The trend toward ESG is taking place at a time of major structural changes in investment styles with the rise of passive investment on one hand and smart beta approaches on the other. The move toward passive investment can be clearly observed by the massive increase in assets invested in exchange-traded funds. Smart beta approaches, while still smaller than passive investments, are gaining traction as investors can expose their portfolios to different investment styles and avoid excessive exposure to capitalization weighted indexes. The total assets under management of the asset management industry at USD 79.2 trillion in 2017. Of those, USD 16 trillion, i.e., approximately 20%, is passively managed. Smart beta is estimated at USD 430 billion but has been growing by 30% per year since 2012. An important question that arises is how ESG integration affects the nature of the passive and smart beta portfolios. A fundamental concern is that improving the score of the portfolio may result in the deterioration of its performance. For passive investors, integrating weights departing from market capitalization may increase the level of tracking errors with respect to the benchmark. For smart beta, the integration of ESG may reduce the efficiency of the factor that is targeted by the strategy. 

Greening the Swiss National Bank’s Portfolio

Rüdiger Fahlenbrach and Eric Jondeau

Abstract: We analyze the carbon footprint and emissions of the Swiss National Bank’s (SNB) U.S. equity portfolio and compare its carbon performance to those of the world’s largest asset manager, BlackRock, and to the Norwegian Government Pension Fund Global (GPFG). The SNB portfolio does as well as BlackRock’s but has a signicantly worse carbon footprint than the portfolio of GPFG. Few firms are responsible for much of the carbon emissions of the SNB portfolio so that carbon conscious investment approaches have a large impact on portfolio emissions but little impact on performance, diversication, or tracking error. We explore several avenues to reduce the carbon footprint of the SNB’s portfolio, while not altering its financial performance. If the SNB excluded the firms with the highest carbon intensity representing 1% of the portfolio value and reinvested in the companies with the lowest intensity in the same sector, the total nanced carbon emissions would be reduced by 22% in 2019, with no impact on the portfolio’s financial performance.

Working Paper

Optimal Strategies for ESG Portfolios

Journal of Portfolio Management, vol. 47, Issue 6, 114-128, May 2021

Fabio Alessandrini and Eric Jondeau

Abstract: Previous research has provided evidence that in the last decade, investing according to screening based on environmental, social, and governance (ESG) criteria would have allowed investors to considerably improve the ESG quality of their portfolio without deterioration of its financial performance. However, a drawback of such a screening process is that it may generate undesirable regional, sectoral, and risk factor exposures. In this article, the authors propose an investment strategy that maximizes the ESG quality of the portfolio while maintaining regional, sectoral, and risk factor exposures within stated limits. They provide evidence that such a portfolio would have produced risk-adjusted performance at least as high as the standard MSCI benchmark for a wide range of ESG criteria and regions over the 2007–2018 investment period.

ESG Investing: From Sin Stocks to Smart Beta
Journal of Portfolio Management, vol. 46, Issue 2, Quantitative Special Issue 2020
Fabio Alessandrini and Eric Jondeau

Abstract: Research on socially responsible investment in equity markets initially focused on sin stocks. Since then, the availability of data has been extended substantially and now covers environmental, social, and governance (ESG) criteria. Using ESG scores of firms belonging to the MSCI World universe, we measure the impact of score-based exclusion on both passive investment and smart beta strategies. We find that exclusion leads to improved scores of otherwise standard portfolios without deterioration of their risk-adjusted performance. Smart beta strategies exhibit a similar pattern, often in a more pronounced way. Moreover, our results demonstrate that exclusion also implies regional and sectoral tilts as well as (possibly undesirable) risk exposures of the portfolios.