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Integrating ESG in Portfolio Construction

Roy Henriksson, Joshua Livnat, Patrick Pfeifer and Margaret Stumpp
The Journal of Portfolio Management April 2019, 45 (4) 67-81; DOI: https://doi.org/10.3905/jpm.2019.45.4.067
Roy Henriksson
is chief investment officer at QMA in Newark, NJ
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Joshua Livnat
is Professor Emeritus of Accounting in the Stern School of Business Administration at New York University and managing director and head of research at QMA in Newark, NJ
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Patrick Pfeifer
is principal and senior quantitative analyst at QMA in Newark, NJ
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Margaret Stumpp
is a senior advisor at QMA in Newark, NJ
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Abstract

In this article, the authors recommend an approach to integrate environmental, social, and governance (ESG) issues into portfolios that is based on two premises. The first is that classification of firms as good or bad ESG companies should be performed using ESG items that are material in that industry. The second premise is that it is possible to overcome the sparse voluntary ESG data reported by firms by constructing an ESG good minus bad (GMB) factor and then finding those firms whose returns load significantly on this factor. The authors provide evidence that shows the superiority of using material, industry-specific ESG items and the merits of expanding the ESG classification using the ESG GMB loadings. Their approach is particularly suitable for quantitative investment approaches that invest in portfolios with large number of positions and many small active exposures, wherein vendor ESG data can be used in portfolio construction efficiently without the need to employ detailed ESG analyses of many individual firms. With such portfolios, it is less about the ESG classification of an individual company than about the aggregate portfolio tilt toward good ESG and away from bad ESG at the portfolio level.

TOPICS: Analysis of individual factors/risk premia, ESG investing, statistical methods

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The Journal of Portfolio Management: 45 (4)
The Journal of Portfolio Management
Vol. 45, Issue 4
April 2019
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Integrating ESG in Portfolio Construction
Roy Henriksson, Joshua Livnat, Patrick Pfeifer, Margaret Stumpp
The Journal of Portfolio Management Mar 2019, 45 (4) 67-81; DOI: 10.3905/jpm.2019.45.4.067

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Integrating ESG in Portfolio Construction
Roy Henriksson, Joshua Livnat, Patrick Pfeifer, Margaret Stumpp
The Journal of Portfolio Management Mar 2019, 45 (4) 67-81; DOI: 10.3905/jpm.2019.45.4.067
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  • Article
    • Abstract
    • LITERATURE REVIEW AND RESEARCH DESIGN
    • DATA AND VARIABLES
    • ESG SCORES AND FUTURE RETURNS
    • EXPANDING THE ESG CLASSIFICATION
    • USING ESG SCORES IN PORTFOLIO CONSTRUCTION
    • CONCLUSIONS
    • ACKNOWLEDGMENTS
    • ENDNOTES
    • REFERENCES
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  • PDF (Subscribers Only)

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