The market is replete with studies that research the relationship of ESG integration and performance. Tracking error is often discussed in conjunction with performance and the issue of tracking error against a strategic benchmark arises in most client conversations around ESG integration.
In our 2021 ESG outlook, we highlighted that investors tracking an underlying benchmark often have strict limits on tracking error embedded in their investment processes.
Yet, deviations from standard benchmarks become inevitable when ESG considerations are included in index methodologies. Also, with rising ESG adoption and the notion of ESG becoming “The New Normal” it is not inconceivable that ESG considerations will make their way into standard benchmarks.
So how should investors evaluate tracking error in light of internal and external pressure for more ESG integration?