We have long been interested in better understanding the various factors driving stock market returns – as we recognised the subjectivity involved in the fundamental valuation of stocks. This led to us researching the drivers of returns on the JSE, and subsequently evolved into providing the framework that we now use in selecting shares.

In building this framework, we tested around 300 factors that influence stock market performance. Using 25 years of data, we looked for factors that delivered consistent, longterm outperformance as well as those having no or a negative correlation with each other (to reduce downside volatility). The end result is that, in addition to our analysts’ calculation of intrinsic value, we now include 11 factors in constructing our stock rankings.

While the fundamental calculation of intrinsic value remains the most important factor in considering a share for inclusion in portfolios, the final weighting is influenced by considering the multifactor ranking of a share. These factors are grouped into three themes:

1. Quality: companies with strong cash flow and improving returns on assets, margins and asset turns.

2. Growth: companies showing potential to deliver stronger earnings growth than the market.

3. Sentiment: short- and longer-term market sentiment indicators give us a sense of the market’s attitude towards a specific company.

These three themes provide important insights that improve portfolio management conviction, assist in guarding against excessive single-theme exposure (such as potential “value traps”) and alert our analysts by highlighting various market information, including sentiment.


While the success of this well-researched process is evident in the relative outperformance of our funds, it is by no means a static model. We constantly monitor market trends and evaluate the robustness of our model. One trend that is gaining increasing global attention is the inclusion of environmental, social and governance (ESG) factors into investment processes. This involves, amongst others, looking at a company’s environmental impact, the health and well-being of its employees (social) and the alignment of management with its shareholders (governance).

Governance and an assessment of management’s stewardship of shareholder capital plays a prominent role in both our investment selection process and ongoing engagements with company management. We have also built the MSCI Intangible Value Assessment (IVA) scores, rating environmental and social risk factors, into our share screening tool.

However, while South African listed companies have comprehensive and standardised financial data, insightful ESG data is not widely available nor is there a consistent reporting framework. As such, we are aware of the need to monitor the potential longer-term impacts of these factors as well as motivate management to provide relevant E, S or G data, where necessary.

It is worth highlighting Credit Suisse’s research conducted in the Australian listed market. Titled Finding Alpha in ESG, the research aimed to determine the value of integrating ESG factors into an investment process.

The research used MSCI’s data and ranked the performance of companies across five measures:


The research used data from May 2008, the time from which the MSCI has been providing quantitative ESG ratings for the S&P/ASX 200 Index. At the end of every month, stocks were ranked from highest to lowest for every one of the five factors listed on the previous page, and split into five quintile portfolios of 40 stocks each.

Broadly, the research rankings showed that “strong management of environmental issues ‘pays’ and weak management of environmental issues ‘costs’ at the portfolio level”. Governance analysis revealed similar results, while social data showed “that companies which have overall the weakest management capabilities and highest exposure to social issues significantly underperform all other companies, i.e. poor social performance ‘costs’ at the portfolio level. However, we find that there is no benefit from a strong social pillar score at the portfolio level.”

Ranking companies on an industry basis provided insight into, for instance, optimal industry diversification as well as the best stocks within poorly rated ESG industries.

The emerging wisdom from this research suggests that ESG ratings are a good proxy measure for a company’s management quality. Simply put, management teams that handle ESG issues well are typically also responding well to many other strategically important business issues.

This was further reinforced in a meta-analysis that referenced over 200 global studies reviewing ESG issues. The 2014 report entitled From Stockholder to Stakeholder was compiled by Arabesque Asset Management in partnership with Oxford University. The key outcome was that 88% of reviewed sources find that companies with robust sustainability practices demonstrate better operational performance, which ultimately translates into cash flows. The second part of the report builds on this, where 80% of the reviewed studies demonstrate that prudent sustainability practices have a positive influence on investment performance.


One of the challenges of undertaking similar research in the South African market is the lack of comparable year-on-year ESG data. Recognising this, four years ago Old Mutual Investment Group partnered with the MSCI to start building up the ESG coverage in both the South African and broader African markets. Since 2012, the MSCI ESG coverage has been extended from 4 659 securities to now well over 6 153 stocks.

Using this limited ESG data, Old Mutual conducted similar quantitative research to what Credit Suisse did in Australia. South African shares were ranked into quintiles on a monthly basis using equally weighted rolled-up ESG scores. The spread between highly rated ESG companies and lower-rated companies is significant, as indicated in the chart below. While the timeframe is still too short to see these as definitive trends, the results appear to mirror those of international findings that suggest ESG as a factor through which risk premia can be assessed and captured.

With four years of data being insufficient for the ESG factor to be formally considered in our investment process, we will nevertheless continue to pursue our ESG research agenda in the local market using MSCI ESG data. As the depth of data deepens and we are able to assess the ESG factors through different investment cycles, our goal would be to develop a level of confidence in the ESG signals that could be used as an input into the “Quality” theme of our investment process. This accords well with our thinking that ESG is a proxy measure of management quality and thus the overall quality of the company.

This further aligns with our overarching view that sustainability (ESG) is a macro-thematic trend that is reshaping the competitive landscape, and that companies that are able to respond to this trend and innovate early, will reap the benefits of stronger growth prospects, enhanced operating efficiencies, stronger social licence to operate, enhanced staff retention, lower cost of capital and, ultimately, stronger and longer competitive advantage. We will continue to look for material trends in the data and incorporate relevant factors into our investment process.


CREDIT SUISSE (June 2015), Finding Alpha in ESG.

ARABESQUE ASSET MANAGEMENT (March 2015), From the Stockholder to the Stakeholder. Retrieved from process.html rcmsustainabilitywhitepaper2011.pdf term-value-and-performance.pdf Paper_16Sept14.pdf


Tracy Brodziak
Head of Research

Leanne Micklewood
Quantitative Analyst


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