ESG in Factors

Environmental, Social, and Governance (ESG) signals are an important part of factor-based investing strategies as they can stem from the same economic rationales as general factor premiums. Because factors are broad and diversified, building portfolios by jointly optimizing factor exposures with ESG and carbon outcomes results in similar historical performance as benchmark factor portfolios which do not include those considerations. We show how sustainable signals, which often involve alternative data, can be integrated in the definitions of factors themselves: we offer two examples on green intangible value and corporate culture quality which enhance traditional financial value and quality factors, respectively