Portfolio Level ESG Integration I

Arun Kelshiker

20 years: Asset management and stewardship

In this video, Arun dives deep into the fascinating realm of ESG integration within investment portfolios. Join him as he unravels the impactful principles set forth by the UN's Principles for Responsible Investment and the CFA Institute's ESG framework.

Sector and Region Transition

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Portfolio Level ESG Integration I

19 mins 12 secs

Key learning objectives:

Understand how to integrate ESG into asset allocation
Understand how to measure an investment portfolio’s ESG and financial risk exposures and limits
Understand how ESG can be integrated at the portfolio construction stage

Overview:

The UN's Principles for Responsible Investment and the CFA Institute's ESG framework guide comprehensive ESG Analysis. This structure has three components: ESG Research, Securities Valuation considering ESG, and Portfolio ESG integration. At the Portfolio Level, key areas are asset allocation, risk management, and portfolio building. Asset allocation, which greatly impacts returns, can be long-term (Strategic Asset Allocation) or short-term (Tactical Asset Allocation). Portfolio risk management emphasises ESG and financial risks, with tools like Value at Risk (VAR) estimating potential losses. ESG integration helps adjust weightings to lower risk. Assessing an investment's ESG profile against its benchmark uncovers relative ESG threats. Portfolio construction, informed by allocation and risk considerations, may fully integrate ESG or apply screens. Full integration offers deeper insights into risks and potential, while screening may exclude based on ethics.

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Summary

How does ESG integration impact asset allocation strategies?

Asset allocation determines a portfolio's mix, influencing up to 90% of returns. Two forms are Strategic Asset Allocation (SAA) for long-term goals, and Tactical Asset Allocation (TAA) for short-term market opportunities. ESG considerations, notably environmental and climate risks, are integral to these decisions. For example, Blackrock's SAA uses "Climate Aware" Capital Markets Assumptions, favouring developed market equities due to their reduced carbon intensity. In TAA, immediate risks like corporate scandals are key. Scenario Analysis evaluates ESG factors' impact on risk and return, with tools like the Inevitable Policy Response aiding in forecasting climate policy effects.

How do ESG factors impact portfolio risk management?

Portfolio risk management evaluates an investment's ESG and financial risk exposures. Common risk measures include portfolio volatility, tracking error, and Value at Risk (VAR), which estimates potential losses over a time frame with specific confidence. Integrating ESG factors means adjusting portfolio weightings to mitigate ESG risks and comparing the ESG profile of a portfolio to its benchmark. For instance, the S&P ESG 500 has a higher sustainability profile than the S&P 500. Moreover, portfolios with significant European utilities holdings face risks from the evolving low-carbon economy. Scenario analysis further assesses ESG impacts on risk and return.

How is ESG integrated into portfolio construction?

Portfolio construction is essentially driven by asset allocation decisions and the portfolio risk management strategy. An investment's ESG profile is often compared against its benchmark. Full ESG integration embeds both financial and ESG insights into decision-making, while alternative methods employ screening, such as norms-based or positive/negative filters. Notably, certain sectors, like fossil fuels, may be excluded based on ESG risks. As a safeguard, portfolios undergo scenario analysis and stress-testing against diverse ESG criteria, ensuring a comprehensive consideration of risks during the construction process.

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Arun Kelshiker

Arun Kelshiker was formerly the Head of Asset Allocation and Portfolio Strategy at Standard Chartered Bank and part of the bank's Global Investment Committee, where he provided investment advisory and multi-asset portfolio solutions. His focus is now with Cambridge Sustainable Investment Partners, which draws its expertise from the Resilience and Sustainable Development Centre at Cambridge University. He is also a university lecturer at the Frankfurt School of Finance and Management and is Vice Chair of the CFA UK's Inclusion and Diversity Committee and its Investment Committee.

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