Some Considerations for Investors Exploring ESG Strategies

Abstract

Investors who are concerned about environmental, social, and governance (ESG) factors face numerous questions. In the author’s opinion, investors need to determine which ESG issues are important for them, and how these issues should be reflected in a portfolio. For some strategies, ESG factors are integral to the investment process, whereas for other strategies, ESG factors are best captured via simple and transparent rules (screens and/or tilts). Investors also face several practical implementation choices. Should each company be evaluated on the basis of its current ESG profile, or is the trend more relevant? Should a company be analyzed on a stand-alone basis or relative to its industry peers? And for the strategy, what is the appropriate level of active risk (tracking error) relative to the policy benchmark? In addition, investors need to determine how to monitor any ESG strategy over time, which will help ensure the strategy is performing as expected. In the author’s opinion, perhaps the biggest challenge facing investors is articulating an investment thesis for an ESG strategy. Which ESG factors are already reflected in security prices, and which ESG factors have the potential to drive outperformance? Finally, the article identifies some differences between equity and fixed income strategies as they relate to ESG.

TOPICS: ESG investing, portfolio theory, portfolio construction