The local asset management industry has been seen as slow to respond to the wave of fast and aggressive financial technology (fintech) players looking for a share of the market. But things are changing. BIMB Investment Management Bhd, for one, has embraced fintech solutions and incorporated them into its investment management process.

BIMB Investment, in partnership with UK-based investment management firm Arabesque Asset Management Ltd, is the first local fund management firm to implement a unique quantitative rules-based technology that will allow its funds to select global stocks that are not just shariah-compliant but also adhere to environmental, social and governance (ESG) principles. It will also let its BIMB-Arabesque i Global Dividend Fund 1 increase its cash holdings immediately and preserve investors’ capital when global markets become too volatile.

According to BIMB Investment CEO Najmuddin Mohd Lutfi, the technology will allow the company to better manage risks and continue delivering good performance in the current volatile markets. It will also help the company to differentiate itself from its industry peers.

“We have applied fintech to investment management by constructing the investment portfolio for capital growth while managing market volatility, analysing data and making intuition-free decisions. The aim is always to preserve investors’ capital first, and then to grow it,” he says.

Arabesque CEO Omar Selim says the company has designed a product of the future. In fact, it was once referred to as the “Tesla of finance” in a media report.

“The product is aimed at meeting the requirements of those who want to protect their values while maintaining investment performance, with no derivatives, futures, options or any form of leverage,” he says.

“Investors increasingly want their money to do good things that align with their values, whatever they may be, and they want their money to go to companies that fit the criteria. It is different from just looking at the risk-return or volatility.”

Arabesque is a values-based investment management firm that integrates ESG data with quantitative investment strategies. It uses fundamental, quantitative, forensic, financial and non-financial data to organise an investment universe of 1,000 global stocks into a combination that delivers a superior risk-return profile. The firm manages two funds — the Arabesque Prime Fund and Arabesque Systematic Fund. The BIMB-

Arabesque i Global Dividend Fund 1 feeds into the latter.

Selim points out that with Arabesque’s funds, when the volatility is lower, the drawdown is also lower. It is much easier to produce returns if investors are exposed to lower volatility. The objective is to reduce the volatility of the equity markets so investors can feel more comfortable.

This partnership is already bearing fruit. According to Bloomberg, the BIMB-Arabesque i Global Dividend Fund 1, launched last November, has delivered a return of 9.62% for its USD class and 8.72% for its RM class, outperforming many of its shariah and conventional counterparts over the six-month period ended Sept 13.

“BIMB Investment is the first [asset management firm] in Malaysia to offer a fund that integrates both shariah and ESG principles. The fund offers investors the opportunity to invest in shariah-compliant listed companies that adhere to the UN Global Compact Principles on ESG,” says Najmuddin.

“There are some players that claim they carry ESG products, but there are certain standards and criteria to meet. We invest in companies that are financially and operationally transparent with the highest standards of corporate governance, are consciously and proactively protecting the environment and contributing to the growth and development of society, as well as those that have shared shariah values.

“We want to invest in companies that will be sustainable in the long term. We don’t want them to crash in a market downturn. The companies we want to invest in should have a sustainable business model.”

When it comes to ESG investing, Selim says investors should drill a little deeper into the environmental issues when they are looking at companies. For example, how do they approach energy, wastewater management and recycling?

“Can these companies be compared? Can people prove that a company that does not waste water is better in terms of stock price and financial performance?” he asks.

“How about good governance? Are companies that are well managed and better controlled going to be better for investors? What about the social aspects? If a company treats its people well, provides women and ethnic minorities a fair chance and pays them equally, will it do better over time? We think so and we can prove it.”

According to a report published by the University of Oxford and Arabesque in March last year, titled From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance, there is indeed a correlation between sustainability and financial performance. “Superior sustainability quality (as measured by aggregate sustainability scores) is valued by the stock market as more sustainable firms generally outperform less sustainable firms. Stocks of well-governed firms perform better than the stocks of poorly governed firms,” says the report.

“On the environmental dimension of sustainability, corporate eco-efficiency and environmentally responsible behaviour are viewed as the most important factors leading to superior stock market performance. On the social dimension, the literature shows that good employee relations and employee satisfaction contribute to better stock market performance.”

Selim says the investment instruments also matter when it comes to sustainable investing. Arabesque’s funds comply with the UNGC’s Principles for Responsible Investment and are free of leverage, short selling or derivatives.

“How do you express your investments? Is it through derivatives, futures, options, cash, equity or hybrids? With each of these, in the end you are just putting money into an index,” he points out.

“Very few investors think about the trouble they cause to the market when they leverage their money, short sell or bet against others. For us, sustainable investing is not only about which company you choose but also the financial instrument you use.”

Arabesque vice-chairman Georg Kell says its quantitative rules-based model combines systematic sustainability analysis with a quantitative approach. Hence, it has the potential to deliver sustainability, aspiration and performance on a large scale. It means investors are giving a premium to companies that perform better on these crucial issues.

“I did not believe that financial people are capable of connecting the dots between the real economy and long-term sustainability. But with this model, we are fundamentally accelerating a market-led transformation towards a more sustainable world,” he says.

Kell is the founder and former executive director of UN Global Compact (UNGC), the world’s largest voluntary corporate sustainability initiative with more than 9,000 corporate signatories across the globe. During his 25 years at the UN, he oversaw the conception and launch of UNGC’s initiatives such as the Principles for Responsible Investment, the Principles for Responsible Management Education and the Sustainable Stock Exchange initiative.

He observes that there are three trends slowly changing the world, and transparency is one of them. Many corporations have ignored this trend while others have had to learn the hard way the impact of their practices. But companies are beginning to realise that being transparent can help them avoid costly mistakes and become more profitable.

“Another trend is the pricing and valuation of external factors. For example, pollution used to be free, but it is increasingly being priced in. Accounting for external factors is becoming even more important,” says Kell.

The third trend is on the investment side. It is about building a market for the future. Economic growth has migrated to the east and south, and technology is moving much faster. These trends, he says, are increasingly putting a premium on robust companies, which are transparent by nature, and look at how they can be part of the solution rather than the problem.

“Financial markets, in my view, have been very slow in understanding this mega trend because the appetite for short-term returns has dictated behaviour and continues to do so. The temptation of 30% or 40% returns is almost irresistible — such is human nature. That is why very few financial thinkers have made the connection between sustainability and financial performance,” says Kell.

However, a growing number of companies — across all industries and regions of the world — are at different stages of disclosure. There are also many initiatives running in parallel, all of which are based on the philosophy of shared values and the realisation that business success depends increasingly on the ability to deliver on ESG issues.

“Many of us who work in this area have noticed that corporations and CEOs, who actually have a long-term vision on these issues, are the ones who are successful. But it wasn’t possible until recently to establish a clear relationship between good ESG performance and financial performance, as the study by Oxford and Arabesque has shown. It was a game-changer for the financial world,” says Kell.

REINVENTING BIMB INVESTMENT

Najmuddin says fintech is all about enhancing efficiency. “We have embraced fintech and this is how we want to position ourselves moving forward. This is the future of fund management.

“In our case, we are already lean. So, it is easier for us to move nimbly and make a switch. We have been in active fund management for 20 years and realise that we need to stay ahead of the curve as the market is very competitive and there is increased and frequent volatility [in the financial markets].”

BIMB Investment is also looking to automate other parts of its business. “In the future, we may want to offer the product directly to clients, who will be able to make their own investments and manage their portfolio. This means cutting out the middleman, which is something similar to robo-advisory. However, we have not reached that point yet because it depends on the demand; we need to have more sophisticated investors. If we have many sophisticated investors, like in the developed markets, obviously the middleman will not be relevant anymore,” says Najmuddin.

He says while the fund management industry has been slow to embrace fintech, it is only a matter of time before it catches up with the other industries. “The [fund management] industry started in the late 1980s. Some of the companies have become very big and have invested a lot in the traditional set-up, so it is hard for them to make a switch.”

Najmuddin spent 16 years at other investment banks and Bank Negara Malaysia before joining BIMB Investment as CEO in February last year. It is his knowledge of both the commercial and regulatory aspects of the business that stands him in good stead as he steers the company forward.

“When I was with Bank Negara, I got to see the whole value chain of the financial industry — the regulatory framework of banking, takaful, insurance and capital markets. I had the opportunity to work closely with various parties on initiatives related to making Malaysia the world’s Islamic finance marketplace. These allowed me to have effective and impactful conversations and engagements with both the public and private sectors.”

One of the things Najmuddin did when he arrived at BIMB Investment was to look at its product range and human resource management. “People are always important. One of the things I did was to realign roles to ensure we have the best talent performing the critical functions of the business,” he says.

“Another key thing I looked into was our product range. I want BIMB Investment to offer investors more product choices and a complete product range to build an optimal shariah investment portfolio. We want investors to be prudent in managing risk/return. We want them to be diversified.”

As BIMB Investment’s previous strategy focused only on Malaysia, Najmuddin wanted to add global products to its range. The company also needed to have a strong back-office operations system to handle more transactions and categories of investors. This, of course, required some investment.

“Previously, our back-office operations were very limited and only catered for domestic investors. Since we want to attract foreign investors to our range of funds, do cross-border transactions, in line with the MIFC initiatives, and plan to go regional, and eventually global, we will need to offer multicurrency products. So, updating our back-office system to handle these is paramount,” he says.

Today, BIMB Investment’s back office can handle multicurrency products, cross-border transactions and various types of foreign fund investment strategies. “We are also focusing more on institutional business, both by building a track record — such as at least three years’ experience managing institutional money and at least RM1 billion under management — and now cementing our partnership with Arabesque Asset Management. We are increasing our capabilities to provide the best solutions for institutional clients with any type of strategy,” says Najmuddin.

He is confident that this new investment process will turn around the performance of some of BIMB Investment’s existing funds, which have provided lacklustre returns over the one-year, three-year and five-year period when compared with peers.

“Many of our funds are Malaysian-centric equity funds that have been around for a long time. They are between 6 and 10 years old. BIMB Investment has been very conservative, largely trading in blue chips and mid-caps. We don’t take positions in small caps,” says Najmuddin.

“When the oil and gas crisis hit and the market was down 300 points in August last year, all sectors got hit as well. We were not spared, even though our portfolios were largely in blue chips, GLC stocks and the telecommunications, construction and plantation sectors. In the banking sector, we only had holdings in Bank Islam and Syarikat Takaful Malaysia Bhd. When these sectors got hit, the previous team was not able to get out early. It did not expect the market to go down to the level that it did. But all this is in the past.”

Last year, Najmuddin and his team cleaned up some of the portfolios. So far, their efforts have produced positive results.

“We are working with Arabesque to provide the stock selection process to integrate with our existing funds. We are also improving the research on the stocks and to have a systematic process to construct our investment portfolios,” he says.

“We are already working on the portfolios, so our local funds have already seen some positive changes. In fact, we have seen quite an improvement in our portfolios because we took a position in export-oriented sectors such as electronics and rubber gloves.”

Bank Islam has always been BIMB Investment’s biggest distributor and partner. The company wants more investors and clients now that it has a very good value proposition. It is in talks with other financial institutions to carry its products.

“In addition to Bank Islam, we also have our agency force, BIMB Investment consultants. Our products are currently available at Fundsupermart, Phillip Mutual, Amanah Raya Investment and KenWealth by Kenanga,” says Najmuddin.

As at end-August, BIMB Investment had almost RM1.1 billion under management. The company expects that to grow to RM1.2 billion by the end of the year. Najmuddin is confident it can achieve this as it has a pipeline of institutional mandates.

The company is optimistic about the investment outlook for the next 12 months as Malaysia still has solid fundamentals. Investors will need to strategise their portfolios according to their risk appetite to get the returns their desire.

“It is interesting for Malaysia in view of the current economic cycle and whether further policies to stimulate the market will be introduced. We have seen a cut in the interest rate. The last five quarters have seen a downward trend in GDP growth, which poses a riskier outlook for our equity market going forward. But we are still optimistic because the fundamentals are still solid and our GDP growth is one of the strongest in the region,” says Najmuddin.

“When we look at the overall market for the next 6 to 12 months, it is obvious that the developed markets look attractive versus the domestic market. But as an investor, you always want to look for attractive valuations. Malaysia is becoming attractive with an average price-earnings ratio of 16 times. It is now about 15.5 times. It may be a good entry point [for investors], which is why we are launching the Malaysian equity fund soon.”

If investors are trying to manage risk-return over the next 12 months, Najmuddin says it is better for them to diversify their assets and allocate a little more to developed markets. “If you are an aggressive investor, you want more equities in your portfolio. You could put 25% in global equities, 20% in Malaysian equities, 35% in Asia ex-Japan equities and maybe 20% in Malaysian sukuk. The target yield per annum for this portfolio would be 11% to 12%.”

For moderate investors aiming at 7% to 8% yield, the sukuk exposure should be about 40%, Malaysian equities about 20%, global equities 20% and Asia ex-Japan equities 20%, he says. Conservative investors, such as retirees, could have higher exposure to sukuk, say, 65% while holding 10% in global equities, 15% in Asia ex-Japan equities and 10% in Malaysian equities.

“I believe this yield for aggressive investors is still possible because there are a lot of opportunities. There are many companies or stocks that are resilient in a crisis, so it is just a matter of identifying the opportunities. That is the role of a fund manager and we think we are able to do it,” says Najmuddin.

“In our global equity portfolio, we have seen some of these companies deliver a very good performance. The 11% to 12% per annum return is not attained by relying on one fund. It has to come from a diversified portfolio, the weighing on equities and the time horizon. A lot of the higher returns for equities came from the emerging markets, but it also came with steep volatility.”

BIMB Investment plans to launch two funds in the next quarter. “We will launch the first Malaysian shariah-ESG fund early in the fourth quarter. The companies in the portfolio will be screened using the highest standard of ESG, adhering to the United Nations Global Compact principles. It will be a multicurrency retail fund, with minimum investment of RM500,” says Najmuddin.

The other fund is a money market fund that has an investment account as the underlying asset. “Bank Islam has an investment account where everyone can deposit money into the instrument. The money market investment account fund that we plan to launch is targeted at corporates as it is tax efficient,” he says.

Equities the new fixed income

The volatility in the global markets has given rise to the question of which assets still provide investors with positive returns. About 60% of the world’s money is in fixed-income investments such as treasuries, gilts and bonds. But over the last 20 years, falling interest rates have seen lower returns from fixed income. What else can investors turn to?

Omar Selim, CEO of Arabesque Asset Management Ltd, laments that “the equity, real estate and commodity markets are at an all-time high while commodities are a function of geopolitical issues and foreign exchange belongs to the central banks”. The only asset class that can still offer positive returns is equities, he says.

“Equities are the new fixed income for now. They are global, listed, transparent and regulated. I believe nothing will be able to compete with the volume of equities — not real estate, nor commodities, nor foreign exchange,” he adds.

Selim says as the markets evolve, a global data revolution is changing the investment landscape. With an abundance of data available, people who can make sense of and use it will benefit from it.

“If you talk about investing in the 1970s or 1980s, people used to study companies, examine the balance sheet and talk to the board before deciding which stocks to buy. That era is over,” he says.

“Financial information — audited, regulated and standardised data — has traditionally driven the investment process. But now, we also have unregulated and unstandardised random data. The self-reported information includes the searches we make on Google and the pictures people take with their phones. And in the same way, how companies report on ESG. The question is, how do we utilise the data?”

To answer that question, says Selim, Arabesque was set up by Barclays Bank in 2011. Its senior management then bought all the rights and intellectual property in 2013 and established Arabesque as an independent firm. The company has been built in cooperation with leading academics from universities such as Harvard, Stanford, Oxford, Cambridge and University College London.

“If what I believe is true, that equity is the new fixed income, then it will change the spirit of investing. Fixed income is risk transferring, but equities is about risk sharing. Going forward, we will not be analysing a company by collateral,” he says.

“Instead, we will want to make sure the company survives because our interests are aligned. We now live in a world of transparency and we talk and read news about climate change and human rights on a daily basis. These are the trends that can and will be fully aligned with equity investments.”

Some people may associate the company’s quantitative model with high frequency trading, but Selim says is it not. Arabesque’s model is not used to time the market or to manipulate it — it is simply a natural investment process, he points out.

Arabesque has a team of experts on ESG, sustainability, quantitative research and shariah principles. While the quantitative model does not allow human intervention in the trading process, there are occasions when the fund manager can intervene to overrule the system. Selim cites the example of Arabesque’s own funds, which are overseen by the chief investment officer (CIO).

“While the CIO cannot remove any rules, she can overrule the system when there are exceptional circumstances. If something happens that the system cannot see, for example, the Ukraine crisis where Russian stocks were about to get blacklisted. This was public information, but the system could not anticipate this, so we overruled the stock selection process,” he says.

Selim stresses that only the CIO can take risk off the table, but she can never express her own views to interfere with the rule-based process. To ensure that the quantitative rules-based system is not manipulated or tampered with, it has a 256-bit encryption and other defence mechanisms.

The BIMB-Arabesque i Global Dividend Fund 1

Najmuddin Mohd Lutfi, CEO of BIMB Investment Management Bhd, says the BIMB-Arabesque i Global Dividend Fund 1 is unique as it employs Arabesque Asset Management Ltd’s model instead of a human fund manager to manage the investment portfolio, which invests in ESG and shariah-compliant companies all over the world.

Although it is a shariah-compliant fund, it uses conventional benchmarks to reach a wider investor base that is shariah agnostic, says Najmuddin. There is a perception that shariah funds underperform conventional funds because they do not have exposure to the banking, alcohol and tobacco industries.

“The investment process enables us to pick and select shariah-compliant stocks that are able to outperform conventional ones. Despite being a shariah-compliant fund, the BIMB-Arabesque i Global Dividend Fund 1 outperforms the conventional benchmark,” he points out.

A unique feature of the fund is the momentum analysis done daily for the stock selection. This means the fund’s portfolio will adjust its cash allocation if market is too volatile, says Najmuddin.

He adds that that daily rebalancing does not make the fund more volatile. In fact, it allows the fund to be better managed in terms of risk or volatility.

When the market is very volatile, Arabesque’s technology quickly increases the allocation of cash in the fund to preserve investors’ capital. It would be very difficult to replicate this in a traditional active fund management setup as fund managers only work a certain numbers of hours per day, compared with a machine that works 24/7.

“We know that we cannot manage the future, so we have the technology like artificial intelligence to anticipate future risks. What it really shows here when the market is very volatile is that we have been able to preserve the capital of the investors,” says Najmuddin, adding that it is an immediate asset allocation based on facts and data, removing all human intuition as well as biases.

“Instead of the traditional way of saying the market is down because there is a crisis in China, we have positioned the investment based on the situation for you, such as increase cash allocation to preserve capital and reduce equity exposure to mitigate market volatility. This is the benefit of embracing financial technology in fund management,” he says.

Arabesque CEO Omar Selim says the company can put in place additional filters to screen out companies that do not fit the criteria of its quantitative model. This is done at the first level of analysis, which is the sustainability analysis.

“The first step is imposing a minimum requirement on the size, free float and daily volume to an investment universe of 77,000 global stocks. We exclude companies with market capitalisations of less than US$1 billion, or where the average daily trading volume over the past six months was less than US$3 million, or with less than 10% of free float. The investment universe will then be reduced to about 4,500 stocks, which still represents about 75% of the global market capitalisation,” he explains.

“The second step is excluding companies with a high probability of unreliable data. By assigning an Accounting and Governance Risk (AGR) score that detects the probability of financial manipulation, companies in the bottom 10% of the AGR ratings are excluded, leaving about 4,000 stocks left in our investment universe.”

The third step is to exclude companies that violate the core principles of the United Nations Global Compact, including human rights, anti-corruption, labour rights and environmental standards. “The fourth step is to use environmental, social and governance (ESG) information to identify companies that are positioned for long-term success,” says Selim.

“Arabesque excludes stocks that fall in the bottom 25% of each country and industry. The percentage could change according to the requirements.”

He adds that companies that show improvements in their ESG score over a certain period will be re-admitted to its investment universe.

With about 3,000 stocks now, the fifth step is to screen out companies that are not shariah-compliant, says Selim. Companies that have significant involvement in prohibited activities or high leverage are excluded. The investment universe is reduced to about 1,000 global stocks after the sustainability analysis. This is done every three months.

“Just like other fund management firms, we then apply financial analysis such as assigning financial and growth scores according to their balance sheets and cash flow as well as growth and earning. We also examine behavioural patterns of sell-side research analysts. At this level, the investment universe is reduced to 300 global stocks,” he says.

The remaining stocks go through momentum analysis, which includes asset allocation that decides on the equity-cash allocation based on market momentum, and stock selection, based on the optimal stock combination that delivers the best risk/return profile. The investment universe is reduced to 100 global stocks at the end of the process.

As at July 1, the fund’s top holdings included Logitech International SA (hardware and software), Kandenko Co Ltd (engineering and construction), Ulta Salon Cosmetics and Fragrance Inc (salon products), Nvidia Corp (visual computing technology), Thor Industries Inc (recreational vehicles), Lonza Group AG (pharmaceutical, healthcare and life science), Edwards Lifesciences Corp (medical technology), Recordati Industria Chimica (pharmaceutical), Boliden AB (metal and mineral products) and Cintas Corp (corporate identify uniform). At any given time, the fund only allocates a maximum of 1% of its net asset value to a stock.

Launched in November last year, the wholesale fund is only offered to sophisticated investors with a minimum investment amount of RM30,000 for its RM class and US$10,000 for its USD class. It charges an annual management fee of 1.8% and trustee fee of 0.06%. Investors may incur a sales charge of up to 5% if they buy through traditional channels. Online distribution channels, such as Fundsupermart, have a 2% sales charge.

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