Meet the Expert: AQR Head of Responsible Investing Christopher Palazzolo on Systematic ESG Investing


Is ESG incorporated in AQR’s strategies? 
AQR has a long history in ESG investing. In fact, ESG has been a part of our investment process since the firm’s inception in 1998. Since then, we’ve continued to expand our commitment to ESG, and today we use ESG information in about 90% of our assets under management.  

ESG can be considered an expanded set of non-traditional information that can be used in an investment process. As a systematic manager, we have decades of experience synthesizing different types of data. Employing ESG information in our strategies has been a natural extension of our systematic investment approach. 

How does AQR approach ESG investing? 
How we use ESG information depends on the goal of the individual strategy. In our standard strategies – those seeking to maximize returns – we use ESG signals that we believe enhance risk-adjusted expected returns. Historically, these signals have fallen into the governance category, but we have now incorporated environmental and social signals into our alpha models as well.  Our use of these signals has also grown significantly.  For example, ESG signals now account for about 15% of our standard stock selection model.

We also manage dedicated Sustainable strategies, which are designed for investors who explicitly want to improve the ESG profile of their investments. These strategies therefore have a dual mandate – the first is to enhance the ESG composition of the strategy’s portfolio to a specified level, or to meet an ESG-related goal like creating a portfolio with 50% less carbon footprint than the benchmark. The second mandate is to maximize returns to the extent possible within the constraints of the ESG goal. In these strategies, we incorporate many signals across the “E”, “S” and “G” categories. 

What are some of the potential benefits of a systematic investment approach in ESG? 
We think a quantitative investment approach has several advantages when it comes to ESG investing.

First, we believe quants are better positioned to incorporate and deliver on non-financial goals while maintaining the risk and return profile of a strategy. Unlike discretionary managers, who may be hard-pressed to say with any degree of certainty what an additional ESG consideration will do to a strategy’s performance, we can easily backtest the effect of adding that new constraint to a strategy. 

For example, let’s say an asset owner wants to take an existing strategy and constrain it to hold a portfolio with 50% less carbon footprint than the benchmark. Without a systematic approach, it’s difficult to determine how this constraint would affect returns.  However, we are able to quantify the expected impact of the constraint, supported by actual data.

Second, we believe that a quantitative approach provides more transparent ESG integration. We can precisely quantify the weight of ESG signals in a portfolio and directly attribute their contribution to performance. In comparison, because a discretionary manager relies on their judgment to make investments, they typically do not have a robust way to separate the effect of one investment decision from another and attribute weights to each. 

Additionally, a quantitative process is theoretically unlimited in how much ESG data it can analyze, whereas a discretionary approach is limited by manpower. Therefore, as a quant we can incorporate more information on a broader swath of securities in a quicker fashion. 

Are responsible ownership practices compatible with a systematic approach? 
Responsible ownership practices can go hand-in-hand with a systematic investment process. Even though we’re highly diversified across many different positions, given our overall size, our aggregate position in many companies ranks within the top ten shareholders. With that size of a position, company management is typically receptive to a dialogue with us and our vote can be meaningful to the outcome of proxy issues. There are certain ESG issues that appear on proxies – such as corporate restructurings – that we already analyze from an investment standpoint. In those cases, our investment process can help inform our responsible ownership approach. In other cases where the issue may not be quantitative in nature, we apply judgement to determine what we believe is in the best interest of our clients as shareholders.

In 2020, we were excited to implement several new responsible ownership initiatives. We began to engage in dialogues with the company management of our 20 largest aggregate holdings, looking to better understand their ESG-related risks and encourage them to have greater transparency on these issues. We also advocate for increased disclosure on financial statements from companies lagging their peers in terms of financial data transparency. 

Lastly, we have implemented a custom sustainable voting policy across all commingled funds. The policy will allow us to evaluate and more frequently vote to voice our support for key ESG issues such as diversity on boards, split Chairman and CEO roles, and transparency in companies’ ESG reporting. 


Source: AQR. As of December 31, 2020.

The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results. AQR Capital Management is a global investment management firm, which may or may not apply similar investment techniques or methods of analysis as described herein. The views expressed here are those of the authors and not necessarily those of AQR.