Description: Investment Risk Management, Skill Evaluation, and Predictive Performance Analytics
ESG constraints and overlays can create significant systematic exposures within equity portfolios. Whereas some of these exposures may be intentional long and short industry bets, others are unintentional bets on the overall equity market or other macroeconomic factors . In order to deploy ESG strategies successfully, it is vital to identify, quantify, and manage the effect of ESG constraints on systemic risk. That is the only way to avoid unintended hidden risks and the poor performance that results.
Over the past decade, institutional investors have been increasingly incorporating Environmental, Social, and Governance (ESG) metrics into their portfolios. Common approaches include separate ESG mandates and ESG constraints applied across entire portfolios. The investors who have implemented these strategies have too often paid little attention to the changes they cause in their portfolios’ factor exposures. This oversight is regrettable, since such changes in systematic risk can dominate subsequent track
To illustrate a typical ESG overlay effect, we created a constrained portfolio using the FTSE-Russell ESG ratings for S&P 500 Index constituent. The constrained portfolio excluded approximately 18% of the index’s market capitalization with low ESG ratings (below 2.5). A highly predictive multi-factor equity risk model allowed us to analyze the constrained portfolio’s tracking error relative to the unconstrained index.
AlphaBetaWorks Charts – Investment Risk Management, Skill Evaluation, and Predictive Performance Analytics
AlphaBetaWorks Insights – Investment Risk Management, Skill Evaluation, and Predictive Performance Analytics
AlphaBetaWorks Charts – Investment Risk Management, Skill Evaluation, and Predictive Performance Analytics