An Integrated Approach to Quantitative ESG Investing

ESG investing is an area of active interest for both the investment and academic communities. Despite the intense interest, there currently is no agreed upon definition of ESG investing, or how to best build investment portfolios that incorporate both return and sustainability dimensions. (Both are important for sustainability-minded investors.) In this article, the authors categorize the broad types of ESG investing currently in the market and introduce an ESG investment framework. This results in a portfolio that optimally combines the dual objectives of alpha and sustainability outperformance. TOPICS:Portfolio theory, portfolio construction, ESG investing Key Findings • It is possible for ESG factors to also generate alpha, provided materiality is taken into consideration. • Standard methods of materiality definition, based on sectors, can be limiting and are not the optimal axis to measure materiality. • ESG investing is based on investor’s sustainability values, which must be incorporated as part of ESG portfolio construction. • In situations where the asset owner’s sustainability values and alpha generation do not align, a quantitative approach can be used to graph an ESG-efficient frontier.