Chapter 8 - ESG Integrated Portfolio Construction and Management Flashcards
(90 cards)
1
Q
Dynamic Asset Allocation
(2 Points)
A
- investment strategy based on long-term asset allocation, but employing short-term tactical trading to maintain investment allocation targets
- continual rebalancing over short-term periods may dimish the value of ESG integration
2
Q
Strategic Asset Allocation
A
Constructed over a multi-decade period and therfore warrants long-term consideration of financial and nonfinancial ESG effects, like Climate Risk.
3
Q
Strategic Asset Allocation Models
(6 Points)
A
- Mean-Variance Optimization (MVO)
- Factor Risk Allocation
- Total Portfolio Analysis (TPA)
- Dynamic Asset Allocation (DAA)
- Liability Driven Asset Allocation
- Regime Switching Models
4
Q
Mean-Variance Optimization (MVO)
(4 Points)
A
- MVO is a mix of assets that produce minimum standard deviation (risk) for maximum level of expected returns
- Black-Litterman Global Asset Allocation is an MVO model
- sensitive to revised assumptions from ESG considerations
- ESG issues could have impact on assumptions for expected return, volatility and correlation
5
Q
Factor Risk Allocation Strategy
(4 Points)
A
- seeks to build diversified portfolio based on sources of risk
- typically include factors such as fundamental risks (GDP, interest rates, inflation) and market risks (equity risk premium, illiquidity, volatility)
- ESG-related risk factors (e.g. climate risk) could help to improve diversification of risks
- links to ESG issues are more difficult to quantify with precision
6
Q
Total Portfolio Analysis (TPA)
(4 Points)
A
- based on agreed risk budget, asset allocations are made on expected risk exposures
- requires specialist knowledge to make informed judgments about future risk
- relevant to consider ESG issues which require interplay between judgment about future and quanitative analysis
- TPA provides greater flexibility to incorporate ESG issues
7
Q
Issues of Liability Driven Asset Allocation
(4 Points)
A
- Liability Driven Investment (LDI) seeks to find most efficient asset class mix driven by funds liabilities
- concerned with return of assets, change in value of liabilites and how assets and liabilities interact to determine overall portfolio value
- sensitive to revised assumptions from ESG considerations
- ESG issues could impact inflation and alter liability assumptions
8
Q
Regime Switching Models
(5 Points)
A
- model abrupt and persistent changes in financial variables due to shift in regulations, policies and other secular changes
- relevant to consider ESG issues where abrupt shift is ecpected over time
- typically based more on forward looking data, then historical data
- potential to capture dramatic shifts in investment environment
- not yet widely used by investment practitioners
9
Q
Portfolio Risk Portions
(2 Points)
A
- isolated risk of individual asset or individual investment strategy
- correlation risk that emerges from combination of all assets and strategies
9
Q
Black-Litterman Asset Allocation Model (BLM)
(4 Points)
A
- BLM is more intuitive and doesn’t require return estimates for each asset class, in comparison to Markowitz-derived MVO approach
- better accommondate areas like pricing climate risk
- Mean-Variance Optimization (MVO) model
- most promising asset allocation framework approach
10
Q
Initiatives for Portfolio Management
(5 Points)
A
- Paris Aligned Investment Initiative (PAII)
- Transition Pathway Initiative (TPI)
- Net Zero Asset Owner Alliance
- Net Zero Asset Managers Initiative
- Net Zero Company Benchmark
11
Q
Paris Aligned Investment Initiative (PAII)
(4 Points)
A
- launched 2019 by Institutional Investor Group on Climate Change (IIGCC)
- European asset owner-coordinated and led initiative
- develop methodologies and assessment tools related to aligning investment portfolios to the Paris Agreement
- Net Zero Investment Framework: defines elements of a net zero strategy and offers recommended approaches and actions for investors to measure and align portfolio to net zero emissions
12
Q
Transition Pathway Initiative (TPI)
(7 Points)
A
- established 2017 in partnership with Grantham Research Institute on Climate Change and Environment at the London School of Economics
- global asset-owner driven, asset-manager supported, initiative
- supports transition towards low-carbon economy
- datasets and tools that utilize forward-looking carbon metrics to measure and determine companies’ pathway relative to the three benchmark scenarios defined by Paris Agreement
- companies are measured in 2 ways:
1. quality of companies’ governance and management of their GHG emissions
2. carbon emission relative to international targets and national commitments as defined by the Paris Agreement
13
Q
Net Zero Asset Owner Alliance
(5 Points)
A
- launched 2019 as an alliance brought together by the United Nations
- group of international asset owners
- commited to achieving emission neutral investment portfolios by 2050 or sooner
- supporting global efforts to limit temperature rises to 1.5°C
- 2025 Target Setting Protocol: outlines how asset owners calculate and establish climate targets within portfolios and allocate capital towards decarbonization efforts
14
Q
Net Zero Asset Managers Initiative
(4 Points)
A
- launched 2020
- group of international asset managers
- support the goal of net zero GHG emission by 2050 or sooner, in line with Paris Agreement of limiting temperature rise to 1.5°C
- signatories (asset managers) also commit to support investing aligned with net zero emission by 2050 or sooner
15
Q
Net Zero Company Benchmark
(5 Points)
A
- launched 2020 by Climate Action 100+
- investor-led initiative
- engages with world largest corporate GHG emitters to drive action
- benchmark assesses corporate climate commitments based on publicly-available information
- understand alignment to corporate climate priorities (strong governance, reduce GHG emissions and improve corporate disclosure) and support investor engagement action
16
Q
Inevitable Policy Response (IPR)
(3 Points)
A
- current policy response to climate change is inadequate, therefore governments may respond to increasing climate-borne damage in sudden reflex reaction
- might include economic incentives (carbon tax, national carbon markets) or more stringent environmental regulations
- speed and scope of transition risk may carry considerable implications for an investment portfolio
17
Q
Mercer Climate Scenario Model
(3 Points)
A
- integrating climate scenario model into long-term strategic asset allocation methodology that extends to 2100
- Mercer’s report “Investing in a Time of Climate Change” addresses need to enlarge asset allocation models beyond equities
- Mercer report extends its climate-informed asset allocation process to sustainability-themed equity, private equity and real assets (incl. natural resources and infrastructure)
18
Q
Ortec Finance Climate Scenario Model
(4 Points)
A
Integrates climate risks into financial scenarios, including:
* transition risk
* physical and extreme weather impacts
* pricing dynamics to cover all asset classes
19
Q
Due Diligance Metrics for Portfolio Manager Selection
(6 Points)
A
- existence of an ESG policy
- affiliation with investor initiatives, such as Principles for Responsible Investment (PRI)
- accountability in form of dedicated personnel and committe oversight
- manner and degree in which ESG is integrated in investment process
- ownership and stewardship activities
- client reporting capabilities
20
Q
ESG Integration embeds ESG Considerations into…
(4 Points)
A
- …the highest level asset allocation decisions
- …portfolio exposure to non-financial factors
- …risk management measures
- …performance attribution
21
Q
Factors of Analysts’ Investment Thesis of a Security
(6 Points)
A
- intrinsic value of the security
- credit analysis
- potential for a re-rating or de-valuation in valuation
- potential risks
- short-term and long-term catalysts
- expectation on security’s earnings growth and cash flow profile
22
Q
Roles of Analysts in ESG Integration
(8 Points)
A
Justify their views in investment theory with different factors:
* intrinsic value of security
* credit analysis
* potential for a re-rating or de-valuation in valuation
* potential risks
* short-term and long-term catalysts
* expectation on security’s earnings growth and cash flow profile
ESG increasingly recognized element within securities analysis and carry meaningful implications that help investment thesis if material enough.
23
Q
Roles of Portfolio Managers in ESG Integration
(6 Points)
A
- constructs and manages portfolio through careful process that aggregates all individual underlying risks
- weight security-specific conviction against:
1. macro- and micro-economic data
2. portfolio financial and non-financial exposure
3. sensitives to potential shocks - ESG, if properly and systematically integrated, should be considered in same light as these other factors
24
ESG Integration in 2 Investment Strategies
| (9 Points)
**Discretionary ESG Investment Strategy:**
* portfolio manager does bottom-up financial analysis alongside consideration of ESG factors to einforce investment thesis
* work to understand aggregate risk at portfolio level across all factors to understand correlation, event risk and potential shocks to the portfolio
* focus on depth within portfolio, through portfolio of few more concentrated holdings
**Quantitative Investment Strategy:**
* rules-based approach employing statistical application of financial and/or non-financial factors to drive securities selection
* quantitative strategies seek to minimize higher costs associated with discretionary strategies
* focus on breadth of portfolio, using larger portfolio of holdings to target risk and volatility-adjusted returns
* weighting ESG in a multi-factor stock selection, including idiosyncratic factors
25
2 External ESG Research Resources
| (6 Points)
**Academic Research:**
* 2000 academic studies indicate overall positive bias between ESG and investment returns
* academic studies on individual basis often end up disconnected from practice and are not widely and generally applicable
* often unhelpful for practicioners who search for cross-regional and cross-temporal factors or frameworks that can be universally applied to portfolios
**Practitioner Research:**
* less rigorous than academic work and tend to be less conservative in its assertion to correlate ESG with investment returns, sometimes ignoring other causal factors at play
26
Investment Practitioner Research Sources
| (10 Points)
* sell-side research and analysis
* academic studies
* investment consultant research
* third-party ESG data provider research
* ESG-integrated fund distribution platforms
* asset owner and asset manager white papers
* investor initiative research
* NGOs research
* government agencies and central banks
* multilateral institutions and agencies
27
Third-Party ESG Data Provider Online Platform Capabilities
| (4 Points)
* upload portfolio to see stock-specific risks on a number of potential ESG metrics
* illustrating portfolio's mean exposure and weighting towards low-, mid- or high-scoring companies on ESG metrics
* producing a picture of portfolio's environmental and cabron exposure on absolute-value basis (e.g. expressed as weighted-average cabron intensity)
* approximating overall controversy or risk score for portfolio
28
Task Force on Climate-Related Financial Disclosures (TCFD)
| (6 Points)
* portfolio managers now treat carbon exposure on a porfolio-weighted basis
* weighted carbon intensity (Scope 1+2+3 Emissions per USD million revenues)
* principle based framework providing recommendations for assessing climate risk and exposure
* because it's not compulsory, different approaches to measure carbon intensity have developed; e.g.:
1. EU Sustainable Finance Disclosure Regulation (SFDR) accounts for Scope 1, 2 and 3 emission
2. UK TCFD practice focuses only on Scope 1 and 2 emissions
29
Sustainability Accounting Standards Board (SASB)
| (3 Points)
* framework and materiality map covers issuer-specific materiality as well as overall porfolio exposure
* covering equities, fixed income, private equity and real assets
* capable of assessing portfolio exposure to sustainability risks and opportunities across each issue
30
Sustainable Industry Classification System (SICS)
| (4 Points)
* developed by SASB
* modeled after Global Industry Classification Standard (GICS)
* offers improved industry classification standard that speaks directly to ESG materiality
* organizes companies according to their sustainability attributes, such as resource intensity, sustainability risks and innovation opportunities
31
Exclusion-Based ESG Investment Approaches (Screening)
| (4 Points)
* Universal Exclusions
* Conduct-Related Exclusions
* Faith-Based Exclusions
* Idiosyncratic Exclusions
32
Universal Exclusions
| (2 Points)
* supported by global norms and conventions, like UN and WHO
* e.g. controversial arms and munitions (cluster munitions and anti-personnel mines), nuclear weapons, tobacco and varying degrees of exposure to coal-based power generation or extraction
33
Conduct-Related Exlusions
| (2 Points)
* generally company or country-specific and often not a statement against the nature of the business itself
* e.g. companies that violate International Labour Organization (ILO) principles
34
Faith-Based Exclusions
Specific to religious instutional or individual investors, faith-based exclusions refer to the exclusion of certain industries or companies from an investment portfolio based on religious or ethical beliefs, such as avoiding investments in alcohol, tobacco, gambling, or weapons industries.
35
Idiosyncratic Exclusions
| (2 Points)
* exclusions that are not supported by global consensus
* e.g. NZ pension funds are bound by law to exclude companies involved in processing of whale meat products
36
Exclusionary Preference Application Issues
| (5 Points)
* most commonly adopted and applied by asset owners rather than asset managers
* smaller investible unverse leads to higher tracking error and unintended sector exposure
* conventional benchmark may be used for a narrow exclusion list; however, for broad exlcusions (e.g. sector exclusions) an ESG benchmark may be more appropriate
* synthetic assets (currencies, interest rate derivatives, broad-based equity indexes and commodity futures) fall outside the convential ESG framework, hence in practice may be omitted from exclusion lists
* exclusion may be considered "reductice" by not considering softer forms of ESG Integration, like stewardship and engagement activities
37
ESG Index Exampels
| (8 Points)
* FTSE Russell
* FTSE4Good
* JP Morgan ESG EMD
* MSCI ESG
* S&P (DJSI) ESG
* Sustainalytics
* Intercontinental Exchange (ICE) ESG
* Global Real Estate Standards Board (GRESB) ESG Benchmark
38
FTSE Russell
| (5 Points)
* rates above 4000 securities in developed and emerging countries on 300 ESG indicators
* measures companies' revenue exposure and management to green and brown (fossil fuel) exposure
* asset class: equities
* indexes: ESG, E, S and G
* ratings: ESG, E, S and G
39
FTSE4Good
| (5 Points)
* applies FTSE Russell ESG ratings data to select companies with at least a 3.1 (developed) and 2.5 (emerging) rating out of 5
* companies exposed to "significant controversies" and certain business activities (tobacco, weapons and coal) are also excluded
* asset class: equities
* indexes: ESG, E, S, and G
* ratings: ESG, E, S and G
40
JP Morgan ESG EMD
| (6 Points)
* combines exclusionary screening against worst offenders alongside ESG ratings integration
* adjusts overall weights based on composite ESG score for each issues which overweights green bonds and companies with better scoring ESG profiles
* designed for both corporate and sovereign emerging market debt
* asset class: fixed income
* indexes: ESG
* ratings: ESG
41
MSCI ESG
| (6 Points)
* offers more than 1000 ESG indexes
* methodology based on ESG ratings with screening criteria available (tobacco, weapongs, coal, fossil fuel, catholic and islamic)
* governance factors measures UN Global Compact compliance only
* asset class: equities
* indexes: ESG, E and S
* ratings: ESG, E, S and G
42
S&P (DJSI) ESG
| (6 Points)
* best-in-class indexes based on an ESG assessment of 4500 corporates
* rules-based selection of top 10% to 30% (global or regional) of sustainable market cap based on ESG score
* DJSI also offers indices with exclusion screens (weapons, alcohol, tobacco, gambling and pornography)
* asset class: equities and fixed income
* indexes: ESG, E, S and G
* ratings: ESG, E, S and G
43
Sustainalytics
| (4 Points)
* supports partner index and passive strategies (such as STOXX, SGX, S&P, iShares and Nifty) that employ different approaches (incl. negative screening, ESG ratings, low carbon and gender diversity)
* asset class: equities
* indexes: ESG, E, S and G
* ratings: ESG, E, S and G
44
Intercontinental Exchange (ICE) ESG
| (5 Points)
* ICE manages roughly 40 ESG-related indexes
* driven on MSCI ESG data, ICE indexes (covering equities, fixed income and real estate) include thematic (environmental, water, energy), ESG best practices and factors such as diversity and inclusion
* asset class: equities and fixed income
* indexes: ESG, E, S and G
* ratings: none
45
Global Real Estate Standards Board (GRESB) ESG Benchmark
| (4 Points - Description/Asset Class/Indexes/Ratings)
* GRESB ESG benchmark leverages GRESB's position as the loading investor initiative focused on real assets and infrastructure with a focus on commercial and residential real estate
* asset class: real assets (infrastructure and real estate)
* indexes: ESG, E, S and G
* ratings: ESG, E, S and G
46
ESG Screening in Listed Equities
| (3 Points)
* most developed asset class in terms of ESG integration due to high transparency and ability for investors to express view through voting rights
* all responsible investment strategies described in this chapter lend themselves to listed equities
* hedge funds or long-short strategies are increasingly embedding ESG into portfolio construction and management
47
ESG Screening in Fixed Income
| (14 Points)
Different securities of some issuer often have multiple risk profiles, e.g. different maturity dates.
e.g. credit portfolio manager may manage long-term climate risks by only investing in an issuer's shorter-dated maturing debt.
ESG investing bonds have emerged, designed to raise funding to deliver social and environmental objectives alongside financial return:
* however, so far no universally recognized standard certification system for sustainable bonds
* a number of standards have emerged, e.g. EU Green Bond Standard (voluntary, requires at least 85% of bond proceeds to be allocated to economic activities that align with EU Taxonomy)
* "green securitization", like collateralized loan obligations (CLOs) also exist by repackaging illiquid "green" assets
Challenging for sovereign debt as screening will further reduce investable universe.
Investors can make use of information from credit rating agencies and the World Bank's Worldwide Governance Indicators database on:
* political stability
* voice and accountability
* government effectiveness
* rule of law
* regulatory quality
* control of corruption
48
Types of Fixed Income ESG Investing Bonds
| (7 Points)
* **Green Bonds:** provide clear benefit to environment, such as renewable energy projects; also called climate bonds
* **Social Bonds:** fund projects for essential services, infrastructure and social programmes to underserved people and communitites, e.g. affordable housing, microfinance, healthcare and education
* **Sustainability Bonds:** more broadly-defined bonds that still create positive social or environmental impact
* **Sustainability-Linked Bonds:** provide financing to issuers wo commit to specific improvements in sustainability-linked outcomes, not necassarily for specific projects
* **Transition Bonds:** provide financing to "brown" industries to transition to greener industries
* **SDG-Linked Bonds:** committing and advancing to specific SDG-related targets
* **Blue Bonds:** fund projects with clear marine and ocean-based benefits, e.g. sustainable fishing
49
Green Securitization
| (3 Points)
* represents the mutualization of illiquid "green" assets, or a series of assets, into a security
* green collateralized loan obligations (CLOs) constitute one such mutualized form of green securitization
* requires common understanding what "sustainable assets" represents in fixed income context
50
World Bank's Worldwide Governance Indicators Database
| (6 Points)
Informs on countries:
* political stability
* voice and accountability
* government effectiveness
* rule of law
* regulatory quality
* control of corruption
51
Mutualization
| (3 Points)
* process of changing a firm's business structure from a joint stock company to a mutual structure where the stockholders or customers own a majority of shares
* they become eligible to receive cash distributions from the company in direct proportion to the amount of revenue the company earns from each member
* e.g. grocery chain where each shopper can become member and receive money each year for shopping there
52
Green Finance Study Group (GFSG)
| (2 Points)
* defines sustainable assets such as sustainable loans, sustainable debt and sustainable bonds as special financial products that target environment and social sustainability
* more general consideration of financial sustainability is also thought about
53
ESG Screening in Private Equity
| (4 Points)
* while exclusionary screening may be implemented, privat equity investors do not have the benefit of the breath and diversity of indices and benchmarks of the listed equities space
* general partners (GP) may apply some form of positive screening or thematic focus
* limited partners (LP) are increasing their expectations for general partners to integrate ESG analysis beyond screening
* private equity ESG data may be more localized or regional, hence capabilities from listed equities may be of limited use
54
ESG Screening in Real Estate
| (4 Points)
* Global Real Estate Sustainability Benchmark (GRESB) provides methodology and framework to measure ESG performance, but data availability is limited to participating companies, funds and assets
* investors may also leverage the modelling capabilities and experience data of general insurance companies, funds and assets
* traditional residential housing model delivery has little regard for ESG factors with a significant carbon footprint; ESG impact may be improved by reducing cabon footprint or deliver affordable housing solutions that provide greater social segmetation
* investors may also profile the exposure to elevation and coastline proximity to access flooding risk
55
Dimensions of ESG Integration in Portfolio Management
| (2 Points)
* **Risk Mitigation:** exercise of assessing and minimizing exposure of a portfolio to ESG risks
* **Alpha Generation:** ESG as means to generate alpha as a portfolio of better-managed and better-governed companies likely outperform a portfolio of poorly managed and governed peers
56
EU Taxonomy
| (3 Points)
* classification system organizing economic activities into environmentally sustainable activities
* provides definitional baseline for ESG investing as protection against greenwashing
* investors benefit from improved quality, prevalence and comparability of non-financial data
57
Risks in ESG Portfolio Management
| (4 Points)
* **Tail Risks:** long-term in nature with potential for significant change or move of risk profile by several standard deviations; e.g. property (beachfront property at risk of coastal retreat) and european utilities (carbon price volatility, stranded asset write-down risk)
* **Idiosyncratic Risk:** firm or stock specific risk, which may be reduced or mitigated via diversification
* **Systematic Risk:** market risk, like economic recession, that cannot be resolved via diversification
* Risks may be represented by both **Quantitive Metrics**, like weighted average carbon intensity, and subjective **ESG Scores and Ranking**
58
EU Sustainability Finance Disclosure Regulation (SFDR)
| (7 Points)
* focuses on disclosure at entity (manager) and product (investment strategy) levels
* applies to financial market participants (FMPs); i.e. fund and asset managers, insurers, pension funds, banks and investment firms
* disclosures on sustainability risks and factors and on certain environmental and social aspects of the financial products on pre-contractial and periodic bases, and on websites
* categorizes investment products into 3 major groups:
1. **Article 9 "Dark Green" Funds:** have sustainable investment as their objective (environmental or social), but must do no significant harm to either of these objectives
2. **Article 8 "Light Green" Funds:** more broadly promote environmental and/or social characteristics
3. **Article 6 "Other" Funds:** do not actively promote sustainable investment objectives
59
Regulatory Technical Standards (RTS)
| (7 Points)
Published by European Commission under Sustainable Finance Disclosure Regulation (SFDR).
Detailed guidance on disclosures relating to principal adverse impacts (PAIs) on sustainability factors.
Among others, defines mandatory reporting template which states the following:
* mandatory indicators of investee companies to be disclosed, i.e. GHG emissions (Scope 1, 2 and 3), carbon footprint, GHG intensity, exposure to companies in fossil fuel sector
* information such as policies on the indication of PAIs; actions and plans to mitigate PAIs
* annual reporting by 30th June
* comply or explain principle
60
Challenges in Integrating RTS Taxonomy Disclosures into SFDR
| (4 Points)
* **Language:** FMPs (financial market participants) have to learn new languages as "Taxonomy-aligned Investments" has been replaced by "Investment in Environmentally Sustainable Economic Activities"
* **Taxonomy KPI:** FMPs are required to disclose share of investments in environmentally sustainable economic activities on basis of all 3 Taxonomy KPIs (turnover, CapEx, OpEx), instead of one single KPI (usually turnover)
* **Taxonomy Disclosure Templates:** not clear whether Article 8 "Light Green" SFDR products must also do the full Taxonomy disclosures
* **Website Disclosure:** RTS provide significant more required website disclosures for PAI consideration, Article 8 products and Article 9 products
61
CFA's Global ESG Disclosure Standards for Investment Products
| (10 Points)
Specify the type of information investment managers should provide to clients and investors how ESG information or issues are incorporated into objective, investment process and stewardship.
States disclosure requirements on:
* systematic consideration of financially material ESG information
* use of an ESG index
* use of ESG screening criteria
* use of ESG targets and constraints
* benchmarking of ESG characteristics or performance
* incorporation of ESG information or ESG issues into stewardship activities
* incorporation of specific environmental and social impact objectives alongside risk and return objectives
Not anchored by any one regionally-specific regulation or prescriptive standard.
62
PRI recognized Screening Approaches
| (3 Points)
* **Negative Screening:** avoids the worst performers
* **Positive Screening:** invests into the best ESG performers among peers
* **Norm-based Screening:** screen issuers against internationally-recognized minimum standards of business practice
63
PRI's 6 Steps in Screening as Investment Approach
| (6 Steps)
* **identify client priorities:** investors should clearly disclose objectives of screening within fund documentation
* **publicize clear screening criteria:** disclose screening approaches in contractual agreements, such as investment management agreement (IMA)
* **introduce overseight:** establish internal control of compliance function that oversees screening, conducts reviews and considers any changes in screening criteria
* **adapt investment process:** consider refining screening approach depending on desired portfolio exposure
* **review portfolio implications:** regularly assess and review implications of screening on portfolio, including changes in exposure to volatility, tracking error and common risk factors
* **monitor, report and audit:** implement process and data assurance control functions that are either internally or externally assured
64
Screening on Absolute Basis
| (3 Points)
* attributes low scores to certain industries or sectors of individual companies
* may sacrifice diversification
* asset-heavy industries that happen to be carbon emission-intensive will likely score poorly on environmental metrics
65
Advantages of Screening on Relative/Peer-Group Basis
| (2 Points)
* better for building and maintaining a balanced, diversified portfolio
* prevents wholesale exclusions of poorly-rated industries like mining
66
ESG Optimization Strategy
| (3 Points)
* organizing securities by their individual ESG profile to solve a specific ESG optimization at the overall portfolio level
* greater or less degree of distortion in a particular ESG dataset may provide multiple paths to realizing the investor's targeted exposure
* strategy might soley invest in the top quartile of funds, or may mean excluding the bottom quartile of companies based on ESG performance
67
Categories of Socially Responsible Investment (SRI) Strategies
| (5 Points)
* full ESG integration
* exclusionary screening
* positive alignment or best-in-class
* thematic investing
* impact investing
68
Full ESG Integration as SRI Strategy
| (5 Points)
* systematic process of fully embedding financial and ESG analysis into investment decision making and portfolio management
* includes financial and ESG analysis and active engagement activities, integrating into the valuation process of a company
* fewer constraints than say exlusionary screening
* portfolios likely to be more concentrated and compose of high conviction holdings
* however, unlike exclusionary screening, the approach lacks the easily understandable optics like a high portfolio ESG score or low carbon exposure
69
Exclusionary Screening as SRi Strategy
| (3 Points)
* screen through an ethical or nomative framework, or a portfolio's exposure to specific sectors
* e.g. "sin stocks" like tobacco, pronography, gambling, weapons, alcohol or energy extraction like thermal coal, oil sands and unconventional oil and gas
* significant portfolio impact, e.g. higher tracking error, exposure and unintended factor exposure
70
Issues of Positive Alignment or Best in Class as SRI Strategy
| (3 Points)
* identify companies with better ESG performance than peers, using a given ESG rating methodology
* challenged by the diversity of rating methodologies and lack of ratings convergence
* by definition, less scope to allow research in lower-scoring companies that may have potential to improve their ESG metrics
71
Issues of Thematic Investing as SRI Strategy
| (7 Points)
* targets sustainability-aligned themes
* sacrifices the benefits of diversification
* greater volatility due to:
1. exposure to changing regulatory incentives / subsidies
2. a scarcity premium that reflected capital flows into and out of the sector
3. poor cash flow profiles
* different themes can have different characteristics, e.g. clean energy tends to underperform when capital spending and the economic cycle contract
72
Impact Investing as SRI Strategy
| (4 Points)
* invests with intention of producing positive measure socio-environmental impacts withouth financial returns
* investment strategies often align themselves to some of the 17 Sustainable Development Goals (SDGs)
* social objectives are prioritized over returns, therefore it's vital to build out and review reporting frameworks
* could be challenging for certain asset classes, like equities, as investments cannot be easily related to SDGs
73
Sustainable Development Investments Asset Owner Platform (SDI AOP)
| (3 Points)
* collective of asset owners, including APG, AustralianSuper and PGGM
* established an aritificial intelligence-driven platform that unifies SDG-related contribution information for investors
* SDI AOPs dataset is unique as it covers more than 12000 assets across all asset classes
74
Active Ownership as ESG Investment Strategy
| (3 Points)
* use of rights and position of ownership to influence the activities or behaviour of investee companies
* may be implemented through direct engagement, collaborative engagement, shareholder proposals and resolutions, and proxy voting strategies
* opposite approach to negative screening, as it views divestment alone as incapable of driving change
75
Passive ESG Investment Strategy
| (4 Points)
* differentiates itself from active investment strategies by nature of its low-costs and the simplicity of a determined rule-based approach
* exclusions-oriented responsible investment approaches were early adapters of passive investing
* methodology is highly individualistic and interpretive, with different providers based on different selection of methodologies, due to problems with ESG data, such as lack of history, comparability, regional breath and voluntary nature of ESG disclosures
* limits the ability to engage with portfolio companies, unless coodinated by an established stewardship team
76
Evolution of Passive Investment Approaches
| (10 Points)
* **1896:** Dow Jones Industrial Average - _first stock index_
* **1970s:** Cap-Weighted Index Investing - _index-based mutual funds and ETFs_
* **1990:** MSCI KLD 400 Social Index - _first ESG index_
* **1999:** Dow Jones Sustainability Index - _first global ESG index_
* **2001:** FTSE4Good Indexes/KLD Broad Market Sustainability Index - _US index for institutional investors; now MSCI USA IMI ESG Leaders Index_
* **2003:** Single-factor ETFs
* **2004:** WilderHill Clean Energy Index - _first alternative energy index_
KLD Select Social Index - _first optimised ESG index; now MSCI ESG Select Index_
* **2013:** Barclays MSCI ESG Fixed Income Indexes - _first global series of ESG fixed income indexes_
* **2014:** Multi-factor Equal-weighted ETFs
* **2016:** ESG + Factors Indexes (FTSE, MSCI, Solactive, Robeco SAM)
Multi-factor Custom-weighted ETFs
77
Passive ESG Index Examples of Asset Owners
| (3 Points)
* **California State Teachers' Retirement System (CalSTRS):** MSCI ACWI Low-Carbon Target Index
* **Taiwan's Bureau of Labour Funds (BLF):** FTSE4Good TIP Taiwan ESG Index
* **Japan's Government Pension Investment Fund (GPIF):** mix of global and domestic environmental strategies and socially-oriented indexes
78
Passive ESG Indexes of Japan's Government Pension Investment Fund (GPIF)
| (5 Points)
* FTSE Blossom Japan Index
* MSCI Japan ESG Select Leaders Index
* MSCI Japan Empowering Woman Index (WIN)
* S&P/JPX Carbon-Efficient Index
* S&P Global Ex-Japan Large Midcap Cabon Efficient Index
79
Single-Factor ESG Strategies
| (4 Points)
* smart-beta and beta-plus
* provide investors passive means to weight an index towards a style factor while also screening for companies that perform better on ESG metrics
* highly dependent on the screening methodology and the ESG dataset employed
* e.g. new MSCI Factor ESG Target Indexes target traditional style factors, like value and low volatility, while weighting the portfolio towards corporates with higher MSCI ESG ratings
80
ESG Challenges of Passive ESG Investment
| (8 Points)
* ESG datasets are poor as they lack history, comparability and regional breath
* for example, most extensive ESG datasets provide little more than a decade of data
* ESG disclosures remains largely voluntary
* there is still little global convergence around ESG accounting standards, such as SASB
* methodology behind passive ESG strategy is highly individualistic and interpretive
* incorporating exclusions potentially carries unintended consequences, noteably by limiting one's ability to diversify; may result in portfolio distortion, unwanted factors and market exposure
* academic research examining performance considerations and trade-offs remain relatively scarce
* limits ability to engage with portfolio companies, unless coordinated by an established stewardship team
81
Most material ESG Factor for Investor in Strategic Asset Allocation
**Climate Risk**
It threatens the financial system and global means of production as much as it poses risk on a more localized level for specific regions, sectors and companies.
82
Discretionary ESG Investment Strategy
| (3 Points)
* portfolio manager does bottom-up financial analysis alongside consideration of ESG factors to reinforce investment thesis
* work to understand aggregate risk at portfolio level across all factors to understand correlation, event risk and potential shocks to the portfolio
* focus on depth within portfolio, through portfolio of few more concentrated holdings
83
Quantitative Investment Strategy
| (4 Points)
* rules-based approach employing statistical application of financial and/or non-financial factors to drive securities selection
* quantitative strategies seek to minimize higher costs associated with discretionary strategies
* focus on breadth of portfolio, using larger portfolio of holdings to target risk and volatility-adjusted returns
* weighting ESG in a multi-factor stock selection, including idiosyncratic factors
84
Brinson Attribution Model
| (4 Points)
One of two popular approaches towards
decomposing performance attribution.
Attribution models serve to quantify and demonstrate the effects of asset allocation and selection decisions on investment returns.
Brinson Attribution Model decomposes performance returns based on a portfolio’s active weights. For a given time series, this generally represents performance returns attributed to regional, sector, and stock-specific exposure.
Emphasizes stock-specific attribution, which generally makes it popular for discretionary managers.
85
Risk Factor Attribution Model
| (6 Points)
One of two popular approaches towards
decomposing performance attribution.
Attribution models serve to quantify and demonstrate the effects of asset allocation and selection decisions on investment returns.
A risk-based performance approach measures investment returns based on a portfolio’s active factor exposures.
These can be well-established Fama–French style factors or less-established factors like liquidity, low volatility, and currency carry.
Risk factor attribution emphasizes both factor and security-specific exposures.
There are efforts to embed ESG within risk factor analysis.
86
CFA Institute ESG Integration Framework
| (31 Points)
**Research Level**
* centralised reasearch dashboard
* ESG agenda at (committee) meetings
* voting
* individual/collaborative/policy engagement
* company questionnaires
* red-flag indicators
* watch lists
* internal ESG research
* SWOT analysis
* materiality framework
* ESG-integrated research note
**Security Level**
* forecasted financials & ratios
* relative ranking
* relative value analysis/spread analysis
* duration analysis
* security sensitivity/scenario analysis
* forecasted financials
* valuation-model variables
* valuation multiples
* forecasted financial ratios
* internal credit assessment
**Portfolio Level**
* ESG and financial risk exposures and limits
* value-at-risk analysis
* ESG profile (vs. benchmark)
* portfolio weightings
* strategic asset allocation
* tactical asset allocation
* portfolio scenario analysis
87
World Bank's influence on ESG-related Bonds
| (3 Points)
The World Bank is often playing a leading role in developing markets and advising bond issuers, where ESG-oriented bonds are typically organised around a few sustainable themes.
2007: first issuance of Green Bond from European Investment Bank (EIB) + World Bank
2018: first issuance of Blue Bond from Seychelles + World Bank
88
Defensive (counter-cyclical) Portfolios
| (2 Points)
Investment in sectors like tobacco and fossil fuels due to maturity, stable operation margins and dividend pay-outs.
89
Cyclical, Growth-Oriented Portfolios
Exclude or minimize exposure to tobacco and fossil fuels.
