FlexShares, the ETF unit of Northern Trust Asset Management, this year launched the FlexShares Developed Markets Low Volatility Climate ESG UCITS ETF and the FlexShares Developed Markets High Dividend Climate ESG UCITS ETF, which track respective STOXX indices1 and were the asset manager’s first ETFs listed in Europe.
The funds implement a quantitative model to select high-quality businesses with a factor target of either low volatility or high dividend. Additionally, constituents are screened for their ESG scoring, while the portfolio also seeks to reduce carbon emissions. The methodology resulted from a close collaboration between FlexShares and Qontigo, manager of STOXX indices.
To hear more about the strategies, we caught up with Chris Huemmer, Senior Vice President and Senior Investment Strategist at Northern Trust Asset Management. Below are excerpts of our conversation.
Chris, these two funds combine a multi-factor approach with ESG and climate objectives. What are the drivers and goals behind these methodologies?
“That’s right. Both factor and sustainability investing are areas where Northern Trust has a rich history. We have worked on the quant and factors side for over 25 years and have developed sustainability strategies for over 30 years. Our clients are really at the forefront of innovation in both areas, and one of the things we have had requests for was to marry the two approaches together. Our aim has been to bring in an innovative way to do just that.”
“One particular attribute and common thread of these two ETFs is their quality score, which is a key component of the strategy. This is a proprietary process that looks into the financial health of companies — criteria including management efficiency, profitability and cash flow — and is one of our systematic tools driving factor exposures into our products. The process is a multi-dimensional, sector-specific approach that we apply on a regional and a sector basis.”
Also on the factor side, there is the high-dividend and low-vol screens. Why those two?
“In the low- or negative-rate environment we are in today, the search for yield is a strong driver for many of our clients’ portfolios. Many of them have stretched on the conventional type of debt you can tap for income, and have had to go to places like dividend-paying stocks. Our dividend approach is designed specifically for those clients.
“Volatility, meanwhile, has also been a key topic for investors, with the events of 2020 being only the latest example. Therefore, another driver of our clients has been to manage that risk within their portfolios. Typically, you would manage volatility by removing some of your exposure to equities and moving it to lower-risk assets like sovereign debt. But with negative rates and a backdrop of rising equity markets, this approach is a very expensive proposition. With that in mind, a low-vol approach to equities is a great way for clients to manage the portfolio risk and stay invested in equities. And they can do that in a way that is also sustainable.”
Which leads me to ask you about the sustainable angle of the ETFs. Can you comment on how you produce that leg of the strategy?
“Sustainable investing has been around for a long time, but we have seen an evolution in the process in which people take to sustainability, due to better data resources, more information and enhanced corporate disclosure. For us, this creates an opportunity to constantly develop new ways to invest sustainably.
“Having the means and the experience in sustainability allows us to not just take an ESG score off the shelf, but rather to aim for a more holistic view of ESG. We take transparent data and work with available frameworks from third-party providers and organizations to map that data. We then take that comprehensive view of ESG and marry it with a specific, targeted climate approach as well.
“Our ESG approach is a three-piece process: firstly, we have a proprietary list of exclusions on things such as social norms, controversies and business involvement. Then we incorporate the Northern Trust ESG Score, which is focused on financial materiality and aligned with industry standards (such as the Sustainability Accounting Standards Board and Task Force on Climate-Related Financial Disclosures), and integrates both historic and forward-looking metrics. And the third piece of the puzzle is climate. Putting targets around climate and carbon reduction is a specific tenet of what we wanted to achieve in this latest strategy.”
“To wrap it all up, we optimize the funds’ portfolio2 to minimize the overall volatility or increase the dividend yield, improve the ESG Score and the Carbon Risk Rating, and reduce the carbon emissions intensity. The optimization is subject to various diversification controls to maintain sector, industry, style, country and regional neutrality.”
Finally, what role does an index provider play in that process?
“Once you design the entire process described earlier, the next step is to find a partner that can take all this information and combine it in an elegant and sophisticated approach into a quantitative methodology. That’s where Qontigo came in. With Axioma’s portfolio construction capabilities, and the expertise that STOXX has as index creator and innovator, we found a partner who can take all that and combine it with Northern Trust’s ESG and quality scores. Add to that the ISS climate data, which is leading in its field and which we were able to access through Qontigo. Being able to merge all this varied and rich information was key to our process and made Qontigo the perfect partner.”
1 The FlexShares Developed Markets Low Volatility Climate ESG UCITS ETF tracks the iSTOXX® Northern Trust Developed Markets Low Volatility Climate ESG Index, and the FlexShares Developed Markets High Dividend Climate ESG UCITS ETF tracks the iSTOXX® Northern Trust Developed Markets High Dividend Climate ESG Index.
2 This process is done through the Axioma Optimizer.