Disclaimer: Views in this blog do not promote, and are not directly connected to any L&G product or service. Views are from a range of L&G investment professionals, may be specific to an author’s particular investment region or desk, and do not necessarily reflect the views of L&G. For investment professionals only.
Do factor investing and ESG go together?
In a major new whitepaper, we explore the complex interaction of factors and ESG objectives.
The following introduces our new whitepaper on factor investing and ESG.
Investor demand for strategies that combine robust financial performance with measurable sustainability outcomes has grown substantially in recent years. For investors pursuing a factor strategy, this raises three important questions:
- How do factors and ESG interact?
- Is it possible to combine multifactor and ESG approaches and achieve meaningful factor exposure while meeting ESG objectives?
- Can combining multifactor investing and ESG objectives deliver stronger, more diversified results?
In our research we have attempted to provide systematic, empirical answers to these questions. To summarise our findings, let’s consider the headline findings of our research in response to the questions above.
Factor/ESG correlation is low
On examining the interaction of factors and ESG, we found that ESG exhibits very low correlation with the standard equity style factors.
This means ESG can serve as a distinct, complementary source of returns, aligned more with industry tilts and structural transitions than with style premia.
This helps to explain the very low correlation between ESG-only and multifactor-only active returns – potentially delivering diversification* when combined.
Objectives can be combined, but the strategy matters
Turning to the question of whether it’s possible to combine multifactor and ESG approaches and achieve meaningful factor exposure while meeting ESG objectives, we found the answer is ‘yes’ – but the strategy/index design needs to be thoughtful.
By integrating both signals systematically, it is possible to construct a multifactor ESG portfolio that captures desirable factor premia while simultaneously improving ESG characteristics.
Risk-adjusted returns
Through our research we were able to empirically observe that combining multifactor investing and ESG objectives resulted in better risk-adjusted returns, and based on our findings, we believe that both multifactor and ESG can be consistent return drivers over time.
*It should be noted that diversification is no guarantee against a loss in a declining market.
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