U.S. Sustainable Equity: Enhancing the U.S. All Cap Portfolio

February 28, 2019

Robert A. Gillam, CFA Chief Executive Officer McKinley Capital Management, LLC

Throughout its nearly 30-year history, McKinley Capital Management, LLC (“MCM”) has sought to improve risk-adjusted returns for its clients, and its quantitative strategies have evolved accordingly. The most recent quantitative strategy update directly impacts U.S. All Cap, the firm’s longest-standing product. Since its inception in 1990, U.S. All Cap has produced 0.77%, net, annualized excess returns above the Russell 3000 Index as of the year-ended 2018. Even during market downturns, U.S. All Cap consistently outperformed the Russell 3000 inception-to-date, and MCM believes the latest update will further augment these excess returns.

Source: Bloomberg, 1/16/2019. Past performance is not indicative of future results.

As the desire to embrace a socially responsible culture expands, investors are eager to incorporate environmental, social, and governance (“ESG”) factors into their portfolios. Traditionally, money managers restricted securities with low ESG scores from purchase, and the resulting portfolios were often suboptimal with lower returns. MCM has developed a way to incorporate these important ESG factors while still pursuing optimal portfolio risk and return characteristics.

Dr. John Guerard, head of the Quantitative Research team, is a Moskowitz Prize winner1 and has earned significant recognition in the field of Socially Responsible Investing (“SRI”). In a recent study of the Russell 1000 Universe2, Guerard and Chris Geczy of the Wharton School found that ESG/SRI portfolios have lower standard deviations of returns than unscreened portfolios. Consequently, ESG/ SRI portfolios tend to produce higher Sharpe Ratios and Information Ratios. Each strategy at MCM is built around an underlying McKinley Quant (“MQ”) score, a proprietary composite variable that includes earnings forecast revisions, price momentum, and standard deviation of returns. To a certain extent, MQ scores already incorporate ESG scores. For example, securities ranked in the top quintile for ESG have a median MQ score of 58.02, in comparison to the lowest quintile of ESG securities which have a median MQ of 44.17. The top ESG quintile also reflects outperformance in price momentum, profitability, dividend yield, size, and liquidity characteristics. Lower volatility is also commonly observed with high ESG scores when compared to the lower ESG quintiles. Overall, by investing in securities with high ESG scores, investors may gain exposure to several favorable characteristics.

Source: FactSet, 2/06/2019. Characteristics are calculated by sorting Russell 3000 Index constituents into quintiles by ESG score at the end of each month and taking the median value and then averaging the month-end values from 3/31/11 to 12/31/18. Hypothetical portfolio characteristics shown [above] are for illustrative purposes only and do not guarantee success or a certain level of performance. The returns are back-tested and not reflective of any actual traded account. Please refer to the disclosure page for more information.


MCM’s unique ESG methodology incorporates these characteristics with the goal of providing a prospect for higher future returns, despite ESG portfolios customarily underperforming. Rather than the common practice of building a portfolio solely of securities with high static ESG scores, MCM’s proprietary strategy selects securities with improving ESG scores and excludes securities with deteriorating ESG scores. As illustrated below, the highest expected returns in the hypothetical back-tested portfolios were derived from improving ESG scores combined with high MQ scores. Furthermore, additional upside capture is possible by avoiding deteriorating ESG scores, which tend to drag on returns, relative to unscreened MQ. Given these findings, MCM is incorporating a dynamic ESG variable into the U.S. All Cap quantitative strategy.

Source: Bloomberg, 1/16/2019. ESG data required to construct portfolios became available starting 6/30/13. Past performance is not indicative of future results.


To accurately reflect this enhancement to the underlying strategy, the MCM U.S. All Cap Portfolio is being renamed U.S. Sustainable Equity. This portfolio will provide clients a prospect for superior risk-adjusted returns while incorporating social responsibility. MCM values your partnership and welcomes any questions that you may have regarding this change. Please feel free to direct your inquiries to info@mckinleycapital.com.

Sources

1Dr. John Guerard was awarded the Moskowitz Prize in 1996 followed by an honorable mention in 2001. The prestigious Moskowitz Prize is the only global award recognizing outstanding quantitative research in sustainable and responsible investing. Since its launch in 1996 by Berkeley-Haas and US SIF, its winners have explored shareholder activism, socially responsible mutual funds, and socially responsible investing as a catalyst to financial performance, among other topics.

2Geczy, C., J.B. Guerard, Jr., and M. Samonov. “Earnings Forecasting and Efficient SRI/ESG Portfolios”. Unpublished Working Paper. 2018. The Wharton School.

3Guerard, J.B., Jr. “Is There a Cost to Being Socially Responsible in Investing?” Journal of Forecasting, 1997, pp. 6, 11-18, 475-490.
4Momentum: total return over the last 12 months, skipping the most recent month 5ROIC: “Return on Invested Capital” =Net Operating Profit After Tax / Invested Capital. This illustrates how efficiently a company uses its capital to generate revenue.

6Dividend Yield: Annual Dividend / Share Price

7Market Cap: Current Market Price per Share * Total Number of Outstanding Shares

8Liquidity Exposure: Axioma liquidity risk factor exposure, expressed in standard deviations from the mean

9Volatility: Annualized standard deviation of daily returns over the last 252 trading days

10Market Beta: the predicted equity market beta from the Axioma risk model.

Disclosure

McKinley Capital Management, LLC (“McKinley Capital”) is a registered investment adviser under the U.S. Investment Advisers Act of 1940. McKinley Capital is registered with the following Canadian provinces: the British Columbia Securities Commission; the Ontario Securities Commission; the Alberta Securities Commission; and the Quebec Financial Markets Authority. McKinley Capital is not registered with, approved by, regulated by, or associated with the Financial Conduct Authority (“FCA”), the Prudential Regulation Authority (“PRA”), the Securities & Futures Commission of Hong Kong or the China Securities Regulatory Commission. Additionally, none of the authorities or commission listed in the previous sentence has commented on the firm, the content of any marketing material or any individual suitability assessments.

Back-tested results are hypothetical (do not reflect trading in actual accounts) and are prepared with the benefit of hindsight. The results are provided for informational and illustrative purposes to indicate historical performance had the model portfolio been available over a relevant period. These results are not intended to recommend trades or be considered investment advice. No representation is being made that any model or model mix will achieve results similar to that shown and there is no assurance that a model that produces attractive back-tested results on a historical basis will work effectively on a prospective basis. Not every client’s account will have the exact characteristics of the backtested portfolio. The actual characteristics with respect to any particular client account will vary based on a number of factors including but not limited to market exigencies at the time of investment. It should not be assumed that any of the investment decisions made in the future will be profitable or will equal back-tested results or current investment performance. The trading strategies retroactively applied were available during the periods presented.

The material provided herein has been prepared for an institutional client presentation, may contain confidential and/or proprietary information, and should not be further disseminated without written approval from McKinley Capital’s Compliance Department. Returns are absolute, were generated using McKinley Capital’s proprietary growth investment methodology as described in McKinley Capital’s Form ADV Part 2A, are unaudited, and may not replicate actual returns for any client. McKinley Capital’s investment methodology has not materially changed since its inception, but it has undergone various enhancements. No securities mentioned herein may be considered as an offer to purchase or sell a firm product or security. Any comment regarding any individual security is presented at the client’s request, may only be used for client reference, and may not be reflective of composite or individual portfolio ownership. McKinley Capital may not currently hold a specific security. In addition, any positive comments regarding specific securities may no longer be applicable and should not be relied upon for investment purposes. No security is profitable all of the time and there is always the possibility of selling it at a loss. With any investment, there is the potential for loss. Investments are subject to immediate change without notice. Comments and general market related perspectives are for informational purposes only; were based on data available at the time of writing; are subject to change without notice; and may not be relied upon for individual investing purposes. Past performance is no guarantee of future results. There is no guarantee of the future performance of any McKinley account. The investment strategy or strategies discussed may not be suitable for all investors. Investors must make their own decisions based on their specific investment objectives and financial circumstances.

Trade date based performance shown reflects the reinvestment of realized gains, dividends, interest and other earnings calculated using McKinley Capital’s growth investment methodology. Portfolio performance is shown gross and/or net of management fees or asset based broker fees as indicated in the text of the presentation. Clients should realize that net returns would be lower and must be considered when determining absolute returns. Detailed account inclusion/ exclusion policies are available upon request. Returns are based on fully discretionary accounts and do not take individual investor tax categories into consideration. Returns reported for the periods prior to January 1, 2001 were initially calculated using McKinley Capital’s quarterly reporting methodology. Monthly returns for the period were retroactively calculated and are considered supplemental information. Returns from January 1, 2001, to current date utilize a monthly reporting methodology. No guarantee can be made that the composite performance reflects a statistically accurate representation of the performance of any specific account. Charts, graphs and other visual presentations and text information are derived from internal, proprietary, and/or service vendor technology sources and/or may have been extracted from other firm databases. As a result, the tabulation of certain reports may not precisely match other published data. Specific results from calculations and formulas may be rounded up. Future investments may be made under different economic conditions, in different securities and using different investment strategies.

For GIPS® compliant presentations, all information is supplemental to the GIPS® compliant composites and a copy of the applicable GIPS® composite(s) is included with the presentation. Composite returns and individual client returns may materially differ from the stated benchmark(s). Deviations may include, but are not limited to, factors such as the purchase of higher risk securities, over/underweighting specific sectors and countries, limitations in market capitalization, company revenue sources, McKinley Capital’s investment process and/or client restrictions. Global market investing, (including developed, emerging and frontier markets), also carries additional risks and/or costs including but not limited to: political, economic, financial market, currency exchange, liquidity, accounting, and trading capability risks. Derivatives trading and short selling may materially increase investment risk and potential returns. These risks may include, but are not limited to, margin/mark-to-market cash calls, currency exchange, liquidity, unlimited asset exposure, and counter-party risk. Foreign accounting principles may also differ from standard U.S. GAAP standards.

Fees are billed monthly or quarterly, which produces a compounding effect on the total rate of return net of management fees. As an example, the quarterly effect of investment management fees on the total value of a client’s portfolio assuming (a) $1,000,000 investment, (b) portfolio return of 5% a year, and (c) 1.00% annual investment advisory fee would be $10,038 in the first year, and cumulative effects of $51,210 over five years and $110,503 over ten years. Actual client fees vary. A fee schedule, available upon request, is described in the firm’s Form ADV part 2A.

Composite returns include only those accounts holding common stocks, preferred stocks, ADRs, ordinary shares, money market instruments and/or cash equivalents – and for non-U.S. and global composites foreign currencies and stocks. For the period prior to April 1, 2001, composites contain both wrap and non-wrap accounts. For this period, net returns for non-wrap accounts were not reduced by wrap sponsor fees, and gross returns for non-wrap accounts were reduced by transactional costs. The performance results prior to March 11, 1991 reflects the investment performance of discretionary brokerage accounts managed by Robert B. Gillam, Chief Investment Officer at FAS Alaska, Inc. (prior to the formation of McKinley Capital) with a growth investment philosophy and methodology similar to that described in McKinley Capital’s brochure.

Data may have originated from various sources including, but not limited to, FactSet, Bloomberg, TQA, ITG™, APT, Zephyr and/or other similar systems and programs. “FTSE®”, “Russell®”, “MTS®”, “FTSE TMX®” and “FTSE Russell” and other service marks and trademarks related to the FTSE or Russell indexes are trademarks of the London Stock Exchange Group companies. All rights in the FTSE Russell® Indices vest in FTSE Russell® and/or its licensors. Neither FTSE Russell® nor its licensors accept any liability for any errors or omissions in the Indices or underlying data. No further distribution or dissemination of the FTSE Russell® data is permitted without express written consent. With regards to any materials, if any, accredited to MSCI: Neither MSCI nor any other party involved in or related to compiling, computing or creating the MSCI data makes any express or implied warranties or representations with respect to such data (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of such data. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in or related to compiling, computing or creating the data have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages. No further distribution or dissemination of the MSCI data is permitted without MSCI’s express written consent. With reference to “ITG™”: the information provided has been taken from trade and statistical services and other sources deemed reliable. Accuracy or completeness is not guaranteed and should not be relied upon as such. No guarantee or warranty is made as to the reasonableness of the assumptions or the accuracy of the models or market data used by ITG or the actual results that may be achieved. These materials are for informational purposes only and are not intended to be used for trading or investment purposes or as an offer to sell or the solicitation of an offer to buy any security or financial product. These materials do not provide any form of advice (investment, tax or legal). Please refer to the specific service provider’s web site for complete details on all indices. McKinley Capital makes no representation or endorsement concerning the accuracy or propriety of information received from any third party. All information is believed to be correct but accuracy cannot be guaranteed. Clients should rely on their custodial statements for the official investment activity records. Clients should contact their custodian with any questions regarding monthly/quarterly receipt of those statements.

To receive a copy of the firm’s ADV, a complete list and description of McKinley Capital’s composites and/or a presentation that adheres to the GIPS® standards, please contact McKinley Capital at 1.907.563.4488 or visit the firm’s website, www.mckinleycapital.com.