ESG Is a Preference, Not a Strategy

Key Points

  • A portfolio’s return is driven by its investment strategy—a set of decisions that governs allocation and timing of capital among the portfolio’s positions. Modest exclusions designed to align a broadly diversified portfolio with an investor’s ESG principles do not change the underlying investment strategy and therefore are not responsible for driving the portfolio’s return.

  • ESG investing is a preference, not a strategy. We view this trait as a benefit to investors, who can align their portfolios’ composition with their beliefs without experiencing a meaningful impact on performance.

  • Because ESG is a preference, not a strategy, investors can incorporate their ESG principles within a wide range of investment strategies, including non-cap-weighted indices. Today, the RAFI ESG strategy allows investors to invest according to their ESG principles and still maintain a valuation discount relative to the market at a time when value appears attractively priced.

Brent Leadbetter

Reality television programming exists in a myriad of settings. Shows focus on a broad range of topics from home renovation, car restoration, gold mining, deep sea fishing, to even selecting a potential spouse from a group of strangers. A reality show likely already exists in any scenario you can imagine. The one constant among them, however, is that they all follow the same strategy: the participants face some sort of adversity. At times this adversity is life-threatening, but more often it simply takes the form of interpersonal crisis embellished with dramatic tension and occasionally with comedy. The various iterations simply exist to meet audience preferences.

We see a similar situation in the investment industry.

We believe the term ESG strategy is generally a mischaracterization. While some managers use ESG measures to identify risks and opportunities, more often ESG metrics merely reflect investor preferences incorporated in an existing strategy.1 An investment strategy represents a decision, or set of decisions, that guide a portfolio’s risk-and-return profile over time. The underlying investment process drives the return of the chosen investment strategy; the ESG preferences reflected in the securities selected for the portfolio do not. We make this distinction not to disparage ESG investing—we actually view this trait as a benefit. We like the ability to align our portfolios’ composition with our beliefs without a meaningful impact on performance.