Environmental, social and governance (ESG) considerations are now so much a part of the investment zeitgeist that ESG has become a catch-all term for a broad range of responsible investing standards and strategies. Studies have established a positive link between companies that perform on ESG metrics and their share prices and cost of capital, and have demonstrated such firms are also relatively less susceptible to market shocks, painting a clear case for the integration of ESG factors into the investment approach.

However it is essential for investors to recognise that ESG factors can impact sectors, geographies and asset classes differently, and need to be intensively analysed and managed, rather than simply adopted wholesale, to ensure portfolios attain performance as well as sustainability goals.

For instance, environmental screens such as greenhouse gas emissions and hazardous material management practices deserve particular scrutiny when applied to companies in the non-renewable energy sector. Governance factors such as the ability to manage systemic risks and the transparency of transactions, meanwhile, are likely to play a more decisive role in the performance of financial services companies.

ESG factors also differ across geographies. Studies show corporate governance scores have a smaller effect on the relative returns of North American companies than those in Asia Pacific, where the impact is greater - presumably because corporate governance may be a better-established practice in North America than in Asia.

This could tie into growing evidence that ESG strategies may have a bigger impact on emerging market equities. A comparison of the MSCI Emerging Markets ESG index with the MSCI World ESG Index between September 2007 and February 2015 found that not only did the former outperform the latter; the emerging markets index also enhanced its outperformance over the world index throughout the study period. This suggests an investment strategy that focuses on emerging market firms with strong ESG track records may enhance a portfolio’s returns over the long term.

Integrating ESG research signals can also help to strengthen fixed-income portfolios by filtering out bonds with material risks, mitigating tail risks by preventing unforeseen downgrades and defaults. As rating agencies have begun to incorporate ESG factors into their decisions, these translate into quantifiable benefits such as smaller spreads and lower refinancing costs, helping contribution to fixed income portfolios performance, especially during times of market stress.

Governance is also a key dimension for bond investments. Research has linked major defaults and rating downgrades to poor corporate governance and management. On the other hand, investment- grade fixed income portfolios that rate highly on governance have been shown to perform better than lower-rated peers by over 500 basis points in a nine-year period from Jan 2007 to Sep 2015.

Infrastructure debt, owing to its highly structured nature, is often effectively embedded with ESG factors, including additional layers of governance that lay down specific frameworks for the use of borrowed funds, limiting legal and regulatory risks. These safeguards help provide a more accurate assessment of risk and additional layers of protection, allowing investors to hold debt at the higher end of the risk scale and pointing to a role for infrastructure debt in ESG portfolio diversification.

The risk of ESG investing is that it devolves into a box-ticking exercise in which investors snap up any company or asset with a high ESG score or sustainability label.

An effective, active ESG investment strategy not only focuses on firms with high material ESG scores, but uses negative filters to weed out companies with ESG-related vulnerabilities. It also examines the specific ESG screens that should be emphasised and evaluated for each firm or asset, considering the industry, geography and overall market context.

Finally, it engages companies at the management level to encourage the adoption of ESG considerations and targets in strategic planning, recognising the contributions these can make to long-term performance. These processes are combined to develop and manage a portfolio that maximises the positive impact of ESG factors, while mitigating risk and avoiding firms that may claim sustainability -- but that lack sustainable business models capable of consistently generating value.