What are we looking for?
Pharmaceutical companies poised to benefit from a non-traditional source of alpha generation.
The screen
The practice of socially responsible investing (SRI) has gone through an evolution over the past decade. Initially, the practice was dominated by what is referred to as “negative screening,” for example: simply not holding tobacco companies or firearm manufacturers. The main question at the time was: “Are investors willing to sacrifice returns in order to have an ethical portfolio?”
Recently, some have argued that an ethical tilt to a portfolio doesn’t necessarily lower returns. Even more recently, studies have shown that, in fact, integrating environmental, social and governance (ESG) issues into the investment research process actually enhances returns by considering both risks and opportunities that in the past were ignored. Last year, Goldman Sachs conducted a study on ESG factors to determine whether and how ESG integration can create alpha, that is, outperformance compared with the broader market. The result was that it does create alpha, with specific factors creating especially strong outperformance.
Companies with higher levels of female employees had an average annual alpha of 3.3 per cent across all sectors, the study showed. There was a wide dispersion among sectors, which intuitively makes sense; a diversity of ideas (which can lead to greater innovation) should have a profound impact for companies whose main asset is intellectual property (IP), and less so for a company whose main assets are heavy machinery or natural resources.
For pharmaceuticals (a very IP- and research-intensive industry), this outperformance was an outstanding 12 per cent annually, and this is where we focus today’s screen.
- We start with pharmaceutical companies globally and screen for at least 45-per-cent female employees. To make sure we are looking at companies that are taking advantage of this potential for greater diversity of ideas, we also require R&D spending to be at least 10 per cent of revenue.
- Next, we use the Thomson Reuters “Combined Alpha Model,” which takes valuation (both relative and intrinsic), price momentum (short-, medium-, long-term and industry-wide), analyst sentiment, short interest and earnings quality into consideration. We assign companies a percentile score, and require a score of at least 90.
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What we found
The company passing the female representation and R&D requirements with the highest Combined Alpha score is AbbVie. On the R&D front, on its latest earnings call the company stated it believes that it has “one of the most compelling pipelines in the industry” and announced that its psoriasis drug, risankizumab, reported best-in-category results across four pivotal studies. Both U.S. and European regulatory applications have recently been filed.
Investors are encouraged to conduct their own research before purchasing any of the investments listed here.
Hugh Smith, CFA, MBA, works in the financial and risk unit of Thomson Reuters and specializes in wealth and asset management.