Ch8 key facts

Question 1

KEY FACTS
1. Responsible investment or sustainable investment acts as an umbrella term under which three dominant investment approaches exist. These approaches often overlap within a given strategy but rarely if ever compete against one another. The approaches are:
▶ exclusionary screening;
▶ ESG investing;
▶ impact investing.

Answer 1

2. Investment approaches can be characterised as ***discretionary and quantitative.

ESG integration in discretionary approaches is process-oriented, while quantitative approaches, whether active or passive quant, are generally rules-based and factor-oriented.

Question 2

3. Exclusionary screening can be organised into four basic categories:

▶ universal;
▶ conduct-related;
▶ faith-based; and
▶ idiosyncratic exclusions.

The exclusionary preferences are generally specified by the asset owners, not asset managers.

As a rules-based investment approach, exclusionary screening is reductive by nature and does not generally consider softer, more qualitative forms of responsible investment such as stewardship and engagement activities.

Answer 2

4. Imposing an exclusion screen or targeting an ESG score may introduce unintended factor exposure or skewness to a portfolio.

Question 3

5. ESG data and ratings methodologies are still nascent.

With correlations among ESG data providers relatively low, investors should recognise the lack of convergence.

One way investors can differentiate themselves is by building ESG analytics platforms that combine off-the-shelf ESG data with proprietary approaches.

Answer 3

6. Portfolio managers should recognise the inherent challenges within ESG data sets and methodologies.

This includes short historical data, lack of comparability and coverage gaps within some asset classes and regions.

Question 4

7. Simply put, passive ESG investing describes rules-based strategies to produce
8. low cost indices and
9. benchmarks.

Answer 4

8. Portfolio optimisation

Allows portfolio managers to target a specific ESG rating or environmental objective,

such as carbon emissions reduction,

while simultaneously managing the portfolio to tracking error range.

Question 5

9. Full ESG integration involves the systematic and explicit inclusion of ESG risks and opportunities within stocks selection and portfolio management.

▶ Exclusionary screening imposes ethical or normative criteria to a portfolio investment universe.

▶ Positive alignment introduces an inclusionary bias to a portfolio as it invests generally in better-performing companies on ESG metrics.

▶ Active ownership strategies employ ownership and voting rights to drive positive change in a company, generally through direct or collaborative engagement between management and investors.

▶ Thematic investing focuses on sustainability-related areas, such as water or renewable energy, with which to build a portfolio of companies.

▶ Impact investing elevates intentionality and additionally, or the need for positive social or environmental impact, alongside (or in the case of concessional impact, below) market returns.

Answer 5

Dynamic asset allocation tactically rebalances relative to its long-term allocation target mix. DAA

Strategic asset allocation, which only intermittently rebalances relative to its target mix, is more aligned to ESG integration,

but investors will have to consider the diversification trade-offs by allocating more to an ESG or sustainability risk budget.

Question 6

In addition, investment strategies, particularly at the multi-asset level, commonly invest in indices for various reasons, including for cash management to cover potential redemptions by investors.

Answer 6

Which of the following is true?

(a) Sovereign debt is susceptible to distortion effects based on ESG ratings.