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Factoring in ESG criteria into portfolio construction

Leon Saunders Calvert
Leon Saunders Calvert
Head of Sustainable Finance, Lipper and I&A Insights

The pressure has been growing for sometime, including recent market conditions that are heightening the focus on ESG investing. But how do active portfolio managers pragmatically incorporate responsible investing into their portfolios?


  1. ESG datasets are developing at pace, and are now being considered by virtually every mainstream institutional finance professional.
  2. The challenge that Covid-19 brings to the issue of sustainability, is on the issue of resiliency to short-term shocks.
  3. If you want to manage long-term risk and opportunity, it is quickly becoming a competitive disadvantage not to understand this investment approach.

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Putting ESG thinking at the heart of your investment process

The speed at which ESG has ascended the list of priorities among the world’s asset managers and investment institutions — welcome though it is — has overtaken the practical capacity of many portfolio managers to encompass this multi-faceted issue.

A new study by Aite Group1 has found that Europe-based institutional investors in particular are demanding more from asset managers regarding their ESG reporting requirements.

A growing number wish to understand ESG risks and opportunities. As a result of this pressure, asset managers need to play catch up. It is quickly becoming a competitive disadvantage not to understand exposure to ESG factors.

Watch: Refinitiv Perspectives LIVE – ESG Investment, a cure all for Asset Management?

Importance of ESG factors

ESG ratings have been called ‘the new credit ratings’. However, it is not to trivialize the complexity involved in such a calculation to observe that credit assessments benefit from having one very clear objective: A company’s creditworthiness.

With ESG, the goals are multi-dimensional and span a multitude of metrics such as carbon exposure or diversity and inclusion. We have been working out how to encompass such factors for a long time.

Building ESG factors into portfolios
Source: Eikon, Sustainable Leadership Monitor

Refinitiv was an early mover in ESG, with data on more than 7,000 companies globally, and history stretching back to 2002 — longer than any other provider.  Companies are now scored on a peer-led relative basis factoring-in Refinitiv’s proprietary materiality weightings.

Watch the video — ESG: A tipping point

Industry-wide adoption

ESG data is now a critical non-financial data-set.

Imperatively, for portfolio managers to assess an investment’s long-term sustainable performance prospects, there needs to be industry-wide adoption of full disclosure on ESG metrics.

We intend to lead in this area with our new scoring methodology that penalizes for material non-disclosure in order to stimulate and encourage transparency.

Using our portfolio analytic tools in Eikon, we have made the systematic factoring-in of 400+ ESG data points easier for portfolio construction, optimization, and selection.

Listen: ESG and Long-Term Planning Can Play a Pivotal Role in the Post-Crisis Recovery

Growth in responsible investing

Importantly, factor analytics based portfolios on ESG themes are becoming more common.

Portfolio managers can produce factor analytics on ESG themes, weight this against a benchmark, and establish proxy analytics for portfolio adjustments to test impacts of allocation changes.

In a field as complex and value-laden as ESG, the science of measuring ESG factors is not always purely quantitative.

Some outcomes are as much a matter of one’s own sustainable investing strategy — the social delta that you want to create and measure — as they are about driving valuations-based returns.

That means that while you need the best possible data source, and the ability to manage this alongside financial performance data, what also matters will be a function of investment strategy associated with one’s choice of social and environmental goals that you want to finance and drive.

ESG and investment performance

New research just published by Refinitiv shows that large companies tend to score higher on ESG factors than smaller ones.2

It may be that some investors will wish to rebalance or refine their perspective, given the fact that only including highly ESG scoring firms in their portfolio introduces a significant size bias.

However, the same report concludes that for U.S. firms there is a negative impact to returns, albeit there is lower volatility when including high scoring ESG firms. When investing in EU firms, there is no such sacrifice on returns.

ESG data may be relatively young, but it is maturing fast and its successful application requires greater sophistication from mainstream institutional finance professionals.

The introduction of ESG in our portfolio analytics tools enable this content to be more consumable, so asset allocators in turn can direct capital towards those securities that are best placed to deliver long-term sustainable investment returns.

1. ‘ESG Data, Ratings and Analytics: Vendors for All Seasons?’ — Sinthunont, April 2019
2. ‘ESG scores and financial performance of large cap US and EU firms’ — Refinitiv February 2020.

Further insights into sustainable investing

Putting ESG thinking at the heart of your investment process