A portfolio manager may need to adopt a more appropriate ESG benchmark rather than a broad
market benchmark if the degree of exclusions results in high active share and high tracking error.
High active share indicates that the portfolio significantly deviates from the benchmark, while high
tracking error measures the volatility of these deviations.
High Active Share: Excluding a significant number of securities from the investment universe to align
with ESG criteria can lead to a portfolio that is very different from the broad market benchmark. This
high active share reflects the extent to which the portfolio composition differs from the benchmark.
High Tracking Error: The deviations from the benchmark can lead to high tracking error, indicating the
portfolio's performance can vary significantly from the benchmark. This variability can be a result of
the different risk and return characteristics of the excluded securities.
Appropriate ESG Benchmark: To accurately measure performance and risk, it is essential to use a
benchmark that reflects the ESG criteria applied in the portfolio. An ESG-specific benchmark would
provide a more relevant comparison and better align with the investment strategy.
Reference:
MSCI ESG Ratings Methodology (2022) - Explains the importance of selecting appropriate
benchmarks for ESG-focused portfolios to ensure alignment with investment objectives.
ESG-Ratings-Methodology-Exec-Summary (2022) - Discusses the impact of exclusions on portfolio
metrics such as active share and tracking error, and the need for suitable ESG benchmarks.
