capital market opens up, and more international investors make allocations to China. We believe that the investment firms that are fundamentally best equipped to manage ESG issues will enjoy the greatest benefits of this increased ESG coverage.

Another record year for SI at Robeco In 2017, we reported seeing a lift-off in sustainable investing. 2018 became the year in which the lift-off took the good ship sustainability into orbit. Masja Zandbergen, Head of ESG Integration, outlines the highlights of a record year for Robeco.

Sustainable assets under management and license at Robeco grew 70% to almost EUR 27 billion. Despite market declines, assets that had environmental, social and governance (ESG) factors integrated into the investment process remained stable at EUR 100 billion. We saw a clear and increased demand for new sustainable solutions during the year. We developed many new solutions, some of them based on our own ideas, and others developed in cooperation with clients.

In our quantitative strategies, we have offered products with an enhanced focus on sustainable since 2013. A variety of strategies were added to this range in 2018, such as Robeco QI Multi Factor Multi Asset and QI Multi Factor

Absolute Return, which combine Robeco’s factor-based knowledge and expertise into one easily accessible multi-asset solution.

Both strategies leverage on Robeco’s long history of sustainable investing by implementing advanced ESG integration in the investment process.

Our fundamental multi-asset team also developed a sustainable solution: Robeco Multi Asset Sustainable (introduced as Robeco ONE Duurzaam for Robeco Retail’s ONE proposition). This new capability

‘One of the most prominent cases was the success that investors led

by Robeco achieved with Shell on climate change’

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combines the expertise of Robeco and RobecoSAM, offering multiple layers of sustainable across all asset classes. In trends investing, our thematic and impact investing platform was expanded with the addition of a smart mobility fund, a global SDG equities fund and a global SDG credits fund.

Engagement pays off Active ownership is an important part of our sustainable efforts, and the value of assets under engagement and voting reached record highs in 2018. Assets under voting (only applicable for equity investments) grew from EUR 63 billion to EUR 70 billion, and we voted at a record number of 5,291 meetings. Assets under engagement grew by almost 60% to EUR 380 billion as we added new clients for whom we take care of the dialogue with companies. We handled 240 engagement cases in 2018 on environmental issues such as climate change strategies and reducing waste. One of the most prominent cases was the success that investors led

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by Robeco achieved with Shell on climate change accountability at the oil giant.

In 2018, we spoke to many clients and prospects across the globe to share our knowledge with them. Specifically, we organized 10 Sustainable Investing Explore

‘Sustainable investing is about creating wealth and well-being’

sessions. The focus of these sessions is knowledge sharing, and the content is always a mix of external academic speakers, Robeco and RobecoSAM experts, and clients. We held sessions in the Netherlands, the Nordics (Stockholm, Helsinki, Copenhagen), Italy, Singapore, Japan, Switzerland, France and the UK. Furthermore, in September, Robeco became one of the founding partners of the Erasmus Platform for Sustainable Value Creation, a network of universities and companies fostering thought leadership in the field of sustainable finance. The platform was initiated by the Rotterdam School of Management to develop new insights through research and education in close collaboration with leading global players in sustainable finance.

External recognition Our efforts have not gone unnoticed in the marketplace. We were again very proud of the A+ scores that both Robeco and RobecoSAM were awarded by the UN Principles for Responsible Investment in all the categories in which we participated. As a company, we won multiple awards in 2018.

Our Big Book of SI was awarded the ‘Best ESG paper’ 2018 by Savvy Investor, while Gilbert Van Hassel was named ‘Sustainable CEO of the Year’ at the Pan-European Global Invest Forum hosted by L’Agefi.

Sustainable investing has clearly taken off, but we see that many investors worldwide are still looking to set up policies and implement them in their investment portfolios. As a long-term player in this field, we applaud this. However, we would also advise caution. Sustainable investing is about creating both wealth and wellbeing. This should be the goal. And our ambition is to set the standard and then keep raising the bar.

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Investing in the SDGs to tackle snake bites How many people do you think die from snake bites? A few hundred? Incredibly it is 11,000 a month, or about 138,000 a year. It is a difficult problem to fix, but investing in the Sustainable Development Goals can help.

Toxic bites by wild animals are still a major public health issue for emerging markets led by India, which suffers about half of all snake bite deaths each year. A further half a million people worldwide are severely injured, often leading to amputation of infected limbs.

And snakes are far from being the biggest killer. The world’s deadliest creatures are not humans causing wars or famine, as many people think, but mosquitos.

Malaria caused by mosquito bites killed 720,000 people in 2016, ranking far above terrorism (34,000) or conflicts (116,000).

Targeting good health The scale of the threat from animals in emerging markets is surprising to people in the West, for whom snakes only reside in zoos and a few pet cages. However, it also offers an opportunity for investors to

support the United Nations’ Sustainable Development Goals (SDGs), some of which strive to eradicate these problems.

Treatments for injuries such as snake bites, malaria and other animal-borne diseases such as rabies are not widely available, and are often not affordable. There is a global shortage of snake venom antidotes, and drugs to prevent malaria from mosquito bites are usually a luxury that only western tourists can afford.

Subsequently, the SDGs aim to channel investment into projects that can lead to enhancement. SDG 3, for example, has a goal of promoting good health and well-being, including the availability of medicines in emerging markets. Some investors are now launching funds to invest in those companies that can directly contribute to the SDGs, such as the RobecoSAM Global SDG credits and equities funds.

Figure 4 | The 17 UN Sustainable Development Goals

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Making an impact “The SDGs function as a taxonomy for investors to categorize the impact that companies have on society,” says Guido Moret, Robeco’s Head of sustainable Integration Credits. “At Robeco and RobecoSAM, we have developed a methodology to assess this impact, based on what companies produce, how their business is run, and if any controversies are known. Next to the positive impact, we also look at the potential negative contribution of a company on the SDGs. If a company does have a negative impact, it is no longer eligible for our SDG credit funds.”

“In the case of providing antidotes for snake bites and treatments for malaria and other diseases, pharmaceutical companies can have a positive impact on SDG 3 – good health and well-being.

In our analysis, we also look for instance at the percentage of their business in emerging markets, and the pricing strategy of pharmaceutical firms. After this assessment, only the pharmaceutical companies that pass the bar of positive contribution remain eligible for investment. It can make a real difference.”

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Earnings growth is not a prerequisite for higher equity prices With global growth leveling off, investors are more focused than ever on corporate results. These reveal a less rosy picture than in previous years, and company expectations are very muted. The good news, however, is that lower earnings growth isn’t necessarily a problem for the stock markets, provided the decline is temporary, as portfolio manager Jeroen Blokland explains.

Speed read

Opinion

• Reasonable chance of a fall in earnings in the next quarter(s) • Lower earnings growth doesn’t necessarily signal a stock slump • Current period comparable with economic cooling of 2015-2016

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In many ways the current period is comparable to 2015-2016, when the global economy cooled and, as we’re seeing now, investors watched the US Federal Reserve and China with bated breath. Earnings per share stalled, even falling into negative territory from the third quarter of 2015, and didn’t start to move higher again until the end of 2016. In the meantime, however,

both the Fed and the Chinese government stepped on the gas and thus prevented a global recession.

In anticipation of this, the MCSI World Index bottomed out in February 2016 and subsequently rose until December – the point at which company earnings started to increase again – by a very respectable 21%. A time period like this between market bottom and earnings growth is not all that unusual. According to calculations by JPMorgan, the MSCI World Index bottomed out five to ten months before earnings growth became positive again in all four of the serious growth slowdowns and recessions over the past 20 years (in 1998, 2003, 2009 and thus 2016).

The stock markets rose sharply in the months after the market hit bottom and earnings growth started to climb again. Once equity

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investors begin to suspect that the end of the earnings dip is near, the markets pick up again.

Recovery on the horizon

‘There’s a reasonable chance we’ll see a fall in earnings per share in the coming quarters’

The question, of course, is whether we can expect another period like that now.

In other words, will the earnings dip be followed by a period of earnings growth anytime soon? There’s a reasonable chance we’ll see a fall in earnings per share in the coming quarters. The last number shows an earnings growth rate of 16%, but this is highly skewed by the tax advantage that US companies enjoyed last year.

If we detract this ‘gift’, US earnings fall back to 4%, compared with a 7% decline in earnings for the rest of the world. What is more important, however, is whether earnings will recover again later this year. The chance of this is also considerable. The Federal Reserve has made some significant policy shifts in anticipation of less flourishing times, leading you to wonder whether it’s actually being a little too cautious.

And China is stimulating its economy, as it did in the

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2015-2016 period. Add to this the still-strong corporate revenue growth, and the fact that US companies in particular are spending billions buying up their own stocks, and the conclusion is that earnings per share should be able to increase again in the last quarters of this year.

What could go wrong?

As always, this scenario is not without risk. We are a few years further into the economic cycle now, and thus also a few years closer to its end. And although the Federal Reserve has taken steps to normalize its monetary policy, this certainly doesn’t apply to all the other major central banks. There is limited opportunity for stimulation. The same applies to China, which cannot and does not want to use unbridled credit growth to boost economic growth.

But our base scenario is that we will not see a recession this year, but rather a cautious recovery aided by central banks and low interest rates, moderate Chinese monetary stimulation and strong labor markets. Generally speaking, this should also be accompanied by higher earnings per share.

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Marlies van Boven

‘Educating clients on smart beta is still important’ Interview

Over the past five years, FTSE Russell’s annual smart beta survey of asset owners has become a must-read. It provides useful insights on how smart beta, and more generally factor investing, is perceived by global institutional investors. To dig deeper into the results of the latest survey, we talked to Marlies van Boven, Managing Director of Research & Analytics at FTSE Russell.

The FTSE Russell annual survey has repeatedly shown that the rapid adoption of factor investing and smart beta is a global phenomenon, and that Europe appears to be leading the way.

How do you explain that?

“European asset owners were the earliest adopters of smart beta strategies. An explanation is that the large European institutional investors usually run money in-house and they often already have quant teams managing active quant strategies. I’m talking here about institutions based in Scandinavia or the Netherlands, where large asset owners tend to be quite sophisticated. For them, embracing smart beta was second nature. And as they did, other people got interested which led to a natural adoption across Europe.”

“In the US, things are a bit different, although there are very sophisticated asset managers offering smart beta strategies.

But because asset owners tend to outsource more of their asset management, they did not initially have the internal resources to really grasp smart beta. This probably explains why the US market has been slower to embrace it.”

A similar phenomenon seems to be at work when it comes to ESG considerations within smart beta strategies. What’s your take?

“Again, this has to do with the same sophisticated European investors, that have been leading the way. In Scandinavia, for example, the regulations clearly encourage ESG adoption and the integration of sustainable goals into portfolios. In the UK as well, large financial institutions have an increasing mandate to incorporate ESG factors.”

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“Meanwhile, in the US, there is more skepticism. It isn’t about investors questioning whether climate change is real or not. They believe climate change should be addressed. But they are more interested in their underlying risk-adjusted performance, so tend to focus more on financial goals. We are seeing that this is beginning to change though.”

One interesting finding of the latest survey is that new information and education still play a critical role in triggering the evaluation and the re-evaluation of smart beta strategies. But that off-the-shelf product availability has become almost as important. What’s the message here?

“As I said, many of the early adopters of smart beta were the large asset owners, which could manage strategies internally or through separate accounts. But smaller asset owners typically don’t have the same resources. They need off-the-shelf products.

And because clients can have different views on how to combine factors or how to integrate ESG and smart beta, there can’t be a one-size-fits-all solution. So, as more products are made available, it is becoming easier for investors interested in factor investing to dip their toe in the water and try it out.”

“However, I think the investment industry also needs to keep up its efforts in terms of education. Educating clients on the role of smart beta in a portfolio is still very important. For most clients, it’s still quite difficult to decide how best to allocate to factors given their investment objectives and constraints.”

Another interesting finding is that asset owners seem to be focusing on a smaller number of strategies. In fact, over half of those who have a smart beta allocation actually only use one type of smart beta while, in the last survey, this figure was only

Robeco QUARTERLY • #11 / MARCH 2019

34%. Is this directly linked to the rise of multi-factor strategies?

“Yes, there is a clear link. Using individual factors is quite difficult because of their cyclical nature. It’s quite a natural development, therefore, to combine factors in a multi-factor solution, where you can achieve better risk-adjusted returns and smaller drawdowns.”

One of the most serious concerns raised by asset owners regarding smart beta related to capacity issues. In the latest survey, one in three respondents mentioned this point as an important barrier to implementation. Interestingly, the word ‘capacity’ had not appeared previously. Is Is this because capacity issues were simply not on their radar?

“We always try to adapt the survey to incorporate additional topics that are on investors’ minds, and capacity has indeed become a very topical issue. Measuring the capacity of smart beta strategies is quite difficult. Some studies have addressed this topic by comparing the amount of assets under management in factor strategies with the total amount of assets under management in the fund industry. The general finding is that passive funds’ share of investments is small. Other studies have focused on the breakeven point of a strategy, the point where trading costs wipe out any expected returns and found that the capacity of factor strategies is huge.”

In the latest survey, most of the respondents said they thought it was impossible to time factors successfully. Was it the first time you included a question on timing in the survey? Do you

Robeco QUARTERLY • #11 / MARCH 2019

have more insight into this topic?

“Yes, this was also a new question. With increasing discussion about factor timing, we thought it would be useful to test opinions on this. Incorporating factors into a portfolio is one thing but deciding on the relative weighting of the factors is another matter altogether. And given their cyclicality, trying to determine which ones are going to outperform requires some understanding of how factors work in different market regimes. You also need to figure out which regime you are in and do some macro analysis and forecasting. It’s not easy.”

Fixed income smart beta seems to be taking off but still very slowly. Are there too many hurdles?

“People are interested in transposing smart beta to fixed income, but it presents its own challenges and is still in its infancy. In many markets, bonds are still largely traded over-the-counter, so transparent prices are more difficult to determine. The amount of data available for research on factors in bond markets is also far smaller than for equities, where factors have been thoroughly researched for many decades.”

“Another difference is that the fee gap between traditional active and passive fixed income products is much smaller than for equities, so it is not as easy to position smart beta as a third option. Investors are showing interest and I am sure it will continue to evolve slowly over time to meet the specific features of bond markets.”

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How ESG integration aids outperformance Robeco has integrated ESG into the investment process for equities for almost a decade. In a first attempt to quantify the contribution it makes, Chris Berkouwer, portfolio manager with the flagship Global Stars Equities strategy, explains how it accounted for a significant part of outperformance in recent years.

Speed read

Research

• ESG explains 180 basis points of outperformance in 2017-18 • Strategy uses bottom-up process to integrate sustainability • Target prices make it possible to quantify ESG attribution

ESG integration in fundamental equity investments is usually done in three steps at Robeco, using a tool we developed in 2014 – the Value Driver Adjustment Framework. The first step is to identify and focus on the most financially material ESG issues affecting the company. The second is to analyze the impact of these material factors on the company’s business model.

Finally, the challenge is to incorporate these factors into the valuation analysis and/or the fundamental view of the company in order to decide whether to buy the stock.

that Robeco introduced in 2017 – adjusting the Competitive Advantage Period (CAP). This is the number of years that the company is expected to generate excess returns on new investments, a timeframe in which the ROIC is higher than the Weighted Average Cost of Capital (WACC).

In quantifying it, the starting point is that we know how much ESG contributes to the intrinsic value of a company, because in integrating ESG in our valuation model, we calculate how much ESG impacts our share price target. This is an important instrument, since price targets broadly signal what we expect the company share price to be at a set date in the future. If the price target is much higher than the current share price, it represents a buying opportunity.

‘What makes the ESG integrated is that it forms one part of a wider three-step process to find the best stocks’

The reason why we do this is because it leads to superior risk-adjusted returns.

Analysis shows that integrating ESG explains about 180 basis points of the Global Stars Equities strategy’s 800 basis points of outperformance over the 2017-2018 time period, or 22% of the alpha.

Identifying the value drivers So, how is it done? The team starts with an investible universe of about 2,000 stocks, and uses research to narrow it down to the 25-40 best picks for the strategy. What makes the ESG integrated is that it forms one part of a wider three-step process to find the best stocks; the strategy also focuses on companies with high free cash flow, and a high Return on Invested Capital (ROIC).

The way the wind is blowing

For example, on the back of the ESG analysis of a leading renewable energy company, we lifted our price target by 16%. Subsequently, we looked at the performance contribution of the company in the portfolio, which was +44 basis points (bps) during the 2017-2018 period.

Multiply both figures and you get a proxy for the ESG attribution to performance; in this case, this is 16% x 44 bps = +7 bps excess performance attributable to ESG.

A further breakdown of the results showed that in 2018, which proved to be a very difficult year for stock markets, the positive ESG tilt in portfolios acted as a performance cushion, contributing 98 bps of excess performance in addition to the 158 bps of outperformance made on stocks where ESG did not impact company valuation. It adds value, and that’s why we remain so committed to integrating ESG.

Five value drivers will be routinely identified for the company – revenue growth, margin development, invested capital needed, likely future risk (as defined by a discount factor), and something

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Robeco QUARTERLY • #11 / MARCH 2019

LAST BUT NOT LEAST

Standing the test of time Should low volatility investing only be about minimizing volatility? Since 2006, we have designed our Robeco Global Conservative Equities strategy to achieve a maximum absolute return per unit of absolute risk, by focusing not just on volatility but also on other proven factors, including value and momentum. Thanks to this multi-factor perspective, the strategy has effectively generated higher long-term risk-adjusted returns compared to the market and major single-factor indices, including a low volatility index. Yet investors should bear in mind that the strategy’s relative performance remains erratic over time and there is a significant chance it will underperform a low volatility index on a one- or five-year basis.

Robeco QUARTERLY • #11 / MARCH 2019

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The long-run value of Conservative Equities Pim van Vliet

What defines a good low volatility strategy for long-term investors? Since 2006, we have designed our Robeco Conservative Equities strategy to achieve a maximum absolute return per unit of absolute risk, by focusing not just on low volatility but also on several other proven factors, including value.

Since inception, the Robeco QI Global Conservative Equities strategy (Robeco Conservative) has used factors such as value and momentum in its investment process to decompose performance by explicitly taking factors other than low volatility into account. To achieve this, we use other widely used MSCI single-factor indices based on value, high dividend, quality and momentum. Table 1 shows the total return of Conservative Equities, the MSCI World Minimum Volatility Index, the market and an equal-weighted factor mix of four MSCI indices (Value, Momentum, Quality and High Dividend) in the period from June 1994 to December 2018. The return is decomposed into three parts: market return, factor alpha and strategy alpha.

single factors that are known to generate additional returns. While raising the bar, this is easier said than done as it unrealistically assumes that investors already have frictionless access to these four factor premiums, without transaction costs or management costs. Still, it offers a deeper insight. The Minimum Volatility Index provided positive exposure to the different return factors, which explains part of the performance. At the same time, it was able to contribute 1.51% of additional alpha. This proves the strength of this defensive investment style.

For Robeco Conservative Equities, 2.93% of the performance can be explained by the portfolio’s exposure to these single factors.

Thus, it offers full exposure to both the MSCI World Minimum Volatility Index as a means to reduce risk and full exposure to the factor mix as a means to enhance returns. Nonetheless, 3.46% of the total return cannot be explained by either market or factor exposure; this alpha can be attributed to positive interaction effects and the use of proprietary Robeco factor definitions.1

‘Conservative Equities has more efficient factor exposures than the MSCI World Minimum Volatility Index’

The market equity premium was 6.87% for this period. Therefore, the return attributable to market exposure was 4.51% for Conservative Equities and 4.53% for the Minimum Volatility Index (which both have a beta of 0.61) and 6.38% for the Factor mix (which has a beta of 0.93). This means that the total added value of the factors in the mix was 2.95% for this sample period. However, a more critical test of the added value of a strategy or index is to look at the contribution of the

Conservative performance and the factor cycle

Robeco Conservative Equities has more efficient factor exposures than the MSCI World Minimum Volatility Index. The differences are most pronounced for value and momentum. Therefore, we analyze the performance of Conservative Equities depending on the return of the value and momentum Table 1 | Return decomposition of Robeco Conservative Equities and MSCI indices factors, as measured by the MSCI World Robeco Cons.

Min. Vol. Index Factor mix Market Return decomposition Value Weighted Index and the MSCI World Momentum Index. Table 2 splits the Market return 4.51% 4.53% 6.38% 6.87% full June 1994-December 2018 sample Factor alpha 2.93% 2.33% 2.95% into four main scenarios, depending on Strategy alpha 3.46% 1.51% the monthly performance of both MSCI Total return 10.90% 8.38% 9.31% 6.87% indices.

Source: Source: Robeco, MSCI. Period June 1994-December 2018. Index returns are net returns in EUR. The factor mix is an equal weighted average of four global developed indices: MSCI World Value Weighted, MSCI World Momentum, MSCI World Quality and MSCI World High Dividend. MSCI World Minimum Volatility Index is EUR-optimized. Robeco is the Global Conservative developed strategy net of transaction costs. Results obtained in the past are no guarantee for the future.

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As expected, the most challenging

Robeco QUARTERLY • #11 / MARCH 2019

factors during the different phases of the business cycle. For this purpose, we use the Dynamic Strategic Asset Allocation (DSAA) business cycle indicator, as proposed in the study ‘Dynamic Strategic Asset Allocation’, published in 2011.3 This DSAA indicator is a standardized measure that combines four cyclical variables: credit spread, earnings yield, industrial production and unemployment rate.

environment is when both value and momentum show relatively weak performance. In this particular scenario, Conservative Equities slightly outperforms the MSCI World Minimum Volatility Index by 0.6%. When value is weak but momentum is strong, the outperformance improves as the gap in returns widens to +1.1%. The best scenario is when both factors perform well. In this case, the added value of Conservative Equities is +4.9% return per annum.2

Based on this indicator, the June 1994-December 2018 sample can be split into four different phases of the business cycle: expansion, slowdown, recession and recovery. These are based on the level (positive/negative) of the DSAA indicator and its one-year change (positive/negative). Figure 1 illustrates these four phases. Since growth slows down more quickly than it picks up, the likelihood of each scenario is respectively 39%, 21%, 26% and 14%. As discussed in Blitz and Van Vliet (2011), low and falling scores (indicating a recession) have historically coincided with formal recessions in the US.

Over the past five years, the percentage of observations was skewed to the left across the four Scenarios. Value was weak 63% of the time in the past five years. Momentum sometimes compensated but was also often weak when value was strong.

The respective probabilities for the four scenarios were 30%, 33%, 27% and 10%. This means that the number of ‘+/+’ months has been three times lower than the number of ‘-/-‘ months over the past five years. This value/momentum perspective clarifies why Conservative Equities has lagged the MSCI World Minimum Volatility Index in the more recent period.

Of course, this methodology is not perfect. Signals can reverse quickly, and it is sometimes difficult to determine when one phase ends and another starts. Still, DSAA provides a structured framework for differentiating the different phases of business cycles based on multiple metrics and over 70 years of data.

This indicator can therefore be a useful tool in explaining the performance of an investment strategy in different macroeconomic contexts.

Factor performance and the business cycle One question that often arises relates to the performance of individual factors in different macroeconomic contexts. Of all the main factors, low volatility can most clearly be linked to certain economic scenarios. For example, when markets go down, low volatility stocks tend to reduce losses. Low volatility stocks also tend to do better during economic downturns. It is therefore interesting to analyze the performance of individual

Outperforming in three out of four phases

Table 2 | Four scenarios based on the monthly performance of Value and Momentum Scenario % observations Robeco Return Min. Vol. Return Hit rate (monthly) Robeco -/- Min. Vol.

ValueMomentum-

ValueMomentum+

Value+ Momentum-

25% 9.3% 8.7% 56% +0.6%

25% 11.7% 10.6% 58% +1.1%

25% 10.1% 6.6% 62% +3.4%

Value+ Momentum+

25% 12.6% 7.7% 61% +4.9%

Source: Robeco, MSCI. Period June 1994-December 2018. Index returns are net returns in EUR. Returns conditional on relative monthly performance of MSCI World Value Weighted Index and MSCI World Momentum Index. Results obtained in the past are no guarantee for the future.

Robeco QUARTERLY • #11 / MARCH 2019

Figure 2 shows the annualized performance of the different MSCI indices and the Robeco Conservative Equities strategy during the four phases of the business cycle. In this case, the sample starts in October 2006, coinciding with the launch of our Conservative Equities strategy.4 Conservative Equities outperformed the MSCI World and MSCI

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World Minimum Volatility Indices in three out of four phases of the business cycle.

‘In the long run, Conservative Equities strategies offer the highest risk-adjusted returns compared to all major single-factor indices’

During periods of economic growth, expansion and slowdown, momentum generated the highest return of all single-factor indices. Value lagged the broad market in these same periods. Conservative Equities only lagged the market during expansions. As expected, defensive stocks did relatively well during the recession. Low volatility and quality reduced losses during this challenging period. Conservative Equities profited from its low-risk exposure and reduced losses significantly, despite its exposure to momentum. Finally, low volatility stocks delivered a modest outperformance during recovery periods. Conservative Equities, however, benefited from its multi-factor exposure during this phase of the business cycle, leading to an even better performance.

Compared to a generic low volatility strategy, Conservative

Equities added value in three out of four phases: expansion, recession and recovery. During the recession and subsequent recovery, Conservative Equities benefited from its exposure to factors like momentum and high dividend. During expansion times, Conservative Equities profited from its positive momentum exposure. Only during economic slowdowns, when value and high-dividend factors performed poorly, did Conservative Equities underperform a generic low volatility strategy.

While predicting the business cycle is challenging, timing factor performance is just as difficult, and a dynamic strategy has several drawbacks.5 For example, the distribution of returns is quite wide in each phase of the cycle. A more prudent option is to avoid making any predictions and to include multiple factors such as value and momentum in a defensive strategy, to strengthen performance throughout the business cycle. Some factors help

Figure 5 | Four phases of the business cycle

Expansion

Slowdown

Recession

Recovery

Growth + Trend +

Growth + Trend -

Growth Trend -

Growth Trend +

Source: Source: Robeco MSCI Sample Oct 2006-Dec 2018. Four phases of the business cycle defined in Blitz and Van Vliet (2011), using credit spread, EY, IP and unemployment rate.

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Robeco QUARTERLY • #11 / MARCH 2019

during economically challenging periods, while other factors, like momentum, can help during good times. Figure 2 shows that the performance of Conservative Equities is pretty stable throughout the business cycle.

downturns. It is difficult to predict single-factor performance, as well as the direction of the economy. Conservative Equities has proved pretty robust throughout the business cycle. The strategy is therefore a viable choice for long-term investors and those who ‘expect the best but prepare for the worst’.

Expect the best but prepare for the worst This article is an excerpt of a longer note available on Robeco.com.

In the long run, Conservative Equities strategies offer the highest risk-adjusted returns compared to the market and all major singlefactor indices, including a low volatility index. Still, the strategy’s relative performance remains erratic over time and there is a significant chance that it will underperform a low volatility index on a one-year (31%) or five-year basis (11%).

1 Further reading: “A guide to low volatility investing”, Robeco white paper, October 2018. “Expect the unexpected”, Robeco white paper, October 2014. “Beauty and the beast of low volatility investing”, Robeco white paper, February 2015.

2 Value and momentum contribute equally to the Robeco strategy in terms of active risk. Still, in this analysis the performance of the value index has a stronger relationship with the relative performance of Conservative Equities than the momentum index. One reason for this is that the MSCI Value definition shows more similarities with our Conservative value variables, while the MSCI momentum factor deviates to a larger extent, as the latter includes only price momentum, while Robeco incorporates analyst revisions as well.

3 The sample of original study was 1948-2007. Blitz and Van Vliet, 2011, “Dynamic Strategic Asset Allocation: Risk and Return across the Business Cycle”, Journal of Asset Management. https://link. springer.com/article/10.1057/jam.2011.12 4 We find a similar pattern when using data starting from 1994. The returns of the MSCI factor indices are higher and based mostly on simulations, so we choose the more prudent sample. We also perform an analysis for European data, which gives similar results. Finally, the appendix shows results for the US going back to 1948.

5 “Factor investing challenges: factor timing”, Robeco white paper, October 2017.

Conservative Equities adds the most (least) value when the value factor performs well (poorly). This added value varies from more than 4% per year to below 1% in scenarios depending on the performance of value.

Factor performance can be linked to the four phases of the business cycle. Defensive factors tend to do better during economic

Figure 6 | Factor performances in the four business cycle phases

Expansion

Slowdown

Momentum 19%

Momentum 18%

Conservative Equities

Quality 19%

Minimum Volatility

14%

Quality 2%

Minimum Volatility

MSCI World

High Dividend

12%

Minimum Volatility

Momentum 9%

Value 14%

Conservative Equities

11%

MSCI World

Conservative Equities

Quality 8%

Momentum -2%

Quality 8%

High Dividend

MSCI World

15%

10%

Recession

High Dividend

9%

MSCI World

7%

Minimum Volatility

8%

Value 5%

Recovery

2%

1% -29%

-4%

Value -4%

Conservative Equities

High Dividend

12% 9%

8%

6%

Value 6%

Source: Robeco MSCI Sample Oct 2006-Dec 2018. Four phases of the business cycle defined in Blitz and Van Vliet (2011), using credit spread, EY, IP and unemployment rate.

Robeco QUARTERLY • #11 / MARCH 2019

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Guido Baltussen

‘Factors are a permanent feature of markets’

Interview

Are factor premiums here to stay? Guido Baltussen, Laurens Swinkels and Pim Van Vliet recently published a new groundbreaking academic research paper1 that looks at the evidence supporting the existence of various factor premiums across multiple asset classes using new and previously unused historical financial data. We asked Baltussen, Professor of Finance at Erasmus University and co-head of Quant Allocation at Robeco, about their reasons for undertaking this study, main findings and conclusions.

Can you explain what triggered this new research effort?

“One of the concerns frequently raised by skeptics of factor investing is that while factors may have been extensively documented by academics in the more recent period, we can’t really be sure they will persist in the future. The main reason is p-hacking, which implies that several academic findings are the result of pure chance. If this is indeed the case, then targeting explicit exposure to factors may not necessarily lead to higher risk-adjusted returns in the long-run.”

“So, for our clients, it is very important to know which factors truly exist and offer attractive expected returns. One powerful way to determine whether factors are just a statistical blip or a result of the data mining of relatively recent data sets is to study their existence over a very long period. This is in essence what we did, going back to 1800 on the major global markets and studying factor portfolios.”

OK, but data mining concerns relate not only to the relatively short length of the time series that are typically analyzed by researchers in finance. Determining which price patterns you want to look at is not as straightforward as it sounds, either. There is still debate about which factors are really relevant for expected returns. How did you address this issue?

“To avoid objections on this front, our approach was to limit the degrees of freedom you have as researcher and consider the six most extensively documented factors in key peer-reviewed scientific journals. We replicated these anomalies and studied data spanning

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two centuries to find evidence of their existence in equity indices, government bonds, currencies and commodities.”

How did you compile such an impressive data set?

“We actually used a combination of different data sets. Historical data on financial markets dating back several centuries is very difficult to come by. Compiling this kind of information requires intensive manual work – scanning, checking, transcribing and crossreferencing with data from archival sources.”

“For this study, Robeco sponsored Erasmus University Rotterdam to obtain historical data from various sources to conduct academic research, and made it available to the Erasmus University community. We then combined this data with information from more conventional providers such as Bloomberg and Reuters.”

What would you say has been your most prominent finding?

“Without any hesitation, I would say the very high level of persistence of factor premiums. Based on earlier research on recent data sets, we were expecting these premiums to be persistent over time. But our results clearly exceeded our initial expectation. In particular, we found significant, persistent and robust momentum, value, seasonal and carry premiums within the four asset classes considered.”

“The evidence supporting the existence of the factor premiums we considered in this study is not limited to any sub-period. We

Robeco QUARTERLY • #11 / MARCH 2019

‘We found convincing evidence of most factor premiums across almost every decade in the period we analyzed for all asset classes’

found convincing evidence of most factor premiums across almost every decade in the period we analyzed for all asset classes. We also identified the existence of significant factor premiums regardless of the market and economic contexts, in bull and bear markets, inflationary vs. non-inflationary periods, as well as during periods of economic boom and recessions.”

“Our results also show that a diversified multi-factor multi-asset portfolio can deliver very stable returns over very long periods of time. This is important as it reinforces our belief that factor premiums are a permanent feature of financial markets rather than just another passing market phenomenon.”

Did your results provide any insights into the underlying causes of factor premiums?

“Well, one of the main conclusions of our work is that the factor premiums we considered are definitely not compensation for risk.

This reinforces the behavioral hypothesis explanation for these

Robeco QUARTERLY • #11 / MARCH 2019

anomalies. It is also consistent with previous research by Robeco and academics which finds that factor premiums are not necessarily compensation for taking higher risk.”

From this perspective, multi-asset factor investing seems like a fairly straightforward style that could be implemented relatively easily, through smart beta equity and fixed income products, for example. Is it really that simple?

“Not quite. For one, harvesting factor premiums within and across multiple asset classes requires a much more sophisticated approach than the one generic factor solutions typically apply. To achieve consistently strong returns, you need to remain well diversified across asset classes, markets and factors – at all times. And to ensure good diversification, you really need a holistic approach. A combination of several generic factor solutions will not provide that.”

1 Baltussen, G., Swinkels, L. and Van Vliet, P., 2019. “Global Factor Premiums”, working paper available on SSRN.

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Column

The undercover MMT practitioner Rarely does an economic theory get so much attention in the media. But MMT is currently in the spotlight.

‘Modern Monetary Theory’ (MMT) is, however, not exactly modern. Its principles can be traced at least as far back as the 1940s or possibly even to Ricardian times. The main conclusion of MMT is that a sovereign state can concentrate on the desired outcomes of policy, like achieving full employment and need not worry about deficits. As it issues its own currency, it can never be forced into default. It can always print additional money to pay off its debts. Interest rates can be kept low and taxes can eventually be used to curb inflationary pressures.

When asked by a US senator what he thought about MMT, Fed Chair Jay Powell answered: “The idea that deficits don’t matter for countries that can borrow in their own currency, I think is just wrong. US debt is fairly high to the level of GDP − and much more importantly − it’s growing faster than GDP, really significantly faster.

We are going to have to spend less or raise more revenue.” The irony of this is that this senator’s question was probably provoked by the fact that MMT has been embraced by the left wing in the US, for instance by US Congresswoman Alexandria Ocasio-Cortez, a rising political star on the left.

But it could be argued that the US president is himself a practitioner of MMT, albeit a silent one (though it’s

probably the only thing he’s silent about), having fired up growth with unfunded tax cuts and attempting to bully the Fed into implementing a low interest rate policy. But they would advise the government to scale back its efforts once full employment has been reached. It can be argued the US has reached this point, or is at least close to it. So perhaps Trump is already overdoing it. It is also understandable that the political opponents of the Republicans would have little desire to start calling for strict budgetary discipline.

That would represent a strange role-reversal in US politics and probably generate little political dividend.

I hasten to add that while it is short, the post-war track record of Democrats is actually better than that of the Republicans when it comes to budgets.

MMT has been ridiculed of late by prominent mainstream US economists. It has clearly hit a nerve. Paul Krugman complained that MMT adherents were playing a game of “Calvinball”, a reference to the ingenious comics by Bill Watterson, in which the main character keeps changing the rules. Larry Summers calls it the new “voodoo economics”, a reference to Bush’s initial criticism of Reagan’s tax cut plans, which were supposed to pay for themselves. These ideas originally came from Laffer, the inventor of the famous Laffer Curve. Reaganomics turned out to be anything but an illustration of MMT, as the Fed kept money tight, initially.

It would now be unthinkable for the Fed to do the same. Therefore, MMT probably has further to run, though the US president currently seems to be picking the wrong battles: take his border wall, for instance.

That said, he seems conciliatory towards China. A more fruitful battle in a pre-election year would be trying to implement additional fiscal stimulus in the form of tax cuts, but this time for the middle class, or maybe infrastructure projects other than the wall.

The Fed will remain accommodative as long as longterm inflation expectations stay subdued, which is likely to be the case for the foreseeable future. In the meantime, I see little reason to believe prices for risky assets won’t continue to drift upwards.

Léon Cornelissen, Chief Economist

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Robeco QUARTERLY • #11 / MARCH 2019

Important Information Robeco Institutional Asset Management B.V. has a license as manager of Undertakings for Collective Investment in Transferable Securities (UCITS) and Alternative Investment Funds (AIFs) (“Fund(s)”) from The Netherlands Authority for the Financial Markets in Amsterdam. This document is solely intended for professional investors, defined as investors qualifying as professional clients, have requested to be treated as professional clients or are authorized to receive such information under any applicable laws. Robeco Institutional Asset Management B.V and/or its related, affiliated and subsidiary companies, (“Robeco”), will not be liable for any damages arising out of the use of this document. Users of this information who provide investment services in the European Union have their own responsibility to assess whether they are allowed to receive the information in accordance with MiFID II regulations. To the extent this information qualifies as a reasonable and appropriate minor non-monetary benefit under MiFID II, users that provide investment services in the European Union are responsible to comply with applicable recordkeeping and disclosure requirements. The content of this document is based upon sources of information believed to be reliable and comes without warranties of any kind. Without further explanation this document cannot be considered complete. Any opinions, estimates or forecasts may be changed at any time without prior warning. If in doubt, please seek independent advice. It is intended to provide the professional investor with general information on Robeco’s specific capabilities, but has not been prepared by Robeco as investment research and does not constitute an investment recommendation or advice to buy or sell certain securities or investment products and/or to adopt any investment strategy and/or legal, accounting or tax advice. All rights relating to the information in this document are and will remain the property of Robeco. This material may not be copied or used with the public. No part of this document may be reproduced, or published in any form or by any means without Robeco's prior written permission. Investment involves risks. Before investing, please note the initial capital is not guaranteed. Investors should ensure that they fully understand the risk associated with any Robeco product or service offered in their country of domicile (“Funds”). Investors should also consider their own investment objective and risk tolerance level. Historical returns are provided for illustrative purposes only. The price of units may go down as well as up and the past performance is not indicative of future performance. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. The performance data do not take account of the commissions and costs incurred on trading securities in client portfolios or on the issue and redemption of units. Unless otherwise stated, the prices used for the performance figures of the Luxembourg-based Funds are the end-of-month transaction prices net of fees up to 4 August 2010. From 4 August 2010, the transaction prices net of fees will be those of the first business day of the month. Return figures versus the benchmark show the investment management result before management and/or performance fees; the Fund returns are with dividends reinvested and based on net asset values with prices and exchange rates of the valuation moment of the benchmark. Please refer to the prospectus of the Funds for further details. Performance is quoted net of investment management fees. The ongoing charges mentioned in this document are the ones stated in the Fund's latest annual report at closing date of the last calendar year.

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Detailed information on the Fund and associated risks is contained in the prospectus.

The prospectus and the Key Investor Information Document for the Robeco Funds can all be obtained free of charge at www.robeco.com.

Additional Information for US investors Robeco is considered “participating affiliated” and some of their employees are “associated persons” of Robeco Institutional Asset Management US Inc. (“RIAM US”) as per relevant SEC no-action guidance. Employees identified as associated persons of RIAM US perform activities directly or indirectly related to the investment advisory services provided by RIAM US. In those situation these individuals are deemed to be acting on behalf of RIAM US, a US SEC registered investment adviser. SEC regulations are applicable only to clients, prospects and investors of RIAM US. RIAM US is wholly owned subsidiary of ORIX Corporation Europe N.V. and offers investment advisory services to institutional clients in the US. Additional Information for investors with residence or seat in Australia and New Zealand This document is distributed in Australia by Robeco Hong Kong Limited (ARBN 156 512 659) (“Robeco”), which is exempt from the requirement to hold an Australian financial services license under the Corporations Act 2001 (Cth) pursuant to ASIC Class Order 03/1103. Robeco is regulated by the Securities and Futures Commission under the laws of Hong Kong and those laws may differ from Australian laws. This document is distributed only to “wholesale clients” as that term is defined under the Corporations Act 2001 (Cth). This document is not for distribution or dissemination, directly or indirectly, to any other class of persons. In New Zealand, this document is only available to wholesale investors within the meaning of clause 3(2) of Schedule 1 of the Financial Markets Conduct Act 2013 (‘FMCA’). This document is not for public distribution in Australia and New Zealand.

Additional Information for investors with residence or seat in Austria

Robeco QUARTERLY • #11 / MARCH 2019

This information is solely intended for professional investors or eligible counterparties in the meaning of the Austrian Securities Oversight Act. Additional Information for investors with residence or seat in Brazil The Fund may not be offered or sold to the public in Brazil. Accordingly, the Fund has not been nor will be registered with the Brazilian Securities Commission – CVM, nor has it been submitted to the foregoing agency for approval. Documents relating to the Fund, as well as the information contained therein, may not be supplied to the public in Brazil, as the offering of the Fund is not a public offering of securities in Brazil, nor may they be used in connection with any offer for subscription or sale of securities to the public in Brazil.

Additional Information for investors with residence or seat in Canada No securities commission or similar authority in Canada has reviewed or in any way passed upon this document or the merits of the securities described herein, and any representation to the contrary is an offence. Robeco Institutional Asset Management B.V. is relying on the international dealer and international adviser exemption in Quebec and has appointed McCarthy Tétrault LLP as its agent for service in Quebec.

Additional information for investors with residence or seat in the Republic of Chile Neither the issuer nor the Funds have been registered with the Superintendencia de Valores y Seguros pursuant to law no. 18.045, the Ley de Mercado de Valores and regulations thereunder. This document does not constitute an offer of, or an invitation to subscribe for or purchase, shares of the Funds in the Republic of Chile, other than to the specific person who individually requested this information on his own initiative.

This may therefore be treated as a “private offering” within the meaning of article 4 of the Ley de Mercado de Valores (an offer that is not addressed to the public at large or to a certain sector or specific group of the public).

Additional Information for investors with residence or seat in Colombia This document does not constitute a public offer in the Republic of Colombia. The offer of the Fund is addressed to less than one hundred specifically identified investors. The Fund may not be promoted or marketed in Colombia or to Colombian residents, unless such promotion and marketing is made in compliance with Decree 2555 of 2010 and other applicable rules and regulations related to the promotion of foreign Funds in Colombia.

Additional Information for investors with residence or seat in the Dubai International Financial Centre (DIFC), United Arab Emirates This material is being distributed by Robeco Institutional Asset Management B.V. (Dubai Office) located at Office 209, Level 2, Gate Village Building 7, Dubai International Financial Centre, Dubai, PO Box 482060, UAE. Robeco Institutional Asset Management B.V. (Dubai office) is regulated by the Dubai Financial Services Authority (“DFSA”) and only deals with Professional Clients or Market Counterparties and does not deal with Retail Clients as defined by the DFSA. Additional Information for investors with residence or seat in France Robeco is at liberty to provide services in France. Robeco France (only authorized to offer investment advice service to professional investors) has been approved under registry number 10683 by the French prudential control and resolution authority (formerly ACP, now the ACPR) as an investment firm since 28 September 2012.

Additional Information for investors with residence or seat in Germany This information is solely intended for professional investors or eligible counterparties in the meaning of the German Securities Trading Act. Additional Information for investors with residence or seat in Hong Kong The contents of this document have not been reviewed by the Securities and Futures Commission (“SFC”) in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. This document has been distributed by Robeco Hong Kong Limited (“Robeco”). Robeco is regulated by the SFC in Hong Kong.

Additional Information for investors with residence or seat in Italy This document is considered for use solely by qualified investors and private professional clients (as defined in Article 26 (1) (b) and (d) of Consob Regulation No. 16190 dated 29 October 2007). If made available to Distributors and individuals authorized

by Distributors to conduct promotion and marketing activity, it may only be used for the purpose for which it was conceived. The data and information contained in this document may not be used for communications with Supervisory Authorities. This document does not include any information to determine, in concrete terms, the investment inclination and, therefore, this document cannot and should not be the basis for making any investment decisions.

Additional Information for investors with residence or seat in Peru The Fund has not been registered with the Superintendencia del Mercado de Valores (SMV) and is being placed by means of a private offer. SMV has not reviewed the information provided to the investor. This document is only for the exclusive use of institutional investors in Peru and is not for public distribution.

Additional Information for investors with residence or seat in Shanghai This material is prepared by Robeco Investment Management Advisory (Shanghai) Limited Company (“Robeco Shanghai”) and is only provided to the specific objects under the premise of confidentiality. Robeco Shanghai has not yet been registered as a private fund manager with the Asset Management Association of China. Robeco Shanghai is a wholly foreign-owned enterprise established in accordance with the PRC laws, which enjoys independent civil rights and civil obligations. The statements of the shareholders or affiliates in the material shall not be deemed to a promise or guarantee of the shareholders or affiliates of Robeco Shanghai, or be deemed to any obligations or liabilities imposed to the shareholders or affiliates of Robeco Shanghai.

Additional Information for investors with residence or seat in Singapore This document has not been registered with the Monetary Authority of Singapore (“MAS”). Accordingly, this document may not be circulated or distributed directly or indirectly to persons in Singapore other than (i) to an institutional investor under Section 304 of the SFA, (ii) to a relevant person pursuant to Section 305(1), or any person pursuant to Section 305(2), and in accordance with the conditions specified in Section 305, of the SFA, or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. The contents of this document have not been reviewed by the MAS. Any decision to participate in the Fund should be made only after reviewing the sections regarding investment considerations, conflicts of interest, risk factors and the relevant Singapore selling restrictions (as described in the section entitled “Important Information for Singapore Investors”) contained in the prospectus. You should consult your professional adviser if you are in doubt about the stringent restrictions applicable to the use of this document, regulatory status of the Fund, applicable regulatory protection, associated risks and suitability of the Fund to your objectives. Investors should note that only the sub-Funds listed in the appendix to the section entitled “Important Information for Singapore Investors” of the prospectus (“Sub-Funds”) are available to Singapore investors. The Sub-Funds are notified as restricted foreign schemes under the Securities and Futures Act, Chapter 289 of Singapore (“SFA”) and are invoking the exemptions from compliance with prospectus registration requirements pursuant to the exemptions under Section 304 and Section 305 of the SFA. The Sub-Funds are not authorized or recognized by the MAS and shares in the Sub-Funds are not allowed to be offered to the retail public in Singapore. The prospectus of the Fund is not a prospectus as defined in the SFA. Accordingly, statutory liability under the SFA in relation to the content of prospectuses would not apply. The Sub-Funds may only be promoted exclusively to persons who are sufficiently experienced and sophisticated to understand the risks involved in investing in such schemes, and who satisfy certain other criteria provided under Section 304, Section 305 or any other applicable provision of the SFA and the subsidiary legislation enacted thereunder. You should consider carefully whether the investment is suitable for you. Robeco Singapore Private Limited holds a capital markets services license for fund management issued by the MAS and is subject to certain clientele restrictions under such license.

Additional Information for investors with residence or seat in Spain Robeco Institutional Asset Management BV, Branch in Spain is registered in Spain in the Commercial Registry of Madrid, in v.19.957, page 190, section 8, page M-351927 and in the Official Register of the National Securities Market Commission of branches of companies of services of investment of the European Economic Space, with the number 24. It has address in Street Serrano 47, Madrid and CIF W0032687F. The investment funds or SICAV mentioned in this document are regulated by the corresponding authorities of their country of origin and are registered in the Special Registry of the CNMV of Foreign Collective Investment Institutions marketed in Spain.

Additional Information for investors with residence or seat in Switzerland This document is exclusively distributed in Switzerland to qualified investors as defined in the Swiss Collective Investment Schemes Act (CISA). This material is distributed by RobecoSAM AG, postal address: Josefstrasse 218, 8005 Zurich. ACOLIN Fund Services AG, postal address: Affolternstrasse 56, 8050 Zürich, acts as the Swiss representative of the Fund(s). UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zurich, postal address: Europastrasse 2, P.O. Box, CH-8152 Opfikon, acts as the Swiss paying agent. The prospectus, the Key Investor Information Documents (KIIDs), the articles of association, the annual and semi-annual reports of the Fund(s), as well as the list of the purchases and sales which the Fund(s) has undertaken during the financial year, may be obtained, on simple request and free of charge, at the office of the Swiss representative ACOLIN Fund Services AG. The prospectuses are also available via the website www.robeco.ch.

Additional Information for investors with residence or seat in the United Arab Emirates Some Funds referred to in this marketig material have been registered with the UAE Securities and Commodities Authority (the Authority). Details of all Registered Funds can be found on the Authority’s website. The Authority assumes no liability for the accuracy of the information set out in this material/document, nor for the failure of any persons engaged in the investment Fund in performing their duties and responsibilities.

Additional Information for investors with residence or seat in the United Kingdom Robeco is subject to limited regulation in the UK by the Financial Conduct Authority.

Details about the extent of our regulation by the Financial Conduct Authority are available from us on request.

Additional Information for investors with residence or seat in Uruguay The sale of the Fund qualifies as a private placement pursuant to section 2 of Uruguayan law 18,627. The Fund must not be offered or sold to the public in Uruguay, except in circumstances which do not constitute a public offering or distribution under Uruguayan laws and regulations. The Fund is not and will not be registered with the Financial Services Superintendency of the Central Bank of Uruguay. The Fund corresponds to investment funds that are not investment funds regulated by Uruguayan law 16,774 dated September 27, 1996, as amended.

Additional Information concerning RobecoSAM Collective Investment Schemes The RobecoSAM collective investment schemes (“RobecoSAM Funds”) in scope are sub-Funds under the Undertakings for Collective Investment in Transferable Securities (UCITS) of MULTIPARTNER SICAV, managed by GAM (Luxembourg) S.A., (“Multipartner”). Multipartner SICAV is incorporated as a Société d'Investissement à Capital Variable which is governed by Luxembourg law. The custodian is State Street Bank Luxembourg S.C.A., 49, Avenue J. F. Kennedy, L-1855 Luxembourg. The prospectus, the Key Investor Information Documents (KIIDs), the articles of association, the annual and semi-annual reports of the RobecoSAM Funds, as well as the list of the purchases and sales which the RobecoSAM Fund(s) has undertaken during the financial year, may be obtained, on simple request and free of charge, via the website www.robecosam.com.

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CONTACT Robeco P.O. Box 973 3000 AZ Rotterdam The Netherlands T +31 10 224 1 224 I www.robeco.com