by Qontigo
In December 2022, the Sustainable Development Investments Asset Owner Platform (SDI AOP)1 expanded its analysis of companies’ alignment with the UN’s Sustainable Development Goals (SDGs) with new, forward-looking information based on firms’ patents.
A new metric called the SDI Innovation Outlook analyzes more than 20 million patents from thousands of companies, providing a unique picture of their future positioning in 130 technology themes that have been identified to advance the SDGs. An SDI Innovation Outlook score is given to companies based on patents issued in the previous ten years that contribute positively to SDGs according to the SDI classification.
In a new whitepaper2, Robert A. Stubbs, PhD, Senior Principal for Incubation at Qontigo, investigates the effectiveness of the SDI Innovation Outlook score in predicting equity returns and enabling the construction of outperforming portfolios. The findings show that the score can be used as a signal to generate outperformance in portfolio returns.
Methodology
An extensive history of the SDI Innovation Outlook score is not available, so Robert uses a rolling SDI 3-year Outlook (3YO) score as a proxy. The 3YO is based on the same processing of patents as the full SDI Innovation Outlook score, but only considers patents issued in the last three years and does not consider patent citations. The full SDI Innovation Outlook score is therefore an extension of the shorter-term 3YO score employed in this research.
The author reviews the information contained in the 3YO score by considering both the information coefficient (IC)3 of the signal at different horizons and the information ratios of long-only portfolios constructed to maximize exposure to the signal. He then tests both measures of information over three different regions: US, Europe, and APAC. Each region is further broken down by market capitalization buckets.
The study first determines that the ICs found in the SDI scores do appear to contain information in predicting equity asset returns above and beyond that which can be explained by risk factors. Not surprisingly, the coefficients tend to increase in strength as the horizon increases. This is consistent with the belief that it takes time for patents to translate into financial success and increase the market value of a firm’s equity.
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Importantly, the author illustrates how the active portfolios, constructed using the 3YO score and with a factor-neutral optimization, outperformed their benchmarks from 2014 to 2022 (Exhibit 1). To do this, Robert considers a simple strategy that maximizes the 3YO score subject to having predicted tracking error to an underlying benchmark of at most one percent and having zero active exposures to all risk factors in the Axioma medium-horizon fundamental risk model for the corresponding region. In some cases, the outperformance is statistically significant.
Exhibit 1 – Annualized total returns of optimized SDI strategies
Robert runs a second back-testing scenario where the portfolios don’t invest in individual equities, but rather into five synthetically created ‘ETFs’, each made up of sets of assets organized according to their label of patent exposure: Unclassified, Ineligible, Adopter, Developer and Innovator. In this case, all segments showed outperformance for the active strategies over the entire backtest period since 2014.
“The consistency of the relative performance across both market-cap segment and region further validates our hypothesis that the 3YO score contains information in predicting future asset returns and thus may be a true alpha-generating signal,” writes Robert.
We invite you to download and read the whitepaper here.
1 The SDI AOP was introduced in 2020 by asset owners APG, AustralianSuper, British Columbia Investment Management Corporation and PGGM to accelerate the market adoption of Sustainable Development Investments (SDIs). Research partner Entis employs artificial intelligence to generate SDI classifications based on a taxonomy developed by the platform’s founding partners. Qontigo is the SDI AOP’s exclusive distribution partner.
2 ‘Outperformance with SDI Outlook Score,’ Qontigo, February 2023.
3 An information coefficient (IC) is the correlation between the signal, 3YO score in our case, and asset returns.
Qontigo is a leading global provider of innovative index, analytics and risk solutions that optimize investment impact. As the shift toward sustainable investing accelerates, Qontigo enables its clients—financial-products issuers, asset owners and asset managers—to deliver sophisticated and targeted solutions at scale to meet the increasingly demanding and unique sustainability goals of investors worldwide.
Qontigo’s solutions are enhanced by both our collaborative, customer-centric culture, which allows us to create tailored solutions for our clients, and our open architecture and modern technology that efficiently integrate with our clients’ processes.
Part of the Deutsche Börse Group, Qontigo was created in 2019 through the combination of Axioma, DAX and STOXX. Headquartered in Eschborn, Germany, Qontigo’s global presence includes offices in New York, London, Zug and Hong Kong.
