Portfolio Level ESG Integration II

Arun Kelshiker

20 years: Asset management and stewardship

In this video, Arun explores ESG integration across asset classes. He also talks about historical trends in applying ESG, compare screening for companies and funds, optimising ESG portfolios, and understanding ESG in passive investing.

Investment Management Sector

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Portfolio Level ESG Integration II

14 mins 4 secs

Key learning objectives:

Understand how ESG has historically been applied to various asset classes
Understand how ESG screening varies between individual companies and collective investment funds
Understand how ESG integrated portfolios can be optimised
Understand how to integrate ESG into passive portfolios

Overview:

ESG integration varies in depth and approach across asset classes. Equities are at the forefront in terms of transparency and shareholder engagement, while fixed income has lagged in ESG adoption. Hedge funds are steadily adopting ESG, as reflected in the PRI's revised frameworks. In private equity, investors commonly employ exclusionary screens, but partners are pivoting to positive ESG screening. Real estate investments offer distinct ESG prospects, with organisations like GRESB providing tailored insights. Screening methods pinpoint ESG risks in both individual companies and broader funds. Balancing risk-return with ESG objectives is vital when refining ESG-integrated portfolios. While ETFs and other passive portfolios are ramping up ESG integration, they face distinct hurdles in active engagement and possible diversification constraints.

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Summary

How can ESG screens be applied to various asset classes?

Historically, ESG application varied across asset classes. Fixed income lagged behind equities due to limited ESG data, especially in government debt and high yield credit. In contrast, listed equities embraced higher ESG integration, leveraging transparency and shareholder voting rights. Hedge funds gradually began incorporating ESG into portfolios, while private equity used exclusionary screens, though with limited benchmark diversity. Real estate and infrastructure, given their direct ownership models, provided better ESG control and organisations like GRESB further streamlined ESG integration in these areas.

How does ESG screening of individual companies compare to collective investment funds?

For individual companies, ESG screening identifies risks and opportunities associated with environmental, social, and governance factors, such as carbon emissions and labor practices. This analysis can lead to portfolio weight adjustments relative to market benchmarks. In comparison, collective investment funds, like mutual funds or ETFs, undergo ESG screening through approaches like negative, positive, and norms-based screening. These screenings target specific objectives, from avoiding poor ESG performers to adhering to international standards, requiring a methodical process of criteria identification, oversight, and regular reviews.

How can ESG integrated portfolios be optimised?

Optimising ESG-integrated portfolios involves managing risk and return dynamics. Investors use asset weights within portfolios to maximise returns for a given risk level. When integrating ESG considerations, it serves as an additional factor that could enhance the portfolio's risk and return profile. Portfolio optimisation techniques can set bounds for variables like ESG datasets or carbon emissions levels, applied both absolutely and relatively compared to a benchmark. Balancing desired ESG outcomes with tracking error relative to the benchmark is crucial to prevent underperformance.

How can ESG be integrated into passive portfolios?

Integrating ESG into passive portfolios, like ETFs that track market indices, has evolved since the introduction of MSCI's KLD 400 social index in 1990. Innovative passive ESG investing approaches now incorporate strategies like smart-beta, weighting indices towards style factors while screening for high ESG performance. Notable examples include MSCI’s New Factor ESG Target indices and investments by large organizations like CalSTRS and GPIF. However, there are challenges, such as unintended portfolio biases due to exclusions, and passive strategies often lack the deep engagement activities seen in active investing.

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Arun Kelshiker

Arun Kelshiker was formerly the Head of Asset Allocation and Portfolio Strategy at Standard Chartered Bank and part of the bank's Global Investment Committee, where he provided investment advisory and multi-asset portfolio solutions. His focus is now with Cambridge Sustainable Investment Partners, which draws its expertise from the Resilience and Sustainable Development Centre at Cambridge University. He is also a university lecturer at the Frankfurt School of Finance and Management and is Vice Chair of the CFA UK's Inclusion and Diversity Committee and its Investment Committee.

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