Factor investing strategies can maximise portfolio returns while reducing risk. Adding ESG objectives to such strategies adds sustainable investing as a third dimension in addition to the return and the risk.
The extent and scope to which investors are integrating sustainability considerations into their investments is proceeding at a rapid pace, says Gregory Taieb, quantitative investment specialist.
Asset managers are responding by creating innovative strategies which combine financial objectives and environmental, social and governance (ESG) goals.
One outcome of these innovations is that factor investing in equities, fixed income and multi-asset portfolios is proving to be a solution well-suited to investors looking to achieve both sustainable and financial objectives.
A few years ago, there was much debate on the benefits of sustainable investing and the risk/return impact it has for an investor. In our view, any such debate is over: Sustainability is now widely recognised as a long-term driver of returns and mitigator of risk. Integrating ESG goals when building a portfolio means asset managers acquire a deeper and richer understanding of the potential reputational, operational and financial risks. Ultimately, they can make better-informed investment decisions for clients.
Historically, the main focuses of sustainable investing were exclusions, stewardship, thematic investing and awareness.
Today, sustainable objectives – and in particular ESG standards – are fully integrated into a wide range of investments: Sustainability has become a core component of investment strategies; it no longer sits on the periphery. Integrating sustainability objectives has become crucial in meeting investors’ expectations and needs. That is why, at the end of 2018, BNP Paribas Asset Management’s quantitative equity investment team added two ESG integration objectives to the exclusions already in place:
The fact that ESG considerations have become core to our strategy implies an evolution in our approach. In the case of multi-factor investing, this means going beyond exclusions to focus on ESG integration at the portfolio construction level. The advantage of such an approach is that if a stock’s characteristics are outstanding from a financial point of view, it can still be part of the portfolio despite a relatively lower sustainability score.
As Exhibit 2 illustrates, multi-factor investment strategies involve both exclusions and integrations as the two main complementary sustainability pillars required by investors.
Factor investing strategies have been designed to maximise portfolio returns while reducing risk using a systematic investment process. By adding ESG objectives to factor investing strategies, sustainable investing can be treated as a third dimension in addition to the return and the risk. Looking ahead, investors will be able to tailor their investments based on three major objectives: the return they expect, the risk they are willing to take, and the sustainable objectives they seek.
This article appeared in The Intelligence Report – 26 February 2019