The Quantitative Approach for Sustainable Investing

Abstract

Sustainable (also known as environment, social, and governance [ESG]) investing is currently of intense interest in the investment world. In this article, the authors consider the salient challenges associated with ESG investing and how quantitative approaches may address them. Compared to fundamental methods of sustainable investing, the authors see quantitative methods as having several advantages: These methods can build on and extend the vast analytical toolbox of modern portfolio theory to incorporate investor preference in portfolio construction; they can leverage the recent data explosion to obtain insights on many intangible sustainability metrics; and they do not have the black box label. Instead, subjective judgement applied to building the quantitative system is essential. A thoughtful analytical system can be applied to a large universe of stocks, and quantitative methods may also be leveraged to predict popular ESG vendor ratings. Although it is in the early days of quantitative sustainable investing, the authors believe these advantages will prove the quantitative method’s worth in sustainable investing.

TOPICS: ESG investing, portfolio theory, portfolio construction, statistical methods

Key Findings

• ▪ Quantitative methods have unique advantages for sustainable investing in the areas of portfolio construction, data application, and scaling domain knowledge.

• ▪ The skillful quantitative practitioner can create the optimal blend of human insight and computing power to extract sustainability insights from data.