ESG Investing and the Long-Short Strategy

ESG investing has been growing exponentially. According to Bloomberg, ESG assets are likely to rise to $53trillion by 2025, comprising a third of the global AUM.

Most investment strategies are either exclusionary (do not buy “bad” stocks) or buy-and-hold. However, a relatively new strategy to ESG investing is the long-short strategy. This strategy involves buying stocks whose prices we expect to go up and simultaneously short sell stocks whose prices we hope to go down. This strategy is also called the 130-30 strategy. This approach involves buying 130% of the funds and short selling 30%.

Short selling is simply selling shares that you do not own. We do this by borrowing shares now to sell them at a future date. The short seller repays the borrowed shares when the trade is closed by buying the shares at lower prices. 

The idea of the long-short strategy is to make money on stocks that are likely to perform well and stocks expected to perform poorly, thus increasing the portfolio’s returns. This strategy also helps in hedging your bets.

This strategy is, now, increasingly being employed in ESG investing. The approach is to buy stocks with high ESG scores and short-sell stocks with low ESG scores. The idea is that companies with high ESG scores are likely to perform well in the market, while those with low scores perform poorly. 

Shorting or short selling low ESG score stocks have three benefits:

  1. It puts out portfolio managers’ investment views. Rather than not holding a stock (a neutral view), the portfolio manager makes a significant statement by shorting the stock.
  2. Shorting helps hedge ESG risks.
  3. The portfolio manager can provide a higher rate of return to the investors.  

Published by Utkarsh Majmudar

Utkarsh Majmudar is a Fellow, IIM Ahmedabad and a professional with experience encompassing academics and administration at top business schools in India (IIM Lucknow, IIM Udaipur, and IIM Bangalore) and working with large corporations. His interest areas include corporate finance and CSR.

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