Building a Resilient Portfolio with ESG in Strategic Asset Allocation

ESG (environmental, social, and governance) investing has gained traction in recent years as an increasing number of investors seek to incorporate ESG factors into their investment strategies. Typically, ESG data is used in conjunction with traditional financial data to make investment decisions. This is especially true for strategic asset allocation (SAA), a strategy in which ESG data can help investors identify potential risks and opportunities across asset classes.

SAA involves setting target allocations at the asset class level and rebalancing the portfolio periodically. Each asset class is assigned an assumed mean return and variance, and an efficient frontier is constructed to determine which strategy achieves the highest expected return for any specified level of portfolio risk. ESG data can be incorporated in SAA with objectives such as maximizing the portfolio’s ESG score, minimizing carbon emissions, or maximizing risk-adjusted returns, among others.

A growing body of evidence demonstrates the importance of implementing ESG factors into SAA in this way. For example, a recent study by MSCI found that ESG-integrated portfolios had lower volatility and better risk-adjusted returns than traditional portfolios.

There are several reasons why ESG factors are important in SAA. Essentially, they can:

• Identify potential risks and opportunities that may not be apparent from financial data alone
• Reveal how a company treats its employees, customers, and other stakeholders
• Assess a company’s long-term prospects and its potential to create sustainable value
• Help investors avoid companies likely to face financial or reputational damage due to poor ESG practices

There are a number of ways to incorporate ESG factors into investment portfolios. Asset managers can invest in companies with a positive ESG profile or avoid investments in companies with poor ESG ratings. ESG data can also be used to screen for companies that are likely to outperform the market. In all of these cases, investors should be aware that there are multiple ESG rating systems available, so it is important to choose one that aligns with their investment objectives.

All of this means asset managers simply can’t afford to ignore ESG factors when constructing portfolios. For multi-asset investors, combining an ESG strategy with effective SAA is the need of the hour. This is why asset managers should find an ESG solution that can easily handle ESG integration for SAA and other critical use cases.

IVP ESG Management is uniquely positioned to help asset managers establish a reliable framework for ESG investing — one that supports accurate and efficient portfolio construction, asset allocation, risk management and compliance, regulatory reporting, and more.

Learn more about the IVP ESG Management solution right now or contact us at sales@ivp.in.