Climate Investing

10Risk Management Challenges in Sustainability Themed Portfolios: An Application to GHG-constrained Portfolios

10.1. Introduction

The past decade has seen greater incorporation of the concept of sustainability into investment portfolios. Sustainability has been one of the key drivers behind the incorporation of environment, social and corporate governance (ESG) criteria to achieve the dual objectives of generating long-term competitive financial returns and positive environmental and societal impacts. Investor demand for strategies that incorporate such criteria is evidenced by assets managed incorporating ESG criteria exceeding $30 trillion on a global basis¹.

Incorporating these criteria into an investment portfolio presents numerous challenges – primarily because of difficulty in both quantifying the attribute question and the associated investment implications. While there are over 160 providers that provide rankings on ESG dimensions – there is little agreement on the relative scores of companies and the evolution of these scores based on the behavior of these companies². From the standpoint of a professional investor however, the poor data quality and the limited availability present both a challenge and an opportunity. Investment decisions, by their very nature, involve making forecasts and risk assessments.

In this chapter, we focus on a particular measure of sustainability related to the “E” in ESG – that is associated with GHG emissions as commonly used in climate ...