Sustainable Equity Discrimination in Asset Liability Management for Practitioners: A Practical Approach

Abstract

CONTEXT: As the financial sector increasingly emphasizes responsible investment, insurance companies are actively seeking user-friendly approaches to incorporate sustainability criteria for equities into their Asset and Liability Management processes. OBJECTIVES: This paper aims to introduce a novel practitioner-centric methodology focused on seamlessly integrating publicly available Environmental, Social, and Governance (ESG) criteria. The objective is also to ensure ease of implementation for companies, emphasizing independence from ESG scoring provided by private data providers. METHODS: The proposed approach involves leveraging accessible sustainability data to construct both a sustainable equity index and a complementary index for non-included shares, utilizing clustering techniques. Subsequently, an efficient frontier is generated through the application of the Markowitz methodology. The effectiveness of the method is demonstrated through its application to a real portfolio, showcasing stability with a notable emphasis on sustainable assets, guided by the efficient reallocations suggested by the Markowitz model. RESULTS: Both constructed indices exhibit similar trends, with the ESG index outperforming, albeit with slightly higher volatility. This performance discrepancy is mirrored in the strategic asset allocation, where a preference is given to the ESG class over the non-ESG class. IMPLICATIONS AND LIMITATIONS: The findings suggest the feasibility of a financial institution successfully developing its own cohesive sustainability index using solely publicly available data. While our constructed ESG index demonstrated superior performance in this study, further research involving alternative data sources is essential to generalize this result.