Ripple Effects of the Infrastructure Bill

The buzz continued around the $1 trillion US infrastructure bill this week, as the bill faced unexpected rocky roads in the House. However, the House was able to clear a path for the bill and now targets a vote on Sept 27. Though there is still uncertainty around the bill’s final details, it feels clear that the focus on infrastructure spending, along with an emphasis on sustainability and clean energy, is here to stay.

Last week, we profiled GRID and ICLN ETFs that represent themes tied to key spending areas within the bill - modernizing the power grid and leveraging clean energy to to reduce the progression of climate change. This week, we’ll extend this analysis to highlight a process using Omega Point’s security screening tools to find alpha opportunities by systematically identifying additional names representing these themes.

Defining Clean Energy Names

Many standard thematic screening processes involve relying on sector classifications to identify stocks tied to specific themes. However, it can be challenging to extend this to sustainability and clean energy, mainly due to the nature of these themes to cross sectors and industries. For example, one may think that to find clean energy stocks it’s best to look within the energy sector; however, this approach would miss all of the technology companies that are innovating in these areas. We'll highlight more details on these examples below, but first, let's outline our proposed process for clean energy screening.

To create our screen, we’ll be leveraging the MSCI ESG Rating scores. In particular, we’ll use the Environmental Opportunities Theme score, which is designed, in part, to capture the extent to which companies take advantage of opportunities in the market for environmental technologies and the development of renewable power production.

To ensure a control for other areas related to sustainability and environmental awareness, we also incorporated the Environment Pillar score into the screen.

To leverage these scores and define our clean energy names, we first analyzed the combination of the ICLN and GRID universes to understand the best thresholds for our screen. As of August 2021, the median Environmental Opportunities and Environment Pillar scores for combining the two ETF universes are 6.5 and 6.9, respectively.

To build the screen, we used the following parameters:

• security belongs to the MSCI ACWI index (proxied using the ACWI ETF)
• security does not belong to the ICLN or the GRID ETFs (to find new names outside of these ETFs)
• market capitalization > $500M and average daily volume > $20M (to remove less liquid, smaller cap names)
• Environmental Opportunities theme score > 6.5
• Environment Pillar score > 6.9
• GICS sector is Energy, Industrials, Materials, Utilities, Information Technology, or Consumer Discretionary (to mirror the sectors represented within the ICLN and GRID ETFs)

After backtesting this screen monthly from Dec 2020 through August 2021, we were able to identify 21 securities on average each month that fit the screening criteria. In this way, we were able to take a universe of over 2000 global securities and narrow our focus down to a list of ~21 names that can drive alpha ideas within the clean energy space.

Clean Energy Outside of the Known Suspects

While the clean energy names within the Energy, Industrials, Materials, and Utilities sectors may typically be more well-known due to their clear linkage to energy-related infrastructure, several names also met our criteria from the Consumer Discretionary and Information Technology sectors. Two such names were Valeo and Fujitsu.

Valeo is a European automotive supplier (in the Consumer Discretionary sector) that develops technologies designed to reduce CO2 emissions and develop autonomous, connected mobility. Below, we can see that this company's top MSCI ESG Ratings exposures center around the themes within the Environment Pillar.

A look at predictive risk using the Axioma Worldwide 4 Medium Horizon (“Axioma Worldwide”) risk model shows that this name is idiosyncratically driven, with specific risk as of August 2021 or close to 60%. This makes sense given Valeo’s high exposure to the clean energy theme, which likely drives some of its idiosyncratic nature from the lens of the traditional factor model.

Fujitsu is a Japanese IT services company (in the Information Technology sector) whose mission is to make the world more sustainable by building societal trust through innovation. Like what we saw with Valeo, Fujitsu also shows a heavy exposure to the themes within the Environment Pillar, with 4 out of the top 5 ESG Ratings scores falling within this pillar.

We see a similar trend with Fujitsu’s risk profile using the Axioma Worldwide risk model. This name has an even more significant tilt towards being an alpha-driven name, with idiosyncratic risk as of August 2021 of over 70%. Again, this likely points to the sustainability-focused nature of the company, which the risk model cannot fully capture.

A Framework for Research Prioritization

As we noted in our analysis above, a repeatable, scalable, and systematic screening process can prove invaluable to investors looking to focus their attention in the right places. This framework is particularly foundational for workflows surrounding 1) Research Prioritization; 2) Construction of Thematic Baskets; or 3) Effective Hedge Construction. Given the amount of data and news facing portfolio managers and analysts on daily, it is paramount to have effective mechanisms to sift through the noise.

The last 18 months have taught us that investors need to look beyond traditional security classifications (i.e. sector) and screening techniques to effectively capitalize on critical market-moving themes. If you’re interested in further exploring our screening tools or understanding how to take advantage of current market themes within your portfolio, please don’t hesitate to reach out to us.

US & Global Market Summary

US Market: 08/23/21 - 08/27/21

• After market losses on Thursday following the explosion at the airport in Kabul in which U.S. troops and Afghans were killed, the three major stock averages closed the week up. The Dow finished up 0.9%, while the S&P 500 added 1.5% and the Nasdaq Composite gained 2.8%.
• Federal Reserve Chairman Jerome Powell prepared the markets for the central bank to pull back on some of its monetary stimulus, indicating The Fed will likely start tapering its $120 billion in monthly bond purchases this year.
• The House narrowly passed a measure approving a $3.5 trillion budget blueprint and locking in a late September vote on a roughly $1 trillion infrastructure bill, ending a standoff between centrist Democrats and party leaders over their legislative agenda.
• Data showed the U.S. economy grew a bit faster than initially thought in the second quarter, in a second estimate of gross domestic product growth.
• Weekly jobless claims increased 4,000 to a seasonally adjusted 353,000 for the week ended Aug. 21.

Normalized Factor Returns: Axioma US Equity Risk Model (AXUS4-MH)

• Value continues its recent rocket trajectory and easily cruises deeper into positive territory to sit atop the US leaderboard for the 4^th consecutive week.
• Volatility’s 7-week slide finally halted with a 0.16 SD gain and finishes as this week’s runner-up.
• Market Sensitivity (Beta) showed signs of life after recent weakness, but still sits at -0.90 SD below the mean.
• Momentum ekes out a positive gain for the 8th straight week, one of only 4 factors to show upward strength.
• Profitability drops like a rock after putting on the breaks last week, its first negative movement since late June.
• Size continues to show weakness and fell for the 5th straight week, moving closer to negative territory.
• Growth took the biggest slide for the 3rd consecutive week, and crosses the negative threshold.
• US Total Risk (using the Russell 3000 as proxy) decreased by 8 basis points.

Normalized Factor Returns: Axioma Worldwide Equity Risk Model (AXWW4-MH)

• Global Value, similar to its US equivalent, continued its explosive rally and ratcheted up another half standard deviation uptick to cross the mean threshold and sit atop this week’s rankings.
• Market Sensitivity (Beta) moves emphatically upward following its slight dip last week and sits on the cusp of positive territory.
• Volatility popped sharply upward after recent prolonged weakness and is one of only 4 positive factors this week.
• Exchange Rate Sensitivity moves positive for the first time since mid-June but still sits at -1.12 SD below the mean (coincidentally the same level as Volatility).
• Profitability takes a breather and dips slightly following its recent extended tear. It will be interesting to note if it follows its US counterpart with a bigger slide next week.
• Growth fell by 0.34 standard deviations and leaves its recent Overbought label in the dust.
• Earnings Yield ends as this week’s biggest loser, falling further from its recent peak of +1.83 SD on 8/9.
• Global Total Risk (using the ACWI as proxy) decreased by 7 basis points.

Regards,
Alyx