IQ Investment Quarterly
Aligning Factor and ESG Views
In the same way that the study of the underlying drivers of risk and return has helped investors identify long-term, durable factor premia, growing research into the potential impacts of environmental, social and governance (ESG) issues on a company’s financial performance is also helping investors understand how to integrate ESG risks and opportunities into their investment decision-making. More investors are seeking to construct portfolios that allow them to capture both the long-term, durable premia of recognized factor tilts as well as invest in companies with attractive ESG attributes. A recent research project from our Global Equity Beta Solutions team showed investors how to invest in companies with positive ESG attributes without compromising their desireto capture long-term factor premia to target better risk-adjusted returns over the long run.
At the heart of the challenge is that ESG and factors will not always be aligned: companies with high ESG ratings will sometimes have undesired factor characteristics. Likewise, companies with desirable factor characteristics may not have the appropriate ESG profile investors want. Fortunately, modern portfolio construction toolkits offer an effective way to resolve this problem. Using a portfolio algorithm such as a mean-variance optimizer allows us to balance competing objectives in a straightfor ward way, delivering portfolios with the desired factor and ESG profile.