Passive sustainable-investing strategies can carry hidden active risks. An Alpha Enhanced solution is designed to help bring transparency, control, adaptability and potentially improved risk-adjusted returns.
Key Takeaways
1 Sustainable Investing Is Inherently Active
Passive sustainable investing strategies are never truly passive. The implementation of sustainability criteria through exclusions or decarbonization targets can alter a portfolio’s investable universe and introduce sector and style tilts that have implications for risk management and returns.
2 Hidden Risks in Passive Strategies
Passive strategies typically start with an equity universe or parent index that is modified according to a set of sustainability criteria. This modification, in an off-the-shelf sustainable index or a bespoke sustainable overlay on a conventional index, can conceal sustainability-related risks, making them harder to manage.
3 Taking Control of Sustainability Risks
We think a quantitative Alpha Enhanced approach that combines some of the benefits of passive investing with the risk management and alpha potential of active strategies could help investors take control of sustainability-related risks.
4 Seeking Alpha and Boosting Transparency
A two-step approach that minimizes tracking error resulting from sustainable-investing criteria, followed by the addition of a dynamic alpha engine, can help smooth out performance volatility in a passive sustainable equity portfolio. This sequenced approach balances the two sources of active risk – the implementation of sustainability criteria and the addition of the alpha component – and makes it possible for investors to separate, measure and attribute their impacts on performance.
5 Adaptable Frameworks for Evolving Analytics
Another key feature of this model is its flexibility to accommodate new data sources and methods. This flexibility is particularly useful in a sustainability world where priorities evolve, new data sets become available, and approaches are refined.
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