Quantitative approach recommended for ESG integration

Using carbon intensity data can improve the risk-return profiles of portfolios, according to Eastspring Investments.

Although it is becoming the mainstream to integrate ESG factors into the investment process, it is often challenging to make investment decisions as there is no standard set of ESG metrics for comparison across companies.

In light of this, Eastspring recommends integrating “carbon intensity” into the investment decision-making process with a quantitative strategy.

“This is one of the more easily adopted ESG metrics [because it is] relatively more objective and less susceptible to manipulation compared with other more qualitative ESG metrics,” said Ben Dunn, head of quantitative strategies at Eastspring Investments.

Carbon intensity is defined as the amount of carbon emissions caused by a company, measured by metric tons of carbon dioxide, divided by its revenue, according to the asset manager. “This figure measures the amount of greenhouse gas that a company emits relatively to the sales it generates from these emissions.”

As more countries and companies are on their way to net-zero emissions, carbon intensity data is becoming readily available, making it measurable across companies.

Investment process

“In a quantitative strategy, we start with a universe of stocks and apply appropriate filters (such as liquidity, market capitalization, dividend yield and value screens) to derive a list of investible names,” said Dunn.

“From this list, we then look for an optimised solution for some specified objective – maximising expected return or minimising expected portfolio volatility, for instance – that also satisfies specified constraints, such as a target dividend yield or relative sector and country weights against the benchmark.”

Unlike the exclusion approach which significantly lower sector weights for carbon-intensive sectors, the quantitative approach fosters a portfolio with attractive yield, lower volatility, and lower carbon profile, while not overweighting or underweighting any certain sectors, the asset manager argues.

Asset managers adopting a quantitative approach can map out an efficient frontier that shows the trade-off between reducing carbon intensity and the expected reduce volatility. This increases the flexibility when constructing a customised portfolio for different ESG needs.

“Driven by the rapid increase in awareness surrounding ESG issues, the ESG data landscape has improved for quantitative investors as more comprehensive, reliable, and comparable datasets have become available,” said Dunn.

“With the exponential increase in ESG data in terms of both volume and categories, a quantitative approach could provide an effective method for integrating ESG into the investment process,” he said.