Case study by SEB Investment Management

In the spirit of showcasing leadership and raising standards of responsible investment among all our signatories, we are pleased to publish case studies of all the winning and shortlisted entries for the PRI Awards 2020.

Give a brief overview of your innovative approach to ESG incorporation, its coverage within your firm and why you decided to undertake this approach. 

In 2019, SEB Investment Management’s quantitative equities team incorporated the EU’s Sustainable Finance Taxonomy into its portfolio management. It did this in collaboration with SEB’s Large Corporates and Financial Institutions division. 

The project had three main objectives: 

  1. To develop a systematic model to measure SEB’s equity portfolios’ alignment to the EU Taxonomy  
  2. To evaluate the Taxonomy alignment of SEB Investment Management’s active sustainable equity funds, as well as to compare the competitive landscape for sustainable mutual equity funds. 
  3. To consider the possibility of incorporating the Taxonomy model into the investment decision-making process. 

SEB Investment Management’s quantitative equities team manages 31 active equity funds, with total assets under management of $13.5 billion, and so it was imperative to develop a model that could measure all listed equities efficiently.  

SEB created a quantitative model in order to do this. The SEB EU Taxonomy Model estimates the Taxonomy alignment of economic activities systematically by approximating the technical screening criteria, based on the EU’s Technical Expert Group (TEG) on Sustainable Finance rationales.  

A process to measure “Do no significant harm” and “Minimum safeguards” criteria is under development but not yet part of the current model version. Reported and estimated sustainability data are used to assess activities, defined by company revenue streams. 

How does this approach stand out in the market? Why is it unique? 

Prior to the development of the model, Taxonomy alignment could at best be estimated in concentrated portfolios, predominately using fundamental analysis – an approach that is ill suited to broad portfolios with many holdings. What was needed was a quantitative model. 

The SEB EU Taxonomy model stands out in the market as a completely quantitative model to evaluate equity portfolios. It covers over 99% of the global equity market capitalisation, enabling insights and comparisons on a broader scale than previously possible. 

As of today, scalable and complete data for evaluating the Taxonomy technical screening criteria is limited in the market. SEB’s model measures alignment with existing sustainability data and approximates the technical screening criteria when needed. The model is flexible enough to capture future updates of the Taxonomy. 

Give a practical example of how you have applied your approach to an investment (security/issuer/sector/asset class/portfolio), including any challenges faced and how you adapted to them

According to SEB’s model, the Taxonomy alignment of its funds ranged between 2.9% alignment and 9.9%, with an average alignment of 6.6%. This was in line with a peer study performed on 105 sustainable mutual equity funds with an average alignment of 6.8%. Taxonomy alignment for a global equity index was 6.6%. 

SEB used a global equity fund with current assets under management of $985 million and a Taxonomy alignment of 9.1% as a case study. The question was posed: How could Taxonomy alignment of this fund be increased while maintaining its current characteristics? SEB took a three-step approach: 

  1. If SEB allowed for moderate active sector and country allocation (+/-2%) and limited carbon emissions in line with benchmark carbon emissions, it could be possible to create a portfolio with 40% Taxonomy alignment.  
  2. Approximately the same results could be achieved by limiting carbon emissions to half of the benchmark for carbon emissions (based on the proposal from TEG for Paris Aligned Benchmark). 
  3. If SEB allowed for higher active sector and country allocation (+/-5%) and limited carbon emission to half of benchmark carbon emission, it could construct a portfolio with 50% Taxonomy alignment. 

In conclusion, the SEB EU Taxonomy model can be applied in a systematic investment process to increase Taxonomy alignment significantly, from 9.1% to 50%. 

What were the outcomes of this initiative for the investment and how have you measured its success? What have you learned from this approach that can be applied more broadly? 

This project has strengthened the hypothesis that environmental sustainability can be measured systematically based on an objective model. In order to measure the success of the initiative, SEB looked at the three project objectives outlined in the first section. 

Objective 1 The EU Taxonomy offers a scientific approach to identify companies that will encourage the transition to a low-carbon economy. The SEB EU Taxonomy model expands on this scientific approach by enabling systematic measurement of portfolio Taxonomy alignment. The model is live and capable of measuring the potential Taxonomy alignment of any equity portfolio. What proved to be more difficult to assess, from a quantitative perspective, was the “Do no significant harm” and “Minimum social safeguards” criteria - these are still under development. 

Objective 2: The model has been successfully used to evaluate the current alignment of SEB Investment Management’s Quantitative Equities sustainable funds specifically, as well as a peer group of sustainable mutual equity funds. SEB learned that its funds had varying degrees of alignment and that its average was close to that of the peer group. For the peer group, Taxonomy alignment was lower than expected (6.8% compared to 6.6% for a global equity index), leading to the important insight that the implementation of the regulation will force sustainable funds to reallocate capital in order to report an alignment significantly different from their current benchmarks. 

Objective 3: The positive results from the evaluation phase gave further motivation to incorporate the SEB EU Taxonomy model into the investment process. This incorporation is still going on. SEB research suggests it can use the model in its systematic investment process to significantly increase Taxonomy alignment. 

One important lesson SEB learned was that certain sectors offer higher Taxonomy alignment (utilities and communication services) while others have close to no alignment (healthcare). Consequently, the degree of investors’ acceptance of active sector allocation and active risk will be the limiting factor in reaching a high alignment. Nevertheless, Taxonomy alignment of sustainable funds can be significantly improved with small deviation from their benchmarks.  

Another important insight is that a high level of alignment can be achieved also when controlling for carbon emissions. 

In addition, the scope of the model has proven broader than that of investment management. It can be extended to evaluate SEB’s credit portfolio and has been used in advisory to institutional and corporate clients.