Environmental, social, and governance (ESG) considerations are increasingly being integrated into quantitative investment strategies. This trend reflects both growing investor demand for sustainable investing options and emerging evidence that ESG factors can be material to long-term returns.
Quantifying ESG Factors
The challenge of incorporating ESG into systematic strategies lies in the subjective and qualitative nature of many ESG assessments. Different rating agencies can produce dramatically different scores for the same company.
Our approach focuses on developing proprietary ESG metrics based on objective, measurable criteria. This includes carbon intensity, board diversity statistics, and governance structure characteristics that can be consistently measured across companies.
ESG as a Risk Factor
Rather than treating ESG purely as a constraint, we model it as a risk factor with potential return implications. Companies with poor governance practices, for example, may face elevated tail risks that are not fully reflected in traditional risk models.
Implementation Considerations
Implementing ESG integration requires careful attention to portfolio construction. Hard exclusions can significantly constrain the opportunity set, while tilts toward higher-ESG securities may introduce unintended factor exposures.
