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Asian Review of Financial Research Vol.36 No.3 pp.105-145
ESG, Style Investing, and Integration
Woody Hyuk Lee 미래에셋자산운용 투자플랫폼사업부문 대표(Head of Investment Platform Business Unit, Mirae Asset Global Investments)
Min-Yeon Han 미래에셋자산운용 투자풀운용부문 자문2팀장(Head of Investment Pool Advisory Team, Mirae Asset Global Investments)
Sol Kim* 한국외국어대학교 경영대학 교수(Professor of Finance, College of Business, Hankuk University of Foreign Studies)
Key Words : ESG,ESG,Investment Strategy,Portfolio,Style,Factor,Integration,Institutional Investors


ESG investing has gained significant traction among institutional investors worldwide. For example, large asset owners such as National Pension Service, CPP Investments, and CalPERS are considering ESG factors in their investment decisions, and this trend is expanding to other institutional investors. In fact, according to Morningstar, ESG fund inflows reached $1.921 trillion in 2021, bringing the global ESG fund universe to $2.744 trillion at the end of 2021. Therefore, from the perspective of institutional investors and asset managers, the question of ‘how' to enhance their investment portfolios has become a more important agenda than the question of ‘why' ESG investing should be made. ESG investing strategies will only be sustainable if they can do what they are supposed to do: generate returns. To improve the performance of ESG investing strategies that invest in companies with high ESG scores, we propose an "ESG Integration" strategy that combines style investing based on market anomalies reported in the academic literature. Our results are summarized as followings. Through ESG Integration, which amalgamates style investing strategies with ESG, such as company size (small-cap) and accruals strategies, we find that greater excess returns can be achieved compared to existing ESG-only strategies. For example, compared to the High ESG-only strategy, the High ESG integrated small-cap style strategy outperforms1.136% per month on average. When we integrate the style based on the accrual anomaly into the ESG, we verify the ESG integration strategy has an excess return of 0.386% per month to the ESG-only strategy. This result pertains to absolute performance and risk-adjusted excess returns, as confirmed using the Carhart (1997) four-factor model. Someone can argue that we could get a loss for ESG scores when we undertake ESG integration than ESG-only strategies. However, we confirm there is a little loss to ESG scores even if we integrate ESG into various style investments. Therefore, by integrating ESG and profitable style strategies based on market anomalies reported by academic literature, investors could enhance the performance of ESG-only strategy without suffering a loss of the very purpose of ESG investing. ESG scores vary a lot by industry's specific characteristics. In Korea, for instance, the banking industry averages the highest ESG score among other industries. Meanwhile, the medical device and service industry shows the lowest ESG score. If we do not consider the industry-specific variations in ESG scores when conducting ESG investments, we could construct a portfolio that is overly tilted to specific industries with high ESG scores on average. Therefore, we employ industry-adjusted ESG scores to construct the ESG Integration strategy. Our result shows that the ESG Integration strategy based on industry-adjusted ESG scores also surpasses the performance of an ESG-only approach. How to handle the risk in their asset management is essential to institutional investors, such as public pension plan sponsors. Even a strategy can deliver enormous profits, but if it is very risky to the level of the risk appetite of institutional investors, investors cannot accept undertaking the strategy. From a risk management standpoint, we present that combining ESG with style strategies results in more favorable risk indicators than pure style strategies. Thus, we confirm that integrating ESG and style strategies can yield superior excess returns over existing ESG-only strategies while mitigating risks compared to conventional style strategies. The direction toward sustainable development through ESG has already garnered agreement and perceived necessity among many international participants. Nonetheless, for companies to sustain their ESG activities, ESG investing in the market must be concurrent. For investors, generating profits through ESG investment is paramount. Presently, consensus on ESG investing predominantly centers around major asset owners like pension funds. However, these pension funds primarily aim to provide pensions to beneficiaries through fund management rather than solely addressing social issues or augmenting societal welfare via ESG investing. Therefore, evaluating whether existing ESG strategies genuinely contribute as investment strategies and how they can be enhanced is pivotal. This study holds significance by proposing practical strategies to boost ESG investment performance, ensuring its sustainability. Furthermore, this research offers empirical evidence that supports not only the social value but also the financial value of ESG investing. Such evidence can be pivotal for future governmental and financial authorities in establishing policies and guidelines related to institutional investors' ESG activities, transcending the social value of ESG investments and encompassing its financial value. Lastly, the integrated strategy to enhance ESG performance, built upon comprehensive information encompassing non-financial ESG factors and financial style strategies, requires a high level of expertise in strategy formulation and execution. Determining how to combine and tailor various strategies, constructing portfolios, rebalancing, monitoring, etc., demands substantial resources, systems, and experience throughout the entire investment process. Institutional investors lacking internal resources may boost investment efficiency and stability by actively leveraging Outsourced Chief Investment Officers (OCIO) such as asset management companies.
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