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Socially Responsible Investing and Factor Investing, Is There an Opportunity Cost?

Li Cai, Ricky Cooper and Di He
The Journal of Portfolio Management Quantitative Special Issue 2022, 48 (2) 181-197; DOI: https://doi.org/10.3905/jpm.2021.1.307
Li Cai
is an associate professor of finance at the Illinois Institute of Technology in Chicago, IL
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Ricky Cooper
is an associate professor of finance at the Illinois Institute of Technology in Chicago, IL
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Di He
is a postdoc at the Postdoctoral Research Center of Industrial and Commercial Bank of China (ICBC) in Beijing, China
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Abstract

This article examines factor investing in the presence of an environment, social, and governance (ESG) screening overlay. The authors find that virtually no degradation in performance or turnover costs occur when using a negative-based ESG screen (i.e., removing only companies that have an actively bad ESG score). However, there are severe risk-induced performance issues and high transactions costs involved when the screening process becomes more active and includes only companies that are ESG-forward. The authors find that this is true for individually constructed factor portfolios, a composite benchmark of factor portfolios, and a stock selection model constructed from factor scores. Interestingly, they find that both screening methodologies produce significant improvement in ESG portfolio scores. They find very modest increases in turnover with the ESG screening of bad companies and significant costs with the more aggressive ESG screening techniques. In general, the authors conclude that ESG screening of negative companies is a positive way forward for agents who wish to add ESG to their factor-based investment portfolios and that the method of implementing ESG makes a large difference in outcomes.

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The Journal of Portfolio Management: 48 (2)
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Vol. 48, Issue 2
Quantitative Special Issue 2022
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Socially Responsible Investing and Factor Investing, Is There an Opportunity Cost?
Li Cai, Ricky Cooper, Di He
The Journal of Portfolio Management Dec 2021, 48 (2) 181-197; DOI: 10.3905/jpm.2021.1.307

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Socially Responsible Investing and Factor Investing, Is There an Opportunity Cost?
Li Cai, Ricky Cooper, Di He
The Journal of Portfolio Management Dec 2021, 48 (2) 181-197; DOI: 10.3905/jpm.2021.1.307
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