UBS Asset Management’s Concentrated Alpha is a team of active equities specialists within the larger firm, bottom-up stock pickers with a fundamental approach to investing. Like many asset managers operating in the EU, the team converted some of its funds to so-called “Article 8” products under the Sustainable Finance Disclosure Regulation (SFDR) this year, and has adapted its approach to ESG integration—the way that data is used to meet environmental, social and governance criteria in building portfolios—to accommodate the new disclosure rules.

“The way we look at ESG and how it feeds into the investing process—that hasn’t changed. But we have adopted a more holistic view of how ESG impacts the overall portfolio. And SFDR has had a big impact on how we are marketing the funds to clients,” says Nicole Lim, a director and equities specialist in the team.  

Concentrated Alpha, led by portfolio manager Max Anderl, takes a fundamental approach, selecting companies that offer upside potential and limited downside risk. The team leverages internal and external resources to filter out companies that can add shareholder value over the long term, Lim says. Those external resources include a range of ESG ratings from third-party sources, including MSCI, Sustainalytics, and ISS. Internally, the team can draw on UBS’s resources.

Over the past few years, UBS as a group has made a collective effort to implement an ESG framework. On the asset management side of the business, this initiative led to the foundation of the Sustainable and Impact Investing (SII) team in 2016, which includes specialist investment analysts.

The SII team developed its own ESG scoring methodology, including a UBS ESG consensus score, a weighted average of ESG score data from internal and external sources that rates companies from 1 to 10.

If a company that Concentrated Alpha is considering for inclusion in a portfolio scores below a certain threshold on the ESG consensus score or on any of the other risk measures, it’s flagged by the UBS ESG Risk Dashboard, a solution that employs data visualization software and that UBS uses for a variety of research frameworks.

Concentrated Alpha team members might not exclude the stock at this point; they might, for example, have their own ideas about a company’s performance based on direct engagement with that company. If they doubt that a red flag on the dashboard is an accurate representation of its ESG status, they can turn to the SII’s specialist analysts for a deeper dive into the fundamentals.

Lim says that as of February 2021, Concentrated Alpha converted some of its funds to Article 8, investing in what it believes to be innovative and sustainable companies with strong or improving ESG profiles. The Article 8 designation obliges them to not only publish in their prospectuses detailed information on the ESG profiles of investee companies, it also obliges them to make sure the companies in the portfolio are maintaining their ESG performance, using the risk dashboard to monitor that on an ongoing basis.

“If we notice that a company has become less attractive on the ESG front, we could sell out of the name,” Lim says.

In summer 2020, WatersTechnology spoke to Lim and Anderl about this approach to ESG integration. As Lim says, the process remains in place today, but they have adapted their selection criteria and marketing to SFDR’s new requirements.

The first stage of the regulation went into effect in March 2021, requiring asset managers to disclose on their websites and in their prospectuses the sustainability risks, impacts and characteristics of their products. The next phase, which applies from the beginning of 2023, will deepen those requirements, making disclosures even more detailed.

Offending articles

Under SFDR’s technical standards, funds can be categorized as Article 6, 8 or 9. Article 6, or “no green” products, have no ESG characteristics, and could include “sin stocks” such as tobacco or weapons. Article 8, or “light green” products, are those that promote ESG characteristics; Article 9, or “dark green” products, have specific sustainable investment objectives.

The ESG fund universe has exploded since asset managers began converting their funds to Article 8 and 9 products in March, when SFDR’s technical standards were published. Research by Jag Alexeyev, head of ESG insights at Broadridge Financial Solutions in New York, has found that firms with in-scope products identified more than 5,700 funds as Article 8 or 9, with combined assets of €3.6 trillion ($4.1 trillion) as of September 2021.

Sixty percent of these funds had not previously been categorized as responsible investment strategies, he says in a white paper based on his research. “Managers chose to align these products with SFDR by providing more specific disclosures or by enhancing the ESG characteristics of their strategies,” the white paper says.  

Alexeyev tells WatersTechnology, however, that there is still a lot of uncertainty among asset managers around how they define an Article 8 fund. The regulators say that for a product to be in scope of Article 8, it must be “promoting” environmental or social characteristics in its marketing materials, but that word is vague in the rule

“An Article 8 fund could be seen as promoting E and S characteristics by referring to them in their marketing documents. That was a bit of a head-scratcher for some practitioners. Is that enough? What does that mean? There is still uncertainty around what constitutes an Article 8 product,” Alexeyev says.

Market participants have told the European regulators that product classification under SFDR is frustratingly vague. In response, the three supervisory authorities—the European Securities and Markets Authority (Esma), the European Banking Authority, and the European Insurance and Occupational Pensions Authority—issued a Q&A, updated standards, and offered other guidance in 2021, and wrote to European lawmakers asking for clarity on certain issues, including the meaning of “promotion” in the context of products promoting environmental or social characteristics. 

These efforts have not brought much clarity to the issue, however, and asset managers will probably have to take their own, individual approaches to these classifications, Alexeyev says. “In the end, it’s up to the asset management company to ask themselves, ‘How do we implement ESG? Is this an Article 8 product? If yes, this is why we think it is one, and this is how we are disclosing it.”

This is exactly what is happening at UBS, which has updated its internal methodology with its own taxonomy defining Articles 6, 8 and 9. Within each article, the firm has a standard set of exclusions; the two funds that Concentrated Alpha converted to Article 8 now face a wider set of exclusions.

“All the funds within UBS Asset Management already apply negative screening on certain sectors like controversial weapons, thermal coal mining, and extraction. All these things are part of the wider UBS Group policy exclusions. But Article 8 funds go a step further: They will exclude companies that generate a certain amount of revenue from tobacco, adult entertainment, gambling, conventional military weapons, and thermal coal-based energy production,” Lim says.

Anderl says that SFDR’s disclosure requirements add more effort and complexity to her job, but says that ultimately, it’s a worthwhile exercise. “It’s clearly more effort, but that’s the whole point. We can help foster change, and that’s what investors expect. Otherwise, we’d continue to do the same thing, and that’s not going to be good for the environment and climate. And we can improve on inequality and other items, that ‘G’ point,” Anderl says.