Invesco Sustainable Pan European Structured Equity Strategy: Positioning & Performance

Using a low volatility focus, the Invesco Sustainable Pan European Structured Equity Strategy combines a strict ESG focus with exposure to the Momentum, Quality and Value factors, each adding value in different market environments. This defensive multi-factor strategy has been able to deliver attractive returns at a reduced risk level.

The portfolio positioning can be best represented by its factor exposures. This is illustrated in the adjacent spider web chart (figure 1). It compares the index’s factor exposures in lighter blue against the portfolio’s exposures in dark blue. As the scale increases from the centre to the rim, the strategy shows higher exposures to all factor characteristics that provide the potential for superior risk-adjusted performance over a full market cycle. The strategy is positively exposed to our factors Momentum, Quality and Value while showing a reduced beta and a smaller size exposure than the benchmark 

Strict application of ESG metrics leads to superior ESG characteristics in the portfolio. While inheriting a stronger ESG score than the benchmark and reducing carbon intensity by roughly 30%, the strategy achieves all of the above without having any exposure to stocks involved in controversial business activities.

The sector and country positions are an outcome of the optimisation process which considers the factor exposures of stocks relative to their risk contribution to the portfolio. These are evaluated and compared to peers from the same region and industry to identify attractive companies from a return perspective.

How is the portfolio allocation impacted by risk parameters?

In times of low market volatility, there is little risk differentiation between cyclical and defensive sectors resulting in a larger allocation of cyclical stocks. In times of market turmoil, like the Global Financial Crisis or the Covid-19 sell-off, the risk gap between risky and defensive sectors widens, thus causing the portfolio to shift into more defensive sectors. This allows the strategy to benefit from attractive stocks from all sectors while moving towards a less risky positioning when it is needed.

Additionally, the optimisation also penalises industries/countries which experience sudden risk spikes. Figure 3 shows the absolute sector allocation of the strategy since its inception in 2006 while the light blue line illustrates the predicted risk from our proprietary risk model.

It can be seen that the Global Financial Crisis (2008/09), the European Debt Crisis (2011) as well as the Covid-19 sell-off were all accompanied by spikes in the predicted risk levels, and consequently led to a move towards the more defensive sectors.

What has been the strategy performance?

The strategy has been able to deliver attractive returns at a reduced risk level benefiting from both the multi-factor approach and its low volatility focus. Figure 3 shows the monthly returns of the MSCI Europe at the bottom and at the top of the chart, the strategy’s active returns of the corresponding month.

In negative months, when markets declined by 3% or more, the strategy achieved an average monthly outperformance of 1.1%, highlighting its defensive nature. In “normal” market periods, the strategy benefited from its multi-factor approach adding 30 bps to the benchmark return on average. Alternatively, in rising markets, the strategy’s defensive nature capped the upside participation to some extend (average by 0.9%).

While the strategy captured approx. 93% of the market upside moves, it only participated on 75% of the downside returns, leading to a significant excess return against the MSCI Europe Index since inception in 2006. The historical average beta has been 0.85. In aggregate this approach results in a style neutral large cap equity portfolio that many of our investors use as a core equity holding.

Outlook

We believe, the combination of superior ESG characteristics, downside protection and extra return potential of equity factors is very appealing to investors. ESG investing will be an essential part of the solution to a sustainable future. As a quantitative investor, IQS can merge the ESG focus with its proven multi factor approach while maintaining its targeted factor characteristics and deliver positive active returns over the long-term.

As our intended factors have added value over full economic cycles, the rationale supporting them remains intact, and we continue to be optimistic about the future. A defensive low volatility strategy serves as a valuable building block for a portfolio, allowing investors to participate in the conversion towards a more sustainable future while being well positioned to weather potential market setbacks.