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Matarin Capital Management (Delisted)

PRI reporting framework 2020

You are in Direct - Listed Equity Incorporation » ESG incorporation in actively managed listed equities » Implementation processes

Implementation processes

LEI 01. Percentage of each incorporation strategy

01.1. Indicate which ESG incorporation strategy and/or combination of strategies you apply to your actively managed listed equities; and the breakdown of your actively managed listed equities by strategy or combination of strategies.

ESG incorporation strategy (select all that apply)

Percentage of active listed equity to which the strategy is applied — you may estimate +/- 5%
100 %
Total actively managed listed equities 100%

01.2. Describe your organisation’s approach to ESG incorporation and the reasons for choosing the particular strategy/strategies.

Matarin integrates ESG in our investment process by focusing on 5 key pillars: 1) Opportunities to Increase Returns; 2) Opportunities to Minimize Risk; 3) Customized Negative Screens; 4) ESG-Focused Proxy Voting; and 5) Matarin’s Own Social Responsibility & Impact.

1. ESG as Predictor of Stock Returns

When forecasting stock returns at Matarin, our process is to first think fundamentally about the ‘why’ and ‘how’ of each individual investment insight, and then complete a quantitative analysis of the unique ideas that merit more consideration. So with ESG indicators, like any other investment ideas, we first ask ourselves “Why would this idea matter to stock prices, and do we believe the stock is being mispriced?”

Matarin has engaged with a number of ESG research and data providers over the course of the past several years including, for example:  Governance Metrics International (GMI), Ethical Investment Research and Information Services (EIRIS), Sustainalytics, Sustainable Accounting Standards Board (SASB), Bloomberg, MSCI ESG, ISS Ethix, TruCost, TrueValue Labs, and CDP (formerly the Carbon Disclosure Project). 

The Patience Premium strategies  integrate ESG data from Sustainalytics into the Patience Premium scoring system, which forecasts returns, in its “Catalyst” concept, as follows:

Our “Progress Toward Sustainability” factor, focused on Long-Term ESG Momentum, is calculated by comparing the current level of the Sustainalytics Environmental, Social and Governance ratings to a multi-year average. The same calculation is completed for each of the ESG scores, individually.

Companies making progress towards sustainability is an important catalyst for their ability to be able to earn long-term returns.   If we are investing for the long-term, we want to know whether a company is preparing for the environmental and social realities of the future. 

There is an open question among market actors about whether ESG investing can add to returns. In Matarin’s view, one important key is to consider ESG investing through the lens of long-termism.  In fact, we believe there may be something like a “J-Curve” for companies making progress towards sustainability.  Because when a company makes an investment to become more sustainable, this may come with an immediate cost in the early years which may even be a drag on cash-flows or earnings (and stock prices). But in later years there’s a hope that this will be a ‘Catalyst’ for better fundamental results in the future, and thus stock price appreciation

At Matarin, we view the inclusion of ESG Factors, like the long-term progress towards sustainability factor, as examples of true ESG integration, in which ESG ideas are included in the same way and on equal footing with other fundamental or technical return and risk factors. 

2. ESG as Mitigator of Risk

In addition to evaluating traditional ESG indicators based upon their ability to predict returns, we have critiqued and evaluated ESG factors based upon their ability to predict or mitigate portfolio risk.

This strategy integrates ESG into the Patience Premium scoring system, which forecasts returns, in its “People” concept, as follows:

When investing in a company for the long-term, we want to know that it has stakeholder-friendly leadership.  This means avoiding companies that have been led through serial or severe ESG controversies.  When ESG crises are too frequent or too deep, it may signal a tarnished organizational culture, starting from the top.

We’ve developed a technique to eliminate the “Worst In Class” ESG Controversy stock(s) within each region-sector peer group (for example, most controversial among European Materials), based upon the Sustainalytics Controversy scores across 10 categories, such as supply chain, products and services, governance, etc. 

Such companies tend to underperform the market over multi-year periods, importantly driving the long-term investment case for good ESG. 

We also believe that the elimination of fossil fuel stocks from the portfolio will mitigate absolute risk on a forward-looking basis.

3. Customized Negative Screens

As discussed elsewhere in this document, this strategy is designed to exclude fossil fuel producers, fossil fuel guzzlers, and tobacco stocks.  These exclusions can be reversed or changed for clients who choose to invest in separate accounts.

In fact, over 50% of Matarin’s existing institutional client accounts have such customized negative screens in place. Because Matarin builds portfolios using quantitative tools with a focus on optimizing risk, the impact of these negative exclusions is directly mitigated.

4. ESG-Focused Proxy Voting

In the equity markets, shareholder action through proxies can be the most direct way to have impact on a firm’s business practices. All proxies voted by Matarin on behalf of its clients are voted based upon ESG standards, through our proxy-voting partner, Glass Lewis which is partnered with Sustainalytics for ESG research. Our ESG proxy guidelines focus on sustainable business practices such as ESG disclosure, risk mitigation and good governance.

5. Matarin’s Social Responsibility & Impact

At Matarin, we are very focused on our own social responsibility and impact as well. Key areas of focus for our team are:

  • A focus on team diversity as a driver of success — as Matarin is a women- and minority-owned business
  • Promoting best practices for our industry in terms of integrity and fairness — for example at Matarin we have policies focused on fair fees, restricted political contributions, no soft dollars, and nurturing a culture of stewardship
  • Community engagement through volunteerism in the fields of responsible investment, youth and education, women’s entrepreneurship, and diversity in asset management.

 

01.3. If assets are managed using a combination of ESG incorporation strategies, briefly describe how these combinations are used. [Optional]


LEI 02. Type of ESG information used in investment decision (Private)


LEI 03. Information from engagement and/or voting used in investment decision-making (Private)


(A) Implementation: Screening

LEI 04. Types of screening applied

04.1. Indicate and describe the type of screening you apply to your internally managed active listed equities.

Type of screening

Screened by

Description

For Matarin’s Patience Premium strategies, we are screening out “Worst in Class” ESG stocks based upon controversies around their activities, products, governance, or practices and performance.

We have designed an approach to fossil free investment that focuses on fossil fuel guzzlers, as well as the energy sector.

We are also offering customized negative screens for customers, based upon their requests.

Screened by

Description

Matarin’s Patience Premium strategies are designed to hold the “Best In Class” Patience Premium stocks, based upon our proprietary scoring system, which includes ESG factors

Screened by

          Sustainalytics
        

Description

We offer customized norms-based screening upon client request.

04.2. Describe how you notify clients and/or beneficiaries when changes are made to your screening criteria.

Matarin communicates any changes to our model to clients through monthly and/or quarterly account reviews. 


LEI 05. Processes to ensure screening is based on robust analysis

05.1. Indicate which processes your organisation uses to ensure ESG screening is based on robust analysis.

05.2. Indicate the proportion of your actively managed listed equity portfolio that is subject to comprehensive ESG research as part your ESG screening strategy.

05.3. Indicate how frequently third party ESG ratings are updated for screening purposes.

05.4. Indicate how frequently you review internal research that builds your ESG screens.

05.5. Additional information. [Optional]

“Robust analysis” of all of the variables which go into our investment process is the basis of our very existence at Matarin!

Our investment processes are time tested. They have worked successfully for over 30 years, and have added significant value to client portfolios over that time.  On a shorter term basis, we perform portfolio attribution analyses regularly and are cognizant of which factors are working in the portfolio and which are not in any given period of time. 

In addition, we continuously perform simulations using new factors to determine if different factors in different weights might have a positive impact on returns for a given level of risk. As quantitative investors, we have many tools available to us to perform this work.

The creation of our investment strategies included numerous simulations to test the efficacy of our stock selection model to predict expected returns, i.e., stock alphas.  Additionally, these simulations tested various portfolio construction considerations such as contribution to risk from:  stock, industry and sector weights; exposure to macro factors such as interest rates and oil prices; and “blind” statistical factors.  The simulation process allows Matarin to both evaluate different input combinations, e.g., constraints on relative sector weights, and understand the interaction among alphas, risk, and transaction costs.  This understanding is especially important as it is essential to the efficient construction of optimal portfolios aimed at achieving various levels of risk, given a specific return objective; or achieving various levels of returns given a specific target for risk.

Matarin’s simulation process is used to test the efficacy of each and every potential factor we might include in our “alpha” or risk models, including ESG factors.   This process includes:

  • Appropriately lagging data so as to avoid any “look ahead” bias in developing factors.
  • Eliminating stocks from the universe which did not meet specific capitalization and/or liquidity criteria.
  • Establishing a targeted predicted tracking error range.  This allows Matarin to increase portfolio risk exposure, as warranted by market opportunities, without creating unnecessary portfolio turnover due to an automatic rebalancing to a single fixed risk target.
  • At purchase, capping stock weights at 1.2% to achieve diversification of stock specific risk.  Additionally, allowing stock weights to rise to a maximum of 2.0%, thus avoiding unnecessary transaction costs from forced rebalancing.
  • Constraining non-blind risk factors, within “common sense” limits, ensuring all quantifiable risk exposures are intended and compensated with expected excess returns.
  • Constraining sector and industry weights, within a specified range, thus avoiding excessive risk exposure and ensuring portfolio excess returns are generated largely from stock specific risks resulting from stock selection.
  • Rigorously analyzing simulation results to ensure that portfolio turnover rates, characteristics, holdings, and constraints were as anticipated, ex ante.
  • Estimating and evaluating simulated returns and risks during two distinct time periods to ensure consistency of outcome and similarity of distribution patterns across time and different market environments.

Matarin’s investment objective is to provide realistically achievable excess returns while controlling for portfolio risks and, in particular, downside risk.  Throughout the simulation process we sought a portfolio construction scenario that afforded a high information ratio, but also one in which downside volatility was dampened.  One of Matarin’s firm objectives is for clients to have sufficient confidence in our process to remain invested during those inevitable periods of challenging markets.  And, ideally, to invest further during such times so as to realize the upside potential as performance of both the portfolio and the market once again improves.  Through our simulation process we have been mindful of this firm objective and have selected an optimal combination of stock alphas and risk parameters to deliver consistency of results with lower volatility.

Matarin’s process for factor creation is dynamic.  Markets are not static and the determinants of future investment returns can vary in influence.  Consequently, our proprietary factors and their weights will evolve as both our thinking and model development adapt to changing market environments.

The starting point for research into new factors is typically an insight regarding what may be predictive of stock prices going forward.  These insights can originate from a variety of sources; a book, academic research, financial periodicals, or even by a comment made by Warren Buffet one year at his annual meeting.  We care little about the source of the ideas, we care more about the quality of the insights and how best to quantify them.  We do not buy any factors from external sources, nor do we rely on sell-side research to aid in the determination of industry or stock specific weights.  All of the value-added insights housed within the models are our own. 

Once each factor has been quantified, they are tested historically to determine how well they performed relative to other factors, and how they interact with other factors.  Our investment team tests only those insights it believes has “Future Investment Merit”…not necessarily those ideas which have worked best in the past, but those they believe are likely to be most predictive of stock prices going forward.  We are not looking to build the top performing back-test, but instead are focused on building a model that will excel in the real world going forward.  The development and testing of these indicators are “assigned” to whoever is most interested in performing them.  Factors are included in the model once they have been thoroughly vetted and agreed to by all members of the investment team.

The process of defining, testing and then using a factor in our models is most definitely “rigorous”. ESG factors are handled in exactly the same way, and with as much care as any financial factor we might be inclined to use in our process. 


LEI 06. Processes to ensure fund criteria are not breached (Private)


(B) Implementation: Thematic

LEI 07. Types of sustainability thematic funds/mandates

07.1. Indicate the type of sustainability thematic funds or mandates your organisation manages.

07.2. Describe your organisation’s processes relating to sustainability themed funds. [Optional]

Matarin's investment team has been actively applying negative screens at the request of clients since 1989. Beginning in 2011, the firm began to take a more active approach to ESG research with the goal of finding factors within the context of sustainability which would either be additive to returns or reduce overall portfolio risk. We have rigorously tested dozens of such factors since that time. As "financial first" investors, we have opted not to include variables with don't add value just because they are ESG variables. We feel they need to contribute to the performance of the models and to returns.

The first factor we incorporated into our US Equity strategies was a governance factor which focused on board diversity. We obtained data for this factor from a proprietary source which we believe continues to be proprietary today. Later, we added risk factors related to the environment/climate (weather) and social (opioid) risks.

In the Patience Premium strategies that we launched in March 2019 we went a s step further and added an incidence factor and "Progress toward sustainability" factor, as well as making the product fossil free by eliminated investments in energy as well as the users of energy such as cruise ships, airlines and truckers. Again, over time we will continue to search for other novel ways to include ESG in our products.


(C) Implementation: Integration of ESG factors

LEI 08. Review ESG issues while researching companies/sectors

08.1. Indicate the proportion of actively managed listed equity portfolios where E, S and G factors are systematically researched as part of your investment analysis.

ESG issues

Proportion impacted by analysis
Environmental

Environmental

Social

Social

Corporate Governance

Corporate Governance

08.2. Additional information. [Optional]

ESG variables are systematically included in all our investment models, such that ESG is used across 100% of our strategies.


LEI 09. Processes to ensure integration is based on robust analysis

09.1. Indicate which processes your organisation uses to ensure ESG integration is based on robust analysis.

09.2. Indicate the proportion of your actively managed listed equity portfolio that is subject to comprehensive ESG research as part your integration strategy.

09.3. Indicate how frequently third party ESG ratings that inform your ESG integration strategy are updated.

09.4. Indicate how frequently you review internal research that builds your ESG integration strategy.

09.5. Describe how ESG information is held and used by your portfolio managers.

09.6. Additional information. [Optional]

Please refer to the detailed section (SG) previously which discusses how we go about doing our research into all variables, including ESG variables.


LEI 10. Aspects of analysis ESG information is integrated into (Private)


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