Research
Climate Change, ESG Investing, ESG Data with implications for CRE and CMBS
I recently presented at the DBRS Morningstar webinar (panel discussion) on “Climate Change, ESG Investing, ESG Data with implications for CRE and CMBS”. It was a well-rounded discussion on ESG factors impacting CRE and implications for CMBS, with perspectives on trends in quantifying climate change data, how and why it matters to investors in fixed income and real assets, the growth of investor interest in sustainable investing, DBRS Morningstar’s ESG initiatives and criteria, and the CMBS credit rating process incorporating these critical issues.
ESG Investing in Public Equity Markets
Delighted to have presented on ESG investing to 2nd year MBA students at Columbia Business School on March 17/2021, as part of their course “ESG Investing in Public Equity Markets”. The presentation was based on my Journal of Investing (2015) paper on using ESG factors in active management for portfolio construction. It explores the predictive power of ESG on returns, volatility and risk adjusted returns of individual securities, and on tail risk, portfolio risk and risk-adjusted return using Portfolio Opportunity Distributions (POD). The main results were that higher return stocks almost always had higher average ESG rating, and stocks with the maximum return that active managers try to identify were always from the non-lower-tail (ESG) group. There was a strong negative correlation between ESG ratings and stock volatility, and this relationship was stronger when market volatility was higher and therefore higher need for diversification benefits. The return profile of random portfolios created from (a) the full sample and (b) a smaller universe created by deleting lowest-rated ESG companies as a tail risk, indicated that deleting worst ESG rated stocks did not necessarily impose opportunity costs and, in fact, tended to be value additive for investors in terms of portfolios with higher average and maximum return. This implies that asset managers can enhance their stock-picking and portfolio construction ability by using ESG information and even more so by excluding the worst ESG stocks.
ESG Investing Part 3: ESG Across Asset Classes and in Asset Allocation
The changing nature of corporations with intangibles driving a greater proportion of enterprise value is a key reason for ESG being an increasingly important data point. ESG has varied impact on return and risk across different asset classes. The use of ESG data started in equities and given the asymmetric return emphasis between equities and bonds (upside capture for equities and preventing downside risk in bonds), is rapidly becoming important in different parts of fixed income given its predictive value over and above the information in credit ratings. This research analyzes recent empirical studies to document the predictive ability of ESG across asset classes (equity, different parts of fixed income, credit, and real assets), how and why it can be used in security selection and asset allocation to design optimal risk-adjusted portfolios.