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How we maintain a low tracking error with ESG exclusions in passive investments
Sustainability is central to our way of thinking.
Written by
Stéphane Cornet
Head of Indexed Equities
Since the Pictet Group was founded over 210 years ago, we have aimed to ensure the prosperity of our clients over the long term. In the field of investment, Pictet was a pioneer in sustainable investment funds and funds with an environmental aspect. For more information on responsible investments.
In our indexed business, we also believe a commitment to responsible investment is important.
What we do
Pictet AM undertakes two forms of engagement in its passive investments: proxy voting and ESG exclusions.
Proxy voting
For passive strategies, we aim to vote on 100% of equity holdings for Swiss index strategies, and on 90% of assets under management for other index strategies. Holdings within the 90% threshold are defined once a year although this can be updated more frequently in case of material deviations.
Voting recommendations are provided by Institutional Shareholder Services Inc. (ISS), the world’s leading provider of corporate governance and responsible investment solutions for asset managers, based on its sustainability policy. We reserve the rights to override ISS’s recommendations on an ad-hoc basis under specific circumstances.
For segregated accounts, clients who delegate the exercise of voting rights to us have the choice between Pictet Asset Management’s policy or their own voting policy.
For more details please refer to our proxy voting policy.
ESG exclusions
ESG exclusions are applied to our Swiss domiciled institutional passive fund range. The exclusion list is defined by the Pictet Sustainability Board, which is in charge of coordinating all activities linked to sustainable development within the Pictet Group. It is reviewed and updated periodically and consists of companies involved in controversial activities such as the production of anti-personnel mines, cluster munitions, biological and chemical weapons (including white phosphorous) and nuclear weapons from countries not signatory to the Treaty on the Non-Proliferation of Nuclear Weapons (NPT).
How we do it
To preserve its low tracking error – a key characteristic of Pictet AM’s replication methodology – we apply the exclusion list with discernment. We reserve the right to use all or part of the list, or even expand it should we decide to apply a more stringent view on grey areas.
Three conditions ensure the tracking error remains low:
- The cumulative weight of excluded companies is capped.
- The annual ex-ante tracking error must remain below a pre-defined threshold.
- Excluded stocks do not totally exclude any industry group.
These different thresholds are calibrated to account for the specificities of each passive strategy.
The flexibility of the team’s proprietary replication algorithm enables the rapid and efficient implementation of exclusions relative to a standard benchmark. For example, to reduce the impact of an excluded stock with a large weight in the benchmark, which results in a larger underweight than otherwise achieved with our full replication method, our algorithm marginally overweighs purchasable stocks in the same industry and country impacted by the exclusion. These partial compensations reduce the impact of systematic risks relative to diversifiable specific ones, and maintain our high replication standards with a low tracking error.
To maintain a sound framework around rules and decisions, the Indexed Equities team reverts to its internal Indexed Equities Exclusions Committee to regularly assess the consequences of exclusion changes on portfolio structure, weight deviations, risk figures and performances.
At the end of January 2018, the exclusion list held 61 stocks across the world, of which only 5 were in standard developed indices and only 4 in standard emerging ones.
Institutional clients favouring passive investing through mandates can also benefit from our expertise by customising their preference as long as their exclusion list is provided and regularly updated and the tracking error threshold and risk figures are agreed.
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The information and data presented in this document are not to be considered as an offer or solicitation to buy, sell or subscribe to any securities or financial instruments or services.
Information, opinions and estimates contained in this document reflect a judgment at the original date of publication and are subject to change without notice. The management company has not taken any steps to ensure that the securities referred to in this document are suitable for any particular investor and this document is not to be relied upon in substitution for the exercise of independent judgment. Tax treatment depends on the individual circumstances of each investor and may be subject to change in the future. Before making any investment decision, investors are recommended to ascertain if this investment is suitable for them in light of their financial knowledge and experience, investment goals and financial situation, or to obtain specific advice from an industry professional.
The value and income of any of the securities or financial instruments mentioned in this document may fall as well as rise and, as a consequence, investors may receive back less than originally invested.
The investment guidelines are internal guidelines which are subject to change at any time and without any notice within the limits of the fund's prospectus. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice. Reference to a specific security is not a recommendation to buy or sell that security. Effective allocations are subject to change and may have changed since the date of the marketing material.
Past performance is not a guarantee or a reliable indicator of future performance. Performance data does not include the commissions and fees charged at the time of subscribing for or redeeming shares.
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