Mr. De Franco, the composition of CAPE indices and ETFs based on them is derived from the Shiller P/E ratio. What are the advantages compared with other valuation methods such as the "classic" P/E ratio?

Carmine De Franco: There are some of those from my perspective. Most valuation ratios compare the share price with earnings or sales at a given point in time. But how these turn out depends on the state of the business cycle at the time. This makes the indicator very volatile.

A typical business cycle extends over an average of ten years. Because the Shiller P/E ratio takes into account the average of earnings over this period, it is much more stable: It does not depend on a single data point. This minimizes the influence of short-term developments, which can make the ratio much more powerful for long-term forecasts than classic valuation models. Incidentally, this is also reflected in the long-term correlation between cape ratio and performance.

That sounds like a value strategy, doesn't it?

De Franco: Let's put it this way: it's a value approach, but not a value strategy. A value strategy involves buying what is cheap to buy and has recovery potential from the investor's point of view. In the past ten years, however, growth stocks have done very well, for example in the pharmaceuticals or technology sectors. Value managers, on the other hand, have struggled because there has been less focus on these companies.

Carmine De Franco, Head of Fundamental Research Ossiam

We look at the Shiller metrics on a relative basis – at the sector level. We don't necessarily buy what's cheap, but rather look for sectors that are cheaply valued relative to their long-term average and therefore have room to move up. These can also be growth stocks. So, we invest in both value and growth, depending on what is interesting at the moment.

However, a favorable valuation alone does not necessarily indicate upside potential...

De Franco: That's true. Most portfolio managers focus on equities and look for bargains at the corporate level. Of course, that comes with risks. Companies can get into trouble or even go out of business. There is no reason to believe that companies will always recover just because they are cheaply valued. So many factors play a role in success or failure that no valuation model, no matter how powerful, can capture. Many things can go wrong.

But we look at sectors. They've been around since the stock market was born. And there are always phases in which they develop stronger or weaker. So it makes sense to look at this level to ensure broader diversification.

That's the main difference between a traditional value manager and a relative value manager. Because the competitiveness or valuation of a sector does not really depend on just one company.

At the end of the valuation process, there are four sectors, each weighted at 25 percent. What is the reason for this equal weighting?

De Franco: You see, there are basically three ways to weight the sectors. The first is to give more weight to the sector with the most favorable valuation. That makes sense at first. But: Of course, this also increases the dependency on this sector. Especially since it may be that a relatively small sector is highly weighted. While this solution is therefore tempting, it is not practical in practice, as it can lead to diversification problems. Another option is to take the four sectors and weight them by market capitalization. In this case, however, one is always heavily dependent on the performance of the largest sectors.

So, from our point of view, the best option is to weight the four sectors equally. We do not know beforehand which of them will perform best – but only that they have the greatest potential according to the Shiller P/E ratio. Therefore, an equal weighting seems to us to be the most appropriate. Within sectors, companies are weighted according to their market capitalization.

Specifically, this is the Ossiam Shiller Barclays CAPE Europe Sector Value TR UCITS ETF (ISIN: LU1079842321), which investment universe is the MSCI Europe. The second ETF is the Ossiam ESG Shiller Barclays CAPE® Europe Sector UCITS ETF (ISIN: IE00080CTQA4) which is the Sustainable version of the European CAPE Shiller Strategy. The third ETF is the Ossiam Shiller Barclays CAPE US Sector Value TR UCITS ETF (ISIN: LU1079841273), which investment universe is the S&P 500. The fourth ETF is the Ossiam ESG Low Carbon Shiller Barclays CAPE US Sector TR UCITS ETF (ISIN: IE00BF92LR56) which is the Sustainable version of the US CAPE Shiller Strategy.

Only low valuation sectors make it into the index composition

What is special about the Shiller-Barclays CAPE indices is that they are based on the valuation model developed by Yale professor Robert J. Shiller in the 1980s, which, unlike the price-earnings ratio, is based on the average inflation-adjusted earnings of the past ten years. On the basis of this so-called Cyclically Adjusted Price-Earnings (CAPE) ratio, also known as the Shiller P/E ratio, the five most highly valued stock market sectors are first sorted out from the ten market sectors of the investment universe. In a second step, a filter is applied to eliminate the sector with the weakest momentum from the five cheapest sectors. This is to avoid falling into the value trap. The index is rebalanced monthly so that investors are always invested in the four cheapest sectors – 25 percent each.

Growth sectors are also taken into account

So basically, it is a value-oriented approach – but that does not mean that growth sectors do not play a role: In order to take into account fundamental valuation differences between sectors, the relative CAPE indicator is used. This means that not only classic value sectors come into question: the US version of the ETF was invested in telecommunications services in each of the first eight months of 2021, for example, as well as in the entire year 2020. The technology sector also made it into the portfolio regularly, especially in the first half of 2020. In addition, financial services and healthcare were frequently represented in the portfolio in 2021, while cheaply valued consumer staples often failed the momentum filter. Overall, technology, healthcare and industrials have been in the portfolio the longest since the inception of the Ossiam Shiller Barclays CAPE US Sector Value TR UCITS ETF. Energy, basic materials and utilities were the least common.

US ETF with additional sustainability overlays

For investors looking to invest in the US CAPE Shiller Strategy with a sustainability focus, the Ossiam ESG Low Carbon Shiller Barclays CAPE US Sector TR UCITS ETF offers a sustainability-oriented version. The Fund differs from the standard version by incorporating an ESG and Low Carbon overlay. The ESG overlay is composed of a multi-dimensional sequence of filters, which is applied after selecting the four most favorable sectors. An initial screening is done through a best-in class filter that removes the 20 percent worst ESG rated stocks. Then, companies that are active in the area of controversial weapons, tobacco and coal or are involved in high controversies regarding environmental, social and corporate governance issues are sorted out. Companies on the major Scandinavian institutions’ (such as Norges Bank) publicly available exclusion lists or in breach of the UN Global Compact are also not included.

Compared to the original index, the strategy aims to reduce total greenhouse gas emissions, carbon intensity – i.e. emissions in relation to corporate sales – and potential greenhouse gas emissions from fossil reserves by 40 per cent.

Different sector mix in Europe

Looking at the Europe focused Ossiam Shiller Barclays CAPE Europe Sector Value TR UCITS ETF, the sector mix is different from the US version. Last year, telecoms and consumer staples as well as consumer cyclicals were among the perennial favorites. Technology, basic materials, utilities and – perhaps somewhat surprisingly – industrials played mostly no role.

Following the success of the US CAPE Shiller ESG version and increasing investor demand, the sustainability-oriented version of the Europe CAPE Shiller, the Ossiam ESG Shiller Barclays CAPE® Europe Sector UCITS ETF was launched on December 17th, 2021. This Fund incorporates an ESG overlay to the Shiller Europe Strategy composed of a multi-dimensional sequence of filters, which is applied after selecting the four most favorable sectors. An initial screening is done through a best-in class filter that removes the 20 percent worst ESG rated stocks. Then, companies that are active in the area of controversial weapons, tobacco and coal or are involved in high controversies regarding environmental, social and corporate governance issues are sorted out. Companies on the Major Scandinavian institutions’ (such as Norges Bank) publicly available exclusion lists; or in breach of the UN Global Compact, are also not included. Specifically for electricity producers, companies that produce more than 20 percent of their output from thermal coal-fired plants are also excluded. Finally, the worst 20 percent rated stocks on the basis of GICS-4 adjusted ESG & Carbon Intensity (Scope 1,2 and 3) are excluded. The remaining stocks are weighted to match the initial weight of each selected sector (25 percent each).

In consultation with clients, investment professionals continuously evaluate markets to ensure that their strategy achieves long-term objectives. In addition, the company is committed to promoting sustainable finance and developing innovative ESG products.

Expertise of more than 20 active managers

Natixis Investment Managers' multi-affiliate approach connects clients with the independent assessments and combined expertise of more than 20 active managers.

One of these is Ossiam. The Ossiam experts have extensive know-how in the areas of systematic trading strategies, quantitative research and management, multi-strategy funds, funds of funds and structured fund management.

The team deals with the development of investment strategies based on quantitative models and fundamental analyses as well as the structuring of funds. Criteria such as liquidity, tradability and representativeness are integrated into the investment process.

The systematic management processes are implemented in rule-based indices that are compiled by independent calculation agencies or index providers. The strategies aim to cover a large universe of underlying assets as well as investment styles.

Ossiam provides access to strategies with different risk profiles in all asset classes and offers its clients long-term investment solutions and products tailored to their specific needs.

* Cerulli Quantitative Update: Global Markets 2021 ranked Natixis Investment Managers as the 15th largest asset manager in the world based on assets under management as of December 31, 2020.

** Assets under management (“AUM”) as of September 30, 2021. AUM, as reported, may include notional assets, assets serviced, gross assets, assets of minority-owned affiliated entities and other types of non-regulatory AUM managed or serviced by firms affiliated with Natixis Investment Managers.