Introducing ESG risk parameters into Trend Following
In an environment with low interest rates and low inflation, trend following has delivered mediocre returns over the last decade, with the exception of 2014 where the strategy was able to capitalise on the strong positive oil supply shock in the second half of that year. However, trend following has shown historically that it can deliver strong real returns across inflationary regimes, including the current supply-driven surge in prices. This is achieved by leveraging directional exposures to commodity markets such as energy, metals and agricultural commodity futures that are sensitive to inflation.
Given increasing environmental, social and governance (ESG) concerns among investors it is highly important for a systematic investment strategy with large directional exposures to commodities (among the other financial assets) to incorporate ESG information into its investment process. In this paper we present a framework for integrating ESG risk into trend following.