The art and science of ESG based portfolio management

Have you ever tried to put together a piece of Ikea furniture without reading the instruction manual? Unless you are an expert in the field, you will end up with unnecessary troubles, and you will spend much more time than necessary trying to reach your end goal. The same concept applies to ESG within your portfolio management strategy.

ESG reports

We have seen many reports about different ways to use ESG (environmental, social, and governance), the usual rules for measuring sustainability.

The majority of reports still concretely considers ESG exclusions only, which refers to refraining from investing in companies which are on exclusion lists by their ESG score providers. But there are some other ways to consider ESG, such as thematic investment, best in class, impact investing, etc. Some critics would argue that one should have a set of sub-criteria and apply such exclusions at that level. Further, some would pretend a portfolio manager should weigh its exposure according to that criteria, with more exposure provided for the most virtuous companies.

The reality, however, is that each institution has its own individual objectives and constraints, and that as such, ways to read ESG scores should be adjusted to each one’s case. Investing is not one-size-fits-all, so it follows that specific portfolios would require specific ways to read ESG to create a customized and successful portfolio.

Take this example: a pension fund in Northern Europe has a domestic and an international equity portfolio. The country is biased to certain industries, so in turn, the domestic portfolio is quite concentrated in terms of risks, with little diversification offered by liquid enough companies for such a large investor. Consequently, it needs to open its international portfolio to companies from different horizons, representing other business and markets. Should the same ESG criteria apply to the home country that it applies to any foreign investments? Going more granular into sustainability ratings, should any company of the portfolio have the same impact on life and land, life below water, or responsible consumption and production? Investors often find it challenging to reach a middle ground in these criteria, but adding ESG into your portfolio management strategy may provide the answers you’ve been searching for.

ESG portfolio management and impact on the real economy

Returning to the example, should our company’s portfolio have the same treatment for variables across the board? Certainly not.

• First, this would be extremely reductive in terms of possible opportunities.
• Second, one can consider that different countries and industries have to go at different paces when it comes to reaching sustainability objectives. It does not mean one should be complacent, but it is actually the exact opposite; by including the most virtuous of those companies into the portfolio, this large shareholder sends a clear signal to the market that those making efforts can be rewarded.

This strategy can expand to have an effect on a global scale. As a matter of fact, speaking about the impact of this strategy long-term, steady investors are instrumental in educating CEOs on how to reach better standards in terms of governance, gender equality, and corporate social responsibility. The list of sustainable developments goals, as defined by the United Nations, represents objectives which go beyond the simple company bottom line and instead reach the entire society. One can mention, for example, zero hunger, quality education, clean water and sanitation, or climate action. This sample is just one way to demonstrate the impact that ESG portfolio management can have on our global community.

We have seen another example came into play during the financial crisis with credit ratings, proving that when too many people use the same thing in the same way and at the same time, this can create market bubbles, which at some point can turn into disasters. If the same rules apply to all investors, then the same companies will be bought, growing their valorisation and concentrating the risks on their sole entities. To prevent disasters such as this, diversification is vital and cannot be overlooked. It is imperative to create specialized criteria throughout different investments.

Benefit from Quantilia’s step-by-step approach to ensure the ease and success of investing

Today, Quantilia proposes different ways to read the ESG markets and apply a clear set of rules to each investor. Together with specialised partners, we can define a relevant ESG policy for your company and design the right tools to ensure it will be applied. While it may seem like a daunting task, Quantilia has a step-by-step approach to ensure the ease and success of investing.

One should not forget that financial and non-financial success are closely tied with each other, and no management would tolerate a significantly bad performance versus benchmark, should only ESG criteria be put into perspective. This is why one should talk about ESG performance analysis or ESG performance contribution, looking at a portfolio production as a whole.

Likewise, a vast majority of investors have now understood that pure financial performance, should it put climate change or human rights at stake, is out of the question. As ESG and performance need to be considered at the same time, Quantilia allows institutional investors to optimise the tracking error or the Sharpe ratio of a trade idea in parallel with a rigorous assessment of the impact of that trade idea on the overall portfolio ESG score.

Let’s return to our Ikea example. Unless you are an expert in building furniture, you will have a hard time assembling your new purchase without any guidelines. Between the complex nature of the craft and the sheer number of pieces you must deal with, it can be a daunting and frustrating task to fit each piece together in the precise manner necessary to achieve your result.

At Quantilia, we are your expert. Our experience in the investing field will guide you through the process of integrating ESG into your portfolio management strategy, and we will show you the most efficient and impactful way to ensure your success in the short-term and the long-term.