Sustainability: now at the core of factor investing
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.
- Factor investing is proving well-suited to achieving both sustainable and financial objectives
- Integrating ESG considerations gives a richer, deeper understanding of the asset being invested in
- Multi-factor investment strategies involve both exclusions and integrations as the two main complementary sustainability pillars
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.
There are good reasons to integrate sustainability into one’s investment 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.
Exhibit 1: five reasons why sustainability matters to BNP Paribas Asset Management
From exclusions to integration
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:
- Increase by 20% the portfolio’s ESG score versus the benchmark’s ESG score
- Reduce by 50% the portfolio’s carbon footprint versus the benchmark’s carbon footprint .
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.
Combining the best of both worlds: Factor and sustainability investing
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
In a world striving for greater sustainability, investment in coal – be it mining or power generation – should be much more selective, hence our new coal investment policy. Also in this issue: how to navigate markets as they swing between the impact of news on the fundamentals and adjustments in central bank liquidity; what to make of the trends in US inflation; and our assessment of the relations and economies of China and the US.
Investors can look forward to greater transparency on sustainable finance as Europe takes the lead with an ambitious plan to help redirect capital flows, define sustainability and foster long-termism. This issue also covers the outlook for US earnings in 2019, incorporating sustainability in factor investing and an insight into who should call the shots in handling the next recession.
A “Great Instability” has followed the Great Financial Crisis and the risk of radical disruptive change looks high, with potentially profound implications for investors