Tools & Resources

ESG in Strategic Asset Allocation (SAA): A practical implementation framework

This study by the DWS Research Institute seeks to address the current blindspot of research to further facilitate comprehensive ESG integration at an overall multi-asset portfolio level. The research focused primarily on liquid global asset classes for which there are a replicable set of underlying indices. As such, the researchers established this framework by leveraging readily available passive ESG indices, which they found sufficient in achieving the various parameters, such as climate risk alignment.
While the authors recognize that alternative asset classes and instruments can play a significant role in enhancing the ESG characteristics of a strategic portfolio, their framework is focused on presenting an intuitive, implementable solution for liquid asset allocations. The analysis concluded that it is possible to have portfolios that reduce significantly ESG risks without meaningfully different risk-adjusted returns versus traditional index SAAs at relatively low levels of tracking error (“TE”). 
Additional findings include: 
  • ESG integration can be run for either individual asset classes or at a total portfolio level. The combined approach (optimizing the SAA and implementing via ESG indices) is the most efficient approach from the standpoint of total ESG utility versus tracking error.
  • Basic integration optimized across regional indices, sector indices, and ESG Indexes provides different levels of ESG improvement that depend highly on index/fund selection. The impact can vary from a reduction of 10 percdent to F-rated (highest risks) stocks and carbon intensity to as much as 80 percent and 50 percent respectively for the same tracking error of 25bps.
  • Changes in regional weights (e.g. having much more Europe versus US than in the standard market cap-weighted portfolio) improves the portfolio ESG characteristics only slightly.
  • Better (ESG) results can be achieved constructing the SAA with traditional sector indexes instead of regional ones.
  • Much better results can be achieved overall with allocating to ESG indexes. In this latter case, the share of worst ESG-rated securities can be reduced by 80 percent and the carbon footprint by 50 percent versus the traditional SAA – for tracking errors as low as 0.25 percent.


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