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ESG Quant (or ESG Quantitative) is an investment strategy, developed by Arabesque Partners,[1] which involves quantitative equity investing[2] while utilizing ESG (environmental, social, and corporate governance) information, often referred to as "non-financial"[3] information. ESG Quant strategies are implemented within systematic trading or quantitative trading approaches that leverage a large and growing collection of commercial ESG, alternative and non-profit or  academic datasets.[4] As such, there is no human judgment or discretionary buy-sell decision making; rather, “in a pure quant model the final decision to buy or sell is made by the model”[5] or through the “utilization of an expert system that replicates previously captured actions of real traders.”[6]

ESG materiality

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ESG Quant funds invest in companies with strong performance on the material ESG issues for their sector and region. As a result, such funds aim to invest in sustainable companies, which are better positioned for future stock price outperformance, as shown by a growing body of literature.[7][8][9]

A growing body of research around ESG Quant funds suggests ESG compliance and alpha generation are not mutually exclusive outcomes.[10][11] Several ESG-modelled portfolio construction frameworks have since surfaced to optimize portfolio returns, including a patented method and system conceived by PanAgora Asset Management’s Mike Chen and George Mussalli.[12][13][14]

Non-financial information

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In determining the ESG properties of companies, ESG Quant funds rely on the use and processing of non-financial performance indicators.[3] Such information is gathered through corporate sustainability reporting or through external data providers, such as Sensefolio or Sustainalytics.[15] A growing number of non-financial disclosure and reporting initiatives are promoting corporate transparency, including the Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC) and the Sustainability Accounting Standards Board (SASB). In addition, there is increasing regulatory pressure, as witnessed by the European Parliament and Council of the European Union directive on "non-financial and diversity information by certain large undertakings and groups".[16]

ESG as a risk factor

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ESG information captures many risk drivers not captured through traditional financial metrics.[4] Quant ESG strategists, for example, can scrape and analyze social media content to help inform and assign value to company intangibles, such as customer and employee reputation.[17] ESG information can be considered as a risk factor that is an investment theme that has stable cross-sectional correlations to returns, thereby rewarding stocks that have an exposure to them.[18] ESG factors can be included with traditional thematic factors such as momentum, value, quality, growth, and volatility. ESG factors may also provide diversification benefits due to their low correlation to traditional factors.[19]

References

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  1. ^ Kell, Georg (2015-10-09). "COP 21: Why It's Time to Bet Big on Sustainability". Huffington Post. Retrieved 2015-10-13. A particularly exciting development is the emergence of a new generation of asset managers that understand how to leverage ESG data not just to reduce risk but also to actively enhance performance. Among them, Arabesque, the world's first ESG Quant fund.
  2. ^ Fabozzi, Frank J.; Focardi, Sergio M.; Kolm, Petter N. (March 2010). Quantitative Equity Investing: Techniques and Strategies. John Wiley & Sons. ISBN 978-0-470-26247-4.
  3. ^ a b "Definition of non-financial performance measures". Financial Times. Retrieved 2015-10-13.
  4. ^ a b Governance, Harvard Law School Forum on Corporate; Regulation, Financial (10 November 2018). "Decoding Quant ESG". corpgov.law.harvard.edu. Retrieved 2020-07-24.
  5. ^ UN PRI. PRI Reporting Framework 2014/15 Main definitions (PDF) (Report). p. 5. Retrieved 2015-10-13.[permanent dead link‍]
  6. ^ Treleaven, Philip; Galas, Michal; Lalchand, Vidhi (2013). "Algorithmic Trading Review". Communications of the ACM. 56 (11): 76–85. doi:10.1145/2500117. S2CID 14938340.
  7. ^ Khan, Mozaffar; Serafeim, George; Yoon, Aaron (2015). "Corporate Sustainability: First Evidence on Materiality". The Accounting Review. 91 (6): 1697–1724. doi:10.2139/ssrn.2575912. S2CID 219338234. SSRN 2575912. Retrieved September 18, 2020.[permanent dead link‍]
  8. ^ Eccles, Robert; Ioannou, Ioannis; Serafeim, George. "The Impact of Corporate Sustainability on Organizational Processes and Performance". Management Science, Forthcoming. doi:10.2139/ssrn.1964011. S2CID 2082942. SSRN 1964011.
  9. ^ Clark, Gordon; Feiner, Andreas; Viehs, Michael (September 2014). From the Stockholder to the Stakeholder (PDF) (Report). University of Oxford; Arabesque Partners. Archived from the original (PDF) on 2015-06-16. Retrieved 2015-10-08.
  10. ^ Governance, Harvard Law School Forum on Corporate; Regulation, Financial (7 May 2018). "Integrated Alpha: The Future of ESG Investing". corpgov.law.harvard.edu. Retrieved 2020-07-24.
  11. ^ "An Integrated Approach to Quantitative ESG Investing". eprints.pm-research.com. Portfolio Management Research. Retrieved 2020-07-24.
  12. ^ "Quantitative ESG Investing" (PDF). FDP Institute. April 2020.
  13. ^ "United States Public Patent Application Publication" (PDF). USPTO Gov. Nov 28, 2019.
  14. ^ Chasan, Emily (Jan 20, 2020). "Quants Say They Can Make Investing More Sustainable". Bloomberg Businessweek.
  15. ^ Scott, Mike (2011-04-03). "Data providers join forces to meet investor demand". Financial Times. London. Retrieved 2015-10-13. In the aftermath of the financial crisis, key data providers have all made the same bet – that in years to come environmental, social and governance (ESG) issues will be a more important part of investors' decision-making.
  16. ^ "Directive 2014/95/EU" (PDF). Official Journal of the European Union: L 330/1. 2014-11-15.
  17. ^ Norton, Leslie P. "To Make Money in Sustainable Investing, Don't Just Buy Stocks With High ESG Ratings". www.barrons.com. Retrieved 2020-07-24.
  18. ^ Bender, Jennifer; Briand, Remy; Melas, Dimitris; Subramanian, Raman (December 2013). Foundations of Factor Investing (PDF) (Report). MSCI. Retrieved 2015-10-08.
  19. ^ Nagy, Zoltan; Cogan, Doug; Sinnreich Dan (February 2013). Optimizing Environmental, Social, and Governance Factors in Portfolio Construction (Report). MSCI. Retrieved 2015-10-08.
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