Optimizing Sustainable Performance: A Strategic Approach to Value Creation and Impactful Investing

Heiko Bailer

Chapter 14 in Sustainable Investing:Problems and Solutions, 2024, pp 375-402 from World Scientific Publishing Co. Pte. Ltd.

Abstract: This chapter thoroughly examines eight long-only MSCI style factors, nine long-only sustainable theme factors, and four long–short sustainable theme factors. Backtests against the historic MSCI World benchmark from September 2019 to November 2023, using MSCI’s Barra Portfolio Manager, reveal that the low active risk and low turnover long-only portfolios performed in line with their MSCI World benchmark. Meanwhile, sustainable themes as well as the MSCI style factor ESG exhibited significantly higher sustainable performance. Testing the 17 long-only factors in a restricted universe, simulating the stringent 2023 Paris-aligned sustainability law of Baden-Württemberg, Germany, showed that stringent universe exclusions negatively impacted performance, increased portfolio size without lowering active risk but reducing emissions, and improved the overall Sustainable Development Goals (SDGs) scores. Remarkably, the long–short sustainable factors exhibit significant risk sustainability-adjusted outperformance compared to the MSCI World benchmark. These findings challenge the conventional notion that sustainability for investors depends mainly on universe exclusions. Moreover, they demonstrate that steering portfolios with sustainable factors not only broadens the universe and diversifies across industries but also reduces concentration risk without compromising performance. This approach seamlessly integrates with impact investing, enabling the pursuit of explicit positive objectives, such as advancing SDGs or facilitating the transition from Brown to Green, potentially serving as an engine for EU Sustainable Finance Disclosure Regulation (SFDR) Article 9 funds.

Keywords: Sustainable Investing; Impact Investing; Corporate Social Responsibility; Materiality; Externalities; Sustainability; ESG; ESG Funds; ESG Factors; ESG Scores; SASB; SDG; DEI; Private Equity; General Partners; Active Ownership; Investment Stewardship; Machine Learning; Natural Language Processing; Large Language Models; Transition Economy; Climate Risk; Net-zero Investing; Divestment; Greenhouse Gas Emissions; Scope 3 Emissions; Modern Portfolio Theory; Venture Investments; Carbon Dioxide Removal; Carbon Credits; Fuel Production; Portfolio Management; Market Sentiment; Factor Investing; Portfolio Optimization; Post-investment Management; Digital Transformation; Fixed Income; Portfolio Performance Measures (search for similar items in EconPapers)
Date: 2024
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