Comparing Methodologies for ESG Integration into Equity Factor Construction

We explore different approaches to incorporate ESG considerations into equity factor portfolio construction, comparing exclusionary screening with inclusionary optimization. We find that portfolio optimization better preserves factor style while enhancing ESG scores. Across the United States, Europe, and Japan, ESG-tilted portfolios benefit from a consistent ESG premium, though at the cost of reduced factor exposure. This article decomposes performance into ESG and factor premium contributions, offering actionable insights for investors balancing sustainability with systematic returns.