Authors
Guido Giese, Linda-Eling Lee, Dimitris Melas, Zoltan Nagy and Laura Nishikawa
Combining ESG and common factors is more complex than integrating ESG into passive portfolios, as investors may seek to gain ESG exposure while not impairing the strategy’s investment objective by reducing exposure to target factors.
The trade-off between ESG exposure and target factors was less severe for defensive factors such as minimum volatility and more severe for dynamic factors such as momentum and value.
In the fourth and final part of this report the authors discuss two ways to combine ESG with common factors: A two-step approach, where a standard factor methodology is applied on top of an ESG index, and a one-step approach, where the strategy is optimised to minimise the sacrifice in factor exposure per unit of ESG improvement.