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This special issue of the EDHEC Research for Institutional Money Management supplement to Pensions & Investments, which aims to provide institutional investors with an academic research perspective on the most relevant issues in the industry today. We first look at the potential for digitalized self-indexing to help institutional asset owners fulfill their fiduciary responsibilities. Indeed, our recent survey reveals that less than half have the capacity to fully analyze their risk exposures, while more than 90% expect the passive investment industry to be headed towards further customization capabilities to account for ESG and climate objectives. At a time when sustainable finance is likely facing an identity crisis, we highlight the interdependence of the main building blocks that sustainable investors ought to consider—themes, levers (exclusions, allocation, engagement) and data, and propose a practical classification of sustainable investments via four families of coherent strategies. We aim to specifically help portfolio managers set greenhouse gas (GHG) emissions reduction targets and avoid “greenwashing” by introducing a new attribution methodology for the GHG emissions of equity portfolios.

Our approach is inspired by environmental economics and breaks down (historically and/or cross-sectionally) emissions into five major drivers. We then show that long-term conditional simulations can be an important ingredient of an equity investment process. Indeed, we define a series of meaningful macroeconomic regimes that significantly impact equity returns and empirically observe that the behavior of equity portfolios can be efficiently extrapolated in different regimes over multiple economic cycles. To assist investors subject to a strict risk budget, we examine the benefits of a factor-based diversification of active risk to stabilize the tracking error relative to a cap-weighted benchmark. Our approach, inspired by the Equal Risk Contribution concept, is applied to the US equity ETF universe where we find supportive empirical evidence. Finally, we contribute to a European debate on the consistency of equity funds reported as sustainable. We analyze the possible tradeoff faced by asset managers between a sustainability objective and financial risk constraints and show that the incremental exclusion of stocks deemed controversial would have no material impact on the risk profile of the funds, especially if a simple optimization procedure is applied to reallocate portfolios.

Contents

1. The Perceived Advantages of Self-Indexing for Institutional Equity Investors
   • Benjamin Herzog, Jenna Jones, Shahyar Safaee
2. Institutional Equity Portfolios: How Can Asset Owners Build Coherent Sustainable Strategies?
   • Vincent Bouchet, Shahyar Safaee
3. Attribution Analysis of Greenhouse Gas Emissions Associated with an Equity Portfolio
   • Vincent Bouchet
4. Simulation of Equity Portfolios Returns in Macroeconomic Regimes
   • Matteo Bagnara, Benjamin Herzog, Benoit Vaucher
5. Active Risk Diversification Helps Stabilise Tracking Errors: Empirical Evidence from US Equity ETFs
   • Benjamin Herzog, Jenna Jones, Shahyar Safaee
6. Do Climate-Related Exclusions Have an Effect on Portfolio Risk and Diversification? A Contribution to the European ‘Article 9’ Funds Controversy
   • Vincent Bouchet, Aurore Porteu de La Morandière