Green finance, ESG investing, climate risk, sustainable finance, socially responsible investing, sustainable development, responsible investment, etc. All these expressions refers to the process of taking due account of environmental, social and governance considerations when making investment decisions in the financial sector.
These lectures have been prepared for the course Advanced Asset Management. They contain 4 sections: (1) ESG investing, (2) Climate risk, (3) Sustainable financing products and (4) Impact investing. They include descriptions about scoring system of ESG ratings, ESG index funds, economic modeling of climate risk, portfolio management with climate risk, carbon intensity (scopes 1, 2 and 3), green bonds, social bonds, voting policy, sustainable development goals (SDG), etc. Two exercices are also added. The first one deals with the design of an ESG scoring system, in particular the relationship between the probability distribution of the ESG score and the transition matrix of ESG ratings. The second one illustrates portfolio optimization when the fund manager would like to improve the ESG score with respect to his benchmark. The slides are available at SSRN.
In this paper, we consider the core-satellite approach to build net zero investment portfolios. The working paper is available at SSRN.
In this paper, we develop a method to model the transition risk and compute the value-at-risk of investment portfolios. The model combines random carbon tax, input-output tables, stochastic pass-through rates, elasticity-based price dynamics, earnings-at-risk and asset pricing. Using the MSCI World index portfolio, we compute the conditional and unconditional value-at-risk and expected shortfall and provide risk allocation with respect to sectors. The working paper is available at SSRN.
In this paper, we compute the greenimum and the social bond premium and provide several analysis on these premia. In particular, we study the ESG preferences of green and social bond holders, and compare the dynamics of the two premia. The working paper is available at SSRN.
In this paper, we consider the integrated approach to build net zero investment portfolios. The working paper is available at SSRN.
In this paper, we consider a multi-period portfolio optimization problem, which is an extension of the single-period mean-variance model. In particular, we solve the portfolio alignment problem of Le Guenedal and Roncalli (2022) when the fund manager has to dynamically control the carbon footprint of his investment portfolio by integrating a carbon reduction scenario. Comparing the single-period and multi-period solutions shows that the active share between the two portfolios may be greater than 25\%. This figure can also reach 40\% if we include carbon trends and they are increasing. The working paper is available at SSRN.
In this paper, we develop a comprehensive framework to assess corporates’ net zero emissions (NZE) policies. Using carbon trends, reduction targets and IEA NZE scenarios, we define several static and dynamic NZE metrics: NZE gap, NZE slope, NZE budget, Time contributions, velocity, zero-velocity and burn-out scenarios. We can then analyze issuers’ NZE policies according to 3 dimensions: participation, ambition and credibility. Empirical results show that net zero carbon emissions are challenging for many issuers for two reasons. The first is that some issuers have a lack of ambition concerning their NZE scenario. The second is that some targets are not compatible with past trends. The working paper is available at SSRN.
This survey has been written for the book "Climate Investing" edited by Emmanuel Jurczenko. In this paper, we review the different climate risk metrics (carbon footprint, carbon transition pathway, transition and physical risks) and the portfolio optimization techniques applied to portfolio decarbonization and alignment (max-threshold, order-statistic, absolute emissions vs. carbon intensity, CTB, PAB, HCIS, one-period vs. multi-period, etc.). Two findings are of great importance for investors. First, portfolio decarbonization is more difficult when we include (partial/full) scope 3 carbon emissions. Second, portfolio alignment is more complex than portfolio decarbonization. Net zero carbon management is then less a free lunch in terms of tracking error risk than the approach of portfolio decarbonization based on scope 1+2 carbon intensity. The working paper is available at SSRN.
In this paper, we explore the interconnectedness between extra-financial and fundamental analysis when considering sovereign risk. We show that few ESG indicators are directly priced in by the market. They concern E and G pillars: transition risk for developed countries, physical risk for emerging countries, national security, infrastructure and mobility. On average, extra-financial analysis explains 13% of sovereign bond yield spreads whereas financial analysis explain 70% of sovereign bond yield spreads. In a second part of this paper, we explore the ESG dimensions that are indirectly priced in by credit rating agencies. We notice that governance themes dominate followed by social issues. We retrieve the classical indicators that were highlighted by academics: government effectiveness, business environment and R&D for the G pillar, and education, demographics and human rights for the S pillar. We notice that environmental issues are ignoring by credit rating agencies. Moreover, the accuracy to predict credit ratings with extra-financial data is better for upper- and lower-grade ratings (AAA, AA, B and CCC) than for crossover ratings (especially the BBB segment). Finally, our results advocate for a greater integration of ESG analysis and credit analysis when assessing sovereign risk. The working paper is available at SSRN.
In this paper we illustrate how we can manage carbon risk in a minimum variance portfolio. The main conclusions are: (1) Measuring carbon risk is different if we consider a fundamental-based approach by using carbon intensity metrics or a market-based approach by using carbon betas; (2) Managing relative carbon risk implies to overweight green firms, whereas managing absolute carbon risk implies having zero exposure to the carbon risk factor. The first approach is an active management bet, while the second case is an immunization investment strategy; (3) Both specific and systematic carbon risks are important when building a minimum variance portfolio and justify combining fundamental and market approaches of carbon risk (i.e. carbon intensity and carbon beta). The working paper is available at SSRN.
The transition towards a low-carbon economy has substantially accelerated in recent years. Spearheaded by the Paris Agreement in 2015, global actors have committed to address the risks associated with climate change by reducing global greenhouse gas (GHG) emissions. Nonetheless, this disorderly transition towards a low-carbon economy introduces uncertain financial impacts originating from physical and transition risks. Considering the major impacts these risks can have, capital markets are starting to price in the potential profits or losses occurring from the transition process. The most commonly used approach to analyzing and managing carbon risk in investment portfolios can be called fundamental: thresholds are set in portfolios for carbon-related firm-specific metrics such as CO2 emissions. The key assumption behind this method is that the transition will have a larger negative impact on the value of companies with higher carbon footprints than on the one of companies with lower carbon footprints. An alternative and more agnostic approach introduced by Görgen et al. (2019) takes the form of a market-based measure of carbon risk, or carbon beta. This paper explores the different ways to build and estimate a carbon beta, and shows empirically and theoretically its impact on portfolio construction. The working paper is available at SSRN.
The study demonstrates the positive impact of ESG on the cost of capital of issuers. For instance, after controlling for the credit quality, we estimate that the theoretical cost-of-capital difference is equal to 31 bps between a worst-in-class corporate and a best-in-class corporate in the case of EUR IG corporate bonds. In the case of USD IG corporate bonds, it is lower but remains significant at 15 bps. These results are important because ESG investing and ESG financing are two sides of the same coin. In order to tackle environmental and social issues, ESG must be a winning bet for both investors and issuers. The working paper is available at SSRN.
The underlying idea of this research is to explore the impact of ESG investing on asset pricing in the corporate bond market. Results differ from one investment universe to another. In particular, we observe that ESG has had a more positive impact on EUR IG bonds in recent years than on the USD IG and HY investment universes. Moreover, we also show that ESG does not only affect the demand side, but is also a significant factor when it comes to understanding the supply side. The working paper is available at SSRN.
This research is an update of the study "How ESG Investing Has Impacted the Asset Pricing in the Equity Market". It extends the original period 2010-2017 by adding eighteen months from January 2018 to June 2019. These new results confirm the previous results as we reach the same essential conclusions once again. ESG investing tended to penalize both passive and active ESG investors between 2010 and 2013. Contrastingly, ESG investing was a source of outperformance from 2014 to 2019 in Europe and North America. However, the last 18 months exhibit three new interesting patterns. First, we observe a transatlantic divide since the results for North America and the Eurozone are different for the recent period. Second, we document a partial ordering between ESG ratings and performance that can be explained by a shift from a static approach (best-in-class selection/worst-in-class exclusion) to a dynamic approach to ESG investing (ESG integration/ESG momentum/ESG improvers). Third, the social pillar seems to have gained traction these last years, and is no longer the laggard pillar. The working paper is available at SSRN.
Generally, academic studies that analyze the relationship between ESG and performance are based on long-term historical data, typically the last 20 years or the last 30 years. Why? Because academics assume that a model or a relationship must be tested on a long history to conclude whether the relationship is true or not. In this paper, we focus on the recent period since 2010, because we think that ESG investing didn’t exist or was so marginal 20 years ago. Moreover, ESG data are certainly not robust or relevant before 2010. Moreover, we do not consider that the relationship between ESG and performance is static (positive or negative). Rather, we think that the relationship between ESG and performance is dynamic. Sometimes, ESG may create performance, but sometimes not. The main result of the paper is twofold. First, ESG investing tended to penalize both passive and active investors between 2010 and 2013 whereas ESG investing was a source of outperformance from 2014 to 2017 in Europe and in North America. Second, the positive performance of ESG investing from 2014 to 2017 is mainly explained by the investment flows of ESG European institutional investors. The working paper is available at SSRN.
This presentation has been done in different academic and professional conferences, in particular at 2nd ESG & Climate Risk in Quantitative Finance Conference (October 6, 2021). The slides are available here.
This presentation has been done in different academic and professional conferences, in particular at the World Bank (May 28, 2019) and the RIA Conference (April 25, 2019). The slides are available here.
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