Environmental, social and governance factors have a role to play in the smart beta strategies that institutional investors have become more familiar with in recent years, according to an investment manager who spoke at a seminar in Toronto on Thursday.
When creating an index, exposure to environmental, social and governance factors can work just like any other factor, said Tony Campos, director of ESG product management at FTSE Russell, during an event hosted by the global index and data provider. ”The continued growth in demand for ESG solutions will mean delivering dual objectives for clients: ESG goals as well as investment objectives,” he said.
While institutional investors certainly feel an ethical motivation for incorporating environmental, social and governance factors into their portfolios, there has been a shift to a more fundamental focus on using them to avoid long-term risk, said Campos.
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When the concept was in its early stages, investors focused on keeping certain problematic investments out of their portfolios, such as tobacco stocks and companies that produce weapons like landmines, he said. But today, there’s a broader focus, allowing investors with different motivations to understand the value of integrating environmental, social and governance considerations into smart beta investments.
An investor with a more modern perspective is seeking broad market returns and index characteristics, as well as environmental, social and governance attributes, said Campos.
As an example of that type of investor, Campos referred to HSBC Bank’s British defined contribution pension plan. According to Campos, the bank’s goal was to target equity exposure using the factors of value, low volatility, quality and size. Also, the fund wanted its investment to incorporate climate change risk by tilting the index towards less exposure to fossil fuel reserves and reduced carbon dioxide emissions, a move Campos referred to as green revenue coming from the opportunities for growth associated with the global shift towards more environmentally friendly practices, especially in the energy sector.
With that set of considerations in mind, the index would “counterbalance risk and potential opportunity” within one structure, he said. Once implemented, the index was able to tilt towards hedging climate change risk without sacrificing the original key factors.