How Can Tailored Portfolios Help Achieve Sustainability Goals?

Portfolio managers who wish to focus on particular sustainability goals need data that measures specific company achievements within broad categories. A new whitepaper by Refinitiv examines the creation of tailor-made portfolios that prioritise sustainability.

1. Many sustainability goals can be measured using granular Environmental, Social, and Governance (ESG) variables, but not all goals can be measured equally well.

2. Custom-designed sustainability portfolios do not compromise on financial performance and in some cases outperform the benchmark.

The ESG investing world encompasses a wide range of issues such as climate change, social responsibility and gender/ethnic diversity in corporate governance.

A company or stock portfolio’s commitment to sustainability is often measured in relation to well-known ESG criteria, and data providers such as Refinitiv publish E, S and G scores for thousands of firms.

Download the white paper: How to measure and improve a portfolio’s contribution to proprietary sustainability goals

Specific Measurements of Sustainability Goals

With more than 450 Refinitiv ESG metrics available, is it possible to be that specific? The short answer is yes. The longer answer is - ‘it depends’.

For example, the 17 UN Sustainable Development Goals (SDGs) include many ESG categories and variables that could reflect particular investment goals. Some are easier to measure than others.

The white paper analysis finds that seven are well-measurable, including “industry, innovation and infrastructure” and “climate action”.

Specific measurements can be used to judge companies’ achievements.

For instance, for the “gender equality” SDG, the variables for corporations include: females on the board, policy diversity and opportunity, targets for diversity and opportunity, female managers and the gender pay gap.

Tailored Portfolios

So it’s possible to measure ESG criteria in detail, but how well do such tailored portfolios perform?

There are several ways, ranging from excluding badly performing companies to including only well-scoring ones, to select stock portfolios that perform well (and better than benchmark) in terms of tailor-made sustainability goals.

A manager must choose the sustainability goals carefully.

If the goals are “elimination of poverty” and “reducing CO2 emissions”, the investment portfolio cannot be optimised with respect to both, as achieving the two goals simultaneously is almost impossible in practice.

To evaluate the effect of the SDGs’ screening on portfolio performance, the analysis constructs and compares a number of portfolios based on the SDG scores and market capitalisation.

Portfolio Construction

The core idea of the portfolio construction is that the analysis keeps the same sector allocation in the portfolios as the benchmark index, and then selects 10 per cent of stocks by certain sustainability criteria within each sector.

In this way, the hypothetical portfolios mimic the same diversification as the benchmark and thus compare performance between portfolios and the benchmark.

In all such suggested portfolio construction methods, the importance of sector diversification stands out, so well-diversified portfolios are constructed that are also superior in terms of sustainability goals.

If the manager doesn’t pay attention to sector diversification but only to SDG performance, the analysis shows there can be a significant sector tilt. For example, if stocks are selected only according to the performance on the “gender equality” SDG, then communications, energy, industrials, material, and utilities sectors would be excluded.

Download the white paper: How to measure and improve a portfolio’s contribution to proprietary sustainability goals

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