Application of Smart-Beta ESG in Portfolio Construction

This article discusses the application of Smart-Beta ESG in portfolio construction and how it can help in evaluating investment performance. It also explains the steps involved in portfolio construction and factors considered for development of portfolio and applying Smart-Beta ESG. The article provides insights into the techniques of Smart-Beta-ESG to assess the performance of the portfolio.

APPLICATION OF SMART- BETA-
ESG IN PORTFOLIO CONSTRUCTION

Table of Contents
Question 1..................................................................................................................................4
Aberdeen Standard Investments.............................................................................................4
Smart Beta and ESG...............................................................................................................4
Assessment of Smart-beta- ESG application in evaluating investment performance............4
Question 2..................................................................................................................................7
Steps evolved in portfolio construction..................................................................................7
Factors considered for development of portfolio and applying Smart beta ESG..................9
Development of Portfolio.....................................................................................................10
Biblography..............................................................................................................................15

Table of Figures
Figure 1: Application of Smart Beta ESG strategy for investor decision..................................4
Figure 2: The extent to which company access Smart beta Strategy for specified securities....8
Figure 3: Factors used in application of Smart Beta-ESG.......................................................10

QUESTION 1
Aberdeen Standard Investments
Aberdeen Standard Investment (ASI) is devoted to assist investors for attaining their
investment objective and widen their financial prospects regarding same. Further, these
investments attempt to offer world-class investment knowledge around a breadth of markets
as well as asset groups. Their full variety of solutions includes equities, multi-asset, fixed
income, independent wealth funds, and property as well as private markets. As the
investment is united with a variety of investment approaches, from quantitatively-controlled
smart beta to extremely active alpha-seeking policies, they convert new investment proposal
into realistic investment products created to deliver real significance for money to investors.
Smart Beta and ESG
It has been observed in recent years that significance of smart beta and ESG has boosted up
comparatively1. It is anticipated that there will be a rise in growth in both the investment
proposals. The connection between these two trends continues to acutely under-researched,
mainly since these strategies are infrequent. Smart beta is known as a niche of a niche.
Assessment of Smart-beta- ESG application in evaluating investment performance
Evolvement of decomposing a rising investment strategy
Smart beta ESG is far from typical, as it is determined that there are more widespread than
might be anticipated for a strategy presently referred to as a niche of a niche2. The reason
1 Amel-Zadeh, Amir, and George Serafeim. "Why and How Investors Use ESG Information:
Evidence from a Global Survey." Financial Analysts Journal 74.3 (2018): 1-17.
2 Amenc, Noël, et al. "Robustness of Smart Beta Strategies." The Journal of Index
Investing 6.1 (2015): 17.

behind same is that less than one-quarter (24%) of the investors states they are operating
smart beta ESG, which is defined as investment approaches which give exposure to the
measure of smart beta as well as EGS . In addition to this, ESG metrics applied in this
strategy utilised quantitative testing to add financial significance to conventional factor
approaches3. Furthermore, investors of this group refer to carbon, corporate environmental
along with governance data. The success of strategy can be accessed from the statement of
Europe that their work with smart beta ESG came off back of a two-year exploration project
which determined how ESG can enhance the risk or return recital of their smart beta
directory4.
Merits of Smart Beta ESG
One of the main advantages offered by smart beta ESG is that with the assistance of its
regulations-based procedure, smart beta provides clarity related to which ESG inputs are
being utilised and enables for targeted ESG disclosures5. The investors ascertain that ESG
metrics are more perceptive than entire scores in an ESG incorporation context. Along with
this, smart beta provides superior quality ESG data over time6. The reason behind same is its
qualitative focus.
3 Jaeger, Lars, and Jeffrey Pease. Alternative beta strategies and hedge fund replication. John
Wiley & Sons, 2018.
4 Johnson, Deborah. "Smart beta is here to stay." Investment Magazine 140 (2017): 14.
5 Fatemi, Ali, Martin Glaum, and Stefanie Kaiser. "ESG performance and firm value: The
moderating role of disclosure." Global Finance Journal (2017).
6 Halland, Håvard, et al. Strategic investment funds: opportunities and challenges. The World
Bank, 2016.

Figure 1: Application of Smart Beta ESG strategy for investor decision
Smart Beta provides clarity related to ESG inputs are being utilised for investment
decision
It is stated by some of the investors that they found intrinsic benefit with smart beta ESG as
an ESG incorporation approach. At the same time, vigorous administration provides a
superior platform for engagement as a result of more concerted portfolios. Furthermore,
Active executives have more flexibility in comparison to smart beta to build up strategic
portfolio alterations in regard to innovative ESG information for example pipeline bursts,
goods recall, and bribery disgraces. In addition to this, Smart beta ESG is considered as a
nascent investment approach, but considerable research is taking place behind the scenes7.
7 Giese, Guido, Arnfried Ossen, and Steven Bacon. "ESG as a Performance Factor for Smart
Beta Indexes." The Journal of Index Investing 7.3 (2016): 7.

It can be concluded from the above discussion that the statement provided in the article of
ASI that Smart-beta-ESG offers better investment performance is correct. The same has been
explained above through citing the merits which Smart Beta ESG provides.
QUESTION 2
Steps evolved in portfolio construction
Step 1: Allotment of Asset
Allocation of the asset is considered one of the most significant decision while creating a
portfolio8. The same implies that it is significant to ensure that the portfolio has a precise mix
of asset harmonising with the person’s conditions, investment aims and outlook to risk. In
order to allocate assets efficiently, qualified investors often seek out to merge assets that tend
to execute well at diverse times. Through assisting the adviser can determine perfect asset
allotment, can operate to redesign the investment over time in order that the company has the
best opportunity of accomplishment of investment goals. Furthermore, investment is
bifurcated various assets classes for example equities, real estate, cash and bonds. Moreover,
these offer the fundamental building blocks for creating an investment portfolio.
Step 2: Allotment of Sub-Asset
After allocation of the asset, the next step is to have a decision on sub-asset allocation. The
same implies that the manner in which money will be bifurcated among the sub-assets, or
various types of asset in every asset class. Every asset class includes different sub-asset
classes. For instance, a sub-asset class in equities can comprise- big organisations, small
firms, growth funds, income funds along with global equities. While the major assets classes
8 Guerard Jr, John B., ed. Portfolio Construction, Measurement, and Efficiency: Essays in Honor of Jack
Treynor. Springer, 2016.

are united, diversification is important when selecting sub-assets. The same will make sure
that the company has not taken risk profligately by focusing on a specific sub-asset class.
Comprehending different sub-assets with various investment styles that can implement within
sub-asset might assist to operate in an efficient manner with a financial adviser to create a
well-diversified investment proposal9.
Step 3: Balance vigorously administered and index funds
The broad choice is available to the investor to involve active, index or both the types of
fund in the portfolio. Passive funds are also known as index or tracker funds. It is suggested
not to select individual securities10. Instead, they concentrate on reflecting the trends or
changes taking place in the market. Further, they operate through trying to track an index, for
example, FTSE All-Share Index closely. Executives are appointed by active funds so that
they can do research and choose equities or bonds with an expectation to beat the pertinent
index or market average. At the same time, in reality, it is complex to exercise for a long
period of time. Selecting an array of uncorrelated active and index funds with an attempt to
decrease overall portfolio instability is possible11.
Step 4 Selecting Fund Executives
Once the type of funds is selected, the next step is to choose a fund executive who is reliable.
It is to be considered that whether index or active executives is selected, there should be an
9 Lee, Stefan Colza, and William Eid Junior. "Portfolio construction and risk management:
theory versus practice." RAUSP Management Journal (2018).
10 Luo, Yin, and Spyros Mesomeris. "Factor Investing and Portfolio Construction
Techniques." Risk-Based and Factor Investing. 2016. 401-433.
11 Song, Irene. New quantitative approaches to asset selection and portfolio construction.
Columbia University, 2014.

enhancement in outperformance though concentrating on those with reduced fund costs since
it is important to keep more of any return the funds attained. The finest manner to break down
and assess fund executives is by considering the four Ps that are people, psychology,
procedures and performance12. If active controlled funds are chosen for investment than in
that case, it is complex to foresee which executive will outperform the target.
Factors considered for development of a portfolio and applying Smart beta ESG
Investor area and size
There are key variations in smart beta adoption when it is accessed in terms of investor region
and size. It has been analysed that big investors are more potential than smaller to be
invested in smart beta. Further, this is intuitive, since investor size is often perceived as a
substitute for innovation capacity.
Funds and mandates
For smart beta funds and mandates are considered as fundamental access points.
Approximately, 48% of the investors access smart beta by funds, comprising devoted funds
as well as co-mingled funds. On the other hand, 38% of the investors assert that they utilise
segregated mandates. Rare investors utilised funds along with mandates, recommending that
investor have clear choices for evaluating smart beta. Moreover, fund states that the access is
through a hedge fund which takes into consideration, derivative involving swaps in order to
execute smart beta approaches.
12 Liagkouras, Konstantinos, and Konstantinos Metaxiotis. "Efficient portfolio construction
with the use of multiobjective evolutionary algorithms: Best practices and performance
metrics." International Journal of Information Technology & Decision Making 14.03 (2015):
535-564.

Figure 2: The extent to which company access Smart beta Strategy for specified securities.
Development of Portfolio
The amount available for investment will be proportionate in below specified weight. Further
securities which are chosen for the development of portfolio are traded at the International
stock exchange. Details relating to securities and relating stock exchange have been provided
below:
SECURITIES WEIGHT
New York Stock Exchange
Aaron’s Inc
ABB Ltd
0.10
0.15
Hong Kong Stock Exchange
Hong Kong Aircraft Engineering Company
Kingway Brewery Holdings Limited
0.25
0.10
Japan Stock Exchange
Passlogy Co., Ltd
Hikari Holdings CO., Ltd
0.10
0.05
London Stock Exchange

Breedon Group Plc
Assura Plc
0.15
0.10
Above specified securities belong to a different industry, i.e. hospitality, technology, power
etc. The concept of diversity has been appropriately followed while developing a portfolio in
order to decrease the extent of the volatility of risk as well as return. Further, the same
concept will also assist in attaining a minimum required rate of return. Moreover, through the
application of ESG investor will be able to attain the investment objective which comprises
growth as well as controlling volatility. Thus, through the application of a multifactor
approach and quantitative investment strategy of Smart-beta- ESG the pre-determined
investment objectives will be attained in a smooth manner.
Applications of techniques of Smart-beta- ESG in order to assess the performance of the
portfolio
There are three techniques of Smart-Beta-ESG that are negative screens, climate tilts and
ESG metrics. The first is a comparatively straightforward method of expanding negative
screens, for example, prohibits organisations which exclude companies operating with
tobacco or contentious firearms, to smart beta approaches. This is typically attained by
authorization, dedicated funds or internally administered portfolios. Few investors in this
class assert that they concentrate their screens on a carbon-related method for examples
carbon intensity contrast to its industry peers. Further, negative screens account for
approximately two-thirds of smart beta ESG instances13.
13 Kula, Gökhan, Martin Raab, and Sebastian Stahn. Beyond smart beta: Index investment
strategies for active portfolio management. John Wiley & Sons, 2017.

The next approach is climate tilts in which investors merge ESG information, and smart beta
approaches through the application of the specified approach. It is specified by one of the
investors that the tilts regulate the final weight of organisation in a factor index based on a
range of climate change-associated metrics, for example, carbon secretions and fossil fuel
exposure. Climate tilts account for 8% of the smart beta ESG.
In addition to this, smart beta engages a sweet spot among active and conservative passive, in
that it provides the latent of market outperformance but at a cost structure which is more
closely allied to passive. Smart beta enables the investor to add significance in a cost-
efficient manner14through the same outlook is not yet accepted and shared at wide level.
Along with this, smart beta provides several but not all of the advantages related to active
administration. Some asset owners ascertain that with their active mandates, they are
increasingly selecting extremely active, executives with a high alpha who utilises high
certainty portfolios for instance hedge funds since they consider such are the kinds of
approaches which are likely to provide enhanced returns15.
14 Melas, Dimitris, Zoltan Nagy, and Padmakar Kulkarni. "Factor investing and ESG
integration." Factor Investing. 2018. 389-413.
15 Portfolio construction A systematic approach to investing. PDF. Available through
<https://www.vanguard.co.uk/documents/portal/literature/portfolio-construction-guide.pdf>.
(2016) [Accessed on 29th November 2018]

Figure 3: Factors used in the application of Smart Beta-ESG16
Furthermore, just like there is an advancement in preeminent practices of aspect investing,
there has been a development in the manner of consideration that ESG execution in the
investment portfolio. ESG incorporation Version 1.0 comprises exclusionary broadcast based
on spiritual beliefs or business and product involvement in alcohol, tobacco and weapons.
Though, this strategy reduces the opportunity set as well as the exclusionary broadcasting
does not enable investors to connect directly with organisations in order to alter
administration practices for the enhancement. In addition to this, ESG incorporation Version
2.0 is related to an effort for creating innovate best practices utilising superior quality ESG
data that is structured as well as unstructured and incorporate that information through taking
into utilisation the latest portfolio construction methods, reweighting holding which is relied
on best-in-class performance or internally specified materiality structures.
16 How to Implement ESG in Smart Beta. ONLINE. Available through <
https://www.ssga.com/products-strategies/how-to-implement-esg-in-smart-beta.html>.
(2018). [Accessed on 29th November 2018]

BIBLIOGRAPHY
Amel-Zadeh, Amir, and George Serafeim. "Why and How Investors Use ESG Information:
Evidence from a Global Survey." Financial Analysts Journal 74.3 (2018): 1-17.
Amenc, Noël, et al. "Robustness of Smart Beta Strategies." The Journal of Index
Investing 6.1 (2015): 17.
Fatemi, Ali, Martin Glaum, and Stefanie Kaiser. "ESG performance and firm value: The
moderating role of disclosure." Global Finance Journal (2017).
Giese, Guido, Arnfried Ossen, and Steven Bacon. "ESG as a Performance Factor for Smart
Beta Indexes." The Journal of Index Investing 7.3 (2016): 7.
Guerard Jr, John B., ed. Portfolio Construction, Measurement, and Efficiency: Essays in
Honor of Jack Treynor. Springer, 2016.
Halland, Håvard, et al. Strategic investment funds: opportunities and challenges. The World
Bank, 2016.
How to Implement ESG in Smart Beta. ONLINE. Available through <
https://www.ssga.com/products-strategies/how-to-implement-esg-in-smart-beta.html>.
(2018). [Accessed on 29th November 2018]
Jaeger, Lars, and Jeffrey Pease. Alternative beta strategies and hedge fund replication. John
Wiley & Sons, 2018.
Johnson, Deborah. "Smart beta is here to stay." Investment Magazine 140 (2017): 14.
Kula, Gökhan, Martin Raab, and Sebastian Stahn. Beyond smart beta: Index investment
strategies for active portfolio management. John Wiley & Sons, 2017.
Lee, Stefan Colza, and William Eid Junior. "Portfolio construction and risk management:
theory versus practice." RAUSP Management Journal (2018).
Liagkouras, Konstantinos, and Konstantinos Metaxiotis. "Efficient portfolio construction
with the use of multiobjective evolutionary algorithms: Best practices and performance
metrics." International Journal of Information Technology & Decision Making 14.03 (2015):
535-564.
Luo, Yin, and Spyros Mesomeris. "Factor Investing and Portfolio Construction
Techniques." Risk-Based and Factor Investing. 2016. 401-433.
Melas, Dimitris, Zoltan Nagy, and Padmakar Kulkarni. "Factor investing and ESG
integration." Factor Investing. 2018. 389-413.
Portfolio construction A systematic approach to investing. PDF. Available through
<https://www.vanguard.co.uk/documents/portal/literature/portfolio-construction-guide.pdf>.
(2016) [Accessed on 29th November 2018]
Song, Irene. New quantitative approaches to asset selection and portfolio construction.
Columbia University, 2014.