On April 9, 2018 Russian companies lost $3 billion of their capitalization in a single day. The aftermaths were felt by investors worldwide. Even those who had invested in Toshiba and Volkswagen suffered losses. Meanwhile, the problems of the said corporations had been apparent long before the current crisis, Arabesque believes. This UK startup has developed a platform for assessing stability of businesses. Such a platform would not have allowed investing in the above risky assets. To assess efficiency and sustainability of companies, the innovative system employs Big Data and learning neural networks. Apart from financial aspects, it takes into account corporate attitudes towards environment, social responsibilities and international norms and practices. The platform was presented a year ago and nowadays it helps investors, regulators, NGOs, businesses and consumers monitor performance of over 7,000 largest global corporations. In January 2018, Deutsche Bank, Solactive and Arabesque jointly launched Sustainability Index Europe for assessing European companies. Ciaran McCale, Head of Media and Communication at Arabesque, told Invest Foresight of the digitalization lowering investors’ risks.
– When was the company founded? What is the key business idea of the company?
– Arabesque was founded in 2013 following a management buyout from Barclays Bank. The firm was built in cooperation with leading academics from universities including Harvard, Stanford, Oxford, Cambridge, Maastricht, and the German Fraunhofer Society. We are a tech company, and an asset management firm that’s focused on quantitative, sustainable investing. We have a screen of 3,000 sustainable equities, from which we use fundamental analysis to identify companies that demonstrate continued growth and increasing earnings, strong balance sheets and cash flow, and we incorporate the behavioral patterns of sell-side research analysts. Our aim is to bring a new dimension to investing, using self-learning quant models and big data to assess the performance and sustainability of globally listed companies. In 2017, we launched Arabesque S-Ray, the most extensive tool of its kind to measure corporate sustainability. It is now being used by clients including State Street, S&P Dow Jones Indices and Deutsche Bank, as well as leading corporations.
– Please, describe your product. How much time did it take to develop it? What technologies do you use?
– When Arabesque was launched, the firm needed to know how sustainable companies are, because we wanted to be a sustainable asset manager. Initially, we thought we would take the service available from current data providers. However, the data was biased, delayed, inconsistent. And so therefore we so built a technology that pulls in a vast amount of available data on corporate sustainability. Through S-Ray, we use a machine-learning algorithm to cross-reference all this information and come up with a score.
The concept is similar to Airbnb, which doesn’t have a single hotel room, but is still the biggest provider of accommodation in the world. Machine learning thrives on big data. Our S-Ray platform refreshes daily, has 10 years of history; and because it’s quantifiable, we can see what contributes to alpha.
– How do you get under the business’ skin – what kind of business data and how do you analyze it? How do you prove the purity of data?
– S-Ray works by scoring companies based on their compliance with UN Global Compact principles on human rights, labor rights, the environment and anti-corruption. It also scores companies on sector specific ESG factors. S-Ray also incorporates filters which organize corporate information based on specific client preferences. We exclude companies that violate UN Global Compact principles, and those with ESG rankings in the bottom 25% of their industry, and those with ESG scores in the bottom 25% of their industry (they are readmitted if they show an improvement over two quarters). Companies that have significant business involvement in certain industries and also excluded.
The underlying set of data sources is proprietary and changes over time, differing between companies based on information identified by the algorithms. However, it is organized in two groups: analyst based long-term sustainability assessments, and news-based short-term sustainability signals. We are constantly seeking to enhance our data sources.
– How do you predict the increase in the number of the connected companies? Do you analyze Russian companies?
– Companies are publishing more and more qualitative information beyond the conventional financial performance indicators. At the same time, the digital revolution we are all experiencing is transforming our ability to quantify and measure sustainability. Investors will use sustainability criteria as a standard performance indicator for investment decisions, like a price-earnings ratio or dividend yield. Sustainability will become an essential component in any risk analysis.
ESG data is only about 10% of what it will be in the next few years, although its availability to the market is increasing rapidly. There are currently just over 7,000 companies within the S-Ray platform, including major Russian corporations, although our coverage will grow as data continues to become available.
– Does your scanning system really help improve business?
– Companies that demonstrate higher sustainability performance generally deliver better operational performance; research has demonstrated this. A key area, for example, is governance. S-Ray prevented us from investing in companies such as Toshiba, Kobe Steel, and Volkswagen, which all had low ratings primarily due to governance issues. We view ESG data as an additional dimension of investing, giving investors more information about companies and their underlying DNA.
– Can algorithms replace investment analysts in the future? How many employees and when might lose their jobs because of this?
– I believe that technology can be used by analysts to enhance the decision-making process, and open up new opportunities. For instance, I think the retail investing space will see a huge impact from capital moving into equities. Buying stocks will give retail investors a way to express their values, shifting funds to areas that are important to them. Block-chain will play a key role in facilitating this shift, as the transparency of distributed ledger technologies will allow retail investors to observe the consequences of their investments, and affect end suppliers directly.
Professional investors are increasingly changing their perception of ESG as a way of evaluating how companies conduct business, as demand and expectation from investors changes. That’s the power of technology.
– Don’t you think that the widespread use of the algorithms will increase the level of volatility in the markets? Is it conceivable that the companies’ stocks will be selling to different investors simultaneously?
– I do not, no. There is a degree of misunderstanding around algorithmic trading – the definition of it – and market volatility, which has been focused on recently in the media. I think the key point to make is that technology has long been a fundamental driver of human progress. And it can now be used within asset management to harness unprecedented amounts of corporate data, and allow us to more clearly search beneath the surface of companies across the globe and identify those which consider the interests of all stakeholders. That is the mission upon which Arabesque was founded: mainstream sustainable investment through ESG big data and technology. It is an approach which can deliver improved risk-adjusted returns, and ultimately shine a light on environmental stewardship, social impact, and on universal values.