Quant with $135 billion in assets adjusts ESG model

The finance industry’s biggest data crunchers are adapting their models to one of the fastest-growing corners of money management, and in the process, finding some strange price developments.

Man Group Plc, a quant focused investment firm that oversees a total of $135 billion in assets, says it has adjusted traditional models to capture the risks inherent in environmental, social and governance investing. That’s because the history of ESG is short and bumpy, which makes it difficult to come up with good probabilities of what’s ahead, without some fine-tuning.

“What’s really hard for quants is that the future is not going to look like the past,” Robert Furdak, who oversees $46 billion as chief investment officer for Man Group’s funds that integrate ESG, said in an interview. “Companies are focusing on these things a lot more than five or ten years ago. So trying to run a 20-year back-test is not going to work. We have to have a forward-looking approach to back-testing.”

That means that pure quant models won’t work with ESG, and humans need to get more involved in the process, according to Furdak. The goal is to scrutinize the raw data through a critical lens and make sure that investors aren’t tricked into thinking they’re looking at a strong ESG stock, when in fact something else is driving the performance.

The fact that Man Group, which is based in London, now allocates roughly a third of its business to ESG shows how quickly the area has come to dominate finance. Globally, the ESG market will exceed $50 trillion by 2025, Bloomberg Intelligence estimates.

‘CRAZY’ VALUATIONS

Furdak says the adjusted quant models that Man Group uses point to some bad pricing. On the one hand, there are “more traditional ESG plays, like wind, solar, some of the infrastructure where there’s some kind of proven technology,” and they “may seem a little expensive, but it’s justified by the higher margins,” he said. But then there are other corners of the market where things look less reasonable.

“Where we are seeing crazy pricing is in some of the ESG darlings, where there’s not really a proven technology,” he said. “It’s kind of speculative. Some of the EV (electric vehicle) structural plays and manufacturers have gone to crazy prizes. That’s where our integrated approach looks at ESG, but also tries to look at valuation and integrate forward looking inputs.”

In general, quants may have an advantage over other asset managers in navigating ESG investments, given their ability to sort through vast mounds of data, according to William Bryant, head of advisory at NorthPeak.

“It’s not easy, but managers are finding alpha signals there in the ESG data that they can then exploit,” said Bryant, who helps advise hedge funds and other alternative managers in the U.S., Asia and London on how to court European clients.

But quants are only as good as their models. The industry delivered mixed results during the pandemic, with some failing spectacularly to predict the shock of a global health crisis. With ESG, they’ll need to figure out how to factor in freak weather events, corporate scandals, and changes to the regulation. But there’s also a behavioral component to take into account.

Furdak says the list of challenges is long. “One is how the future is going to unfold, changing corporate behavior focusing on the stakeholder versus the shareholder. How’s that going to manifest going forward?” Another is “the slow moving nature of ESG data,” he said. “How do you use that, particularly around faster strategies, for example, climate change.”

“You are measuring things over decades and centuries, and if you’re running a strategy which has a three-week holding period, how do you square that?” Furdak says that Man AHL, the firm’s quantitative investment program, is now “trying to do that research.”

“Climate change is a longer-term phenomenon,” he said. “But there are some shorter-term episodic things to take advantage of.”