This industry veteran thinks ESG funds are insufficient. So he turns to AI and carbon permits to fix them.

John Pileggi, whose 35-year career in asset management includes managing a bank’s mutual fund and distribution business, believed ESG investing was hampered by two problems he believed he could address: the challenges active managers face when trying to deliver consistent alpha, and the need to assure investors that the funds actually do what they promise and are not simply engaged in greenwashing. Greenwashing is not just a theoretical problem. It’s a question that has put asset managers in the crosshairs of regulators, who are increasingly on the alert. In fact, Securities and Exchange Commission Chairman Gary Gensler has mentioned the possibility of requiring clearer labels for sustainable funds.

Shortly after meeting the co-founders of Turing Technology Associates, which backs an approach called Ensemble Active Management, Pileggi thought he had the solution to the first problem, alpha. EAM uses data science techniques known as ensemble methods, which have been used successfully in almost every industry except investing. According to several articles, including one published in 2019 in the CFA Institute Enterprising investor, these contribute to preserving the alpha of active managers with a new approach to diversification. By using ensemble methods, which rely on artificial intelligence and machine learning, companies can use the most compelling stock picks from multiple managers, rather than the individual managers employed by most active funds. , to provide downside protection. Put in context, it makes sense. Alexey Panchekha, PhD in Mathematics and Physics and one of the co-founders of Turing, said: “Concentrated portfolios are statistically more likely to outperform. Your best thought is valuable, but your fiftieth – not so much.

Although there are now active funds using the ensemble methods, nothing is available on the ESG front.

“Many of the greatest managers tend to water down their ability to create alpha. The science of EAM eliminates many problems and leverages the wisdom of experts,” said Pileggi, who is the CEO of Strategic Innovations Advisors. since 2017. He has witnessed the failures of active management decades ago at the bank (ING Bank, which was acquired by a rival after the global financial crisis) and other wealth managers and advisers over the years.

When Pileggi met Panchekha and Turing CEO Vadim Fishman, he thought the ability to leverage the expertise of multiple managers would be particularly revolutionary in ESG, where value-based stock picking was a relatively new area. and required some expertise, and where many investors were still waiting to see that the funds could generate good returns as well as good results, such as reducing the carbon footprint of companies.

Then Pileggi stumbled upon Climate Vault, a nonprofit that develops net zero solutions. Climate Vault seemed to offer an elegant and systematic solution to the problem of greenwashing. “They make no value judgments about a company’s philosophy or values. They simply say that if you have a wallet and the features of the wallet are right for you, we have the expert wisdom to help you figure out what your carbon footprint is dollar for dollar. We can fix the problem,” he said.

Here’s how it works: Pileggi’s company provides information about the Turing-generated portfolio, and Climate Vault then offers a price to decarbonize it. Funded by management fees, rather than deducting the cost of the portfolio where investors would pay, Pileggi’s company makes an irrevocable donation to Climate Vault.

Essentially, the decarbonization component is structured as an overlay to the portfolio; the overlay is performed monthly. Thanks to the partnership with Climate Vault, SIA measures the carbon footprint of each company in the portfolio. Carbon permits are then purchased on cap-and-trade compliance markets and locked in a virtual vault so that emitters cannot use them. Since the number of permits is capped, the solution permanently reduces the amount of carbon dioxide in the atmosphere.

The only way Climate Vault will put these permits back into circulation is if the proceeds can be used to further the development of impact technologies for companies that cannot access capital markets.

The design structure reduces, dollar for dollar, the carbon emissions from the inventory held by the NetZero Wallet. Although many ESG funds may ultimately invest in companies that will make a difference in reducing greenhouse gas emissions or develop innovative solutions to climate issues, Pileggi’s fund could immediately document its positive results.

“Investors benefit from the advantages of EAM and all that goes with it. Second, they can decarbonize the wallet I create,” Pileggi said. SIA currently runs what it calls the NetZero Investment Solution, a strategy for clients. The company has a number of future plans, including an exchange-traded fund version of the strategy.

Pileggi is creating a fund that will provide environmental benefits that can be proven and documented. But that’s where his goodwill ends. It does not share it with other asset managers, having recently filed a patent on the concept and design.

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