Developing Innovation for ESG and Sustainability Investing

[With over 1200 ESG and sustainable ETFs currently available to investors globally, the overlap of investment approaches, ESG screens, and index compositions makes it hard for investors to distinguish between managers and be able to properly diversify their portfolios within this investment universe. Rather than coming down to marketing and branding to distinguish these products, investor-centric innovation may be what is necessary to redraft and redirect some of these prevailing sustainable investment options into a new narrative for investors. The field of investing in ESG and sustainability may be in need of an overhaul.

McKinsey & Company, in their article “Beyond the Rubicon: Asset Management in an Era of Unrelenting Change ”, called out the critical role of innovation needed in asset management: “…in a highly competitive environment with more moderate flows, opportunities for outsized growth will more often arise from innovation that creates and captures new pools of assets.” As average market returns from passive products begin to decline, McKinsey expects a surge of innovation from active managers as clients re-examine their core investment beliefs and manager relationships.

To explore this need for continuing innovation in sustainable and ESG investing, we were introduced to Mamadou-Abou Sarr,?Co-Founder, President of V-Square Quantitative Management – a global asset management firm with sustainability and innovation at its core. They offer a broad product suite of equity and fixed-income strategies including a family of ETFs and a sustainability analytics platform backed by their global “listening tours” and their Research Advisory Committee comprised of prominent scholars in the fields of quantitative finance, sustainability, social innovation, and global change. We asked them questions to better understand how they are meeting this challenge of needed innovation in this space.]

Hortz: How did your investment experiences lead you to such a strong focus on innovation?

Sarr: My initial random walk down Wall Street, from starting my career as an FX trader to becoming the global head of sustainability and product innovation at a large asset management firm, taught me a lot. As I embarked on my new adventure in early 2020, I had an informed view and global expertise on sustainability issues gained from thousands of engagements with investors, academia, and regulators around the world, and I had launched a handful of first-to-market strategies.

I caught the bug for innovation at an early stage in my career by refusing to limit my input at any position I held to the bullet points of my job description, reporting structures, and dotted lines, and instead was motivated by finding a personal and professional joy in solving problems and innovating. Newton’s first law of motion (otherwise known as the Law of Inertia) – a body at rest or moving at a constant speed will continue at rest or in motion until it is acted upon by an outside force - can make us realize what status quo could do to organizations, teams, and talent.

As the world of finance evolves, asset management strategies must keep up with changing trends and technology. The traditional methods of managing assets are no longer enough to meet the demands of today's markets and investors. We have entered a new era of asset management, where innovation and disruption are the name of the game. In this dynamic landscape, those who dare to challenge the status quo are the ones who will come out on top. The vision I had for V-Square was to create a specialized boutique global asset manager with a focus on research and innovation and a drive to challenge the status quo.

Hortz: Did you develop a specific approach or process to building your innovation capacity?

Sarr: As a business leader, I always think about ways to make the organization more efficient. Our edge as a newly formed investment firm is that we have intentionally embedded a set of atemporal corporate resolutions in the fabric of V-Square. Examples of these corporate resolutions include managing unproductive time taken up through excessive meetings and PowerPoints, driving a fast-tracking process for innovation, and actively managing talent. I made a deliberate decision to reprogram our time management and communication approach to strategic activities and innovation.

With more time at hand, our approach to innovation combines embedded investment research with a fast-tracked innovation cycle placing investors' desired risk-adjusted and sustainability outcomes at the heart of what we do. We have developed a streamlined process allowing us to move from strategy ideation to innovation within a short timeframe.

For us, the key part in achieving higher efficiency in product innovation was to use the old Japanese manufacturing system, Kanban, and build a plug-and-play solution platform. This enables us to run a multitude of customized solutions pro-forma, leverage pre-agreed terms with index and data providers, and legal/operation set-ups. Fast-tracking innovation creates good habits within organizations and, in turn, fuels further innovation.

Hortz: Where did you determine that innovation was most needed and how have you been addressing those areas?

Sarr: Through careful research and analysis, I was able to pinpoint the gaps where innovation is most desperately needed, particularly in the area of ESG and sustainability metrics and analysis. For example, we developed an ESG analytics tool called ESGCentral ? allowing us to access 1,000+ ESG metrics across data providers to create bespoke portfolios for investors. The tool is powered by Foxberry Foxf9 - our proprietary AI modern analytics platform that has been developed to source, aggregate, standardize, and integrate ESG data. It provides a deeper insight into scoring methodologies and ESG data.

Hortz: How do you actually go about applying what you have learned from your innovation efforts to investment management? How did you construct your ETF offerings?

Sarr: An important source of context here is that per FactSet (October 2021), six out of the top 10 ESG ETFs are sold by the same ETF provider and the average holdings overlap across these ETFs is 95%. Investors and asset allocators are challenging us to think outside of this box and innovate. We see tremendous opportunities in doing so.

However, one must remember that innovation is only valuable if it can be applied to solve real-world problems. When it comes to innovation, I strongly believe that listening - more than talking - can be the key to success. By actively listening to investors’ challenges and pain points, you can gain valuable insights and perspectives that you may have overlooked otherwise.

All our V-Shares ETFs were informed and constructed by investors’ insights, regulatory shifts, and gaps in the industry. Our US Leadership Diversity ETF (VDNI) invests in domestic companies and our MSCI World ESG Materiality and Carbon Transition ETF (VMAT) are both first-to-market strategies focusing on diversified human capital, sustainability accounting standards, and the transition to a low carbon economy.

Hortz: How do you develop and ensure your ongoing innovation efforts for your investment management efforts?

Sarr: Every year we perform what we call listening tours across the Nordics region, Australasia, and the U.S. The objective of the roadshows is to gather information and get a pulse of asset owners and advisor priorities and existing challenges. The second step for us is to identify themes and key trends investors are focused on. The third step is research and data driven. All our identified themes need to be backed by quantitative data.

Lastly, V-Square engages with academia, and we believe that intellectual curiosity is the cornerstone of our approach to financial markets. Our approach to research follows the same framework as “embedded research” in academia where the benefits of our multidisciplinary researchers working in tandem with portfolio managers are compounded.

V-Square has formed partnerships with internationally renowned engineering and business schools, as we believe that creating a two-way bridge between theory and practice fuels innovation. The end goal is to: drive innovation in the field of quantitative finance and sustainability, make a positive impact on the education of the public and further awareness, and be part of an international network of prominent scholars and investment professionals driven to break new ground in research.

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