CFA Institute Updated Sustainable-Investing Exam Questions and Answers by amirah

Applying energy sector exclusions typically results in thelargest deviationfrom broad market benchmarks inequity portfolios. This is because the energy sector represents a significant portion of many equity indices. As a result, excluding it canmaterially alter portfolio returnscompared to the index, creating ahigher tracking error. In contrast, bond portfolios (both high yield and investment grade) usually have more diversified sector exposures, so excluding energy has asmaller impacton tracking error.

CFA materials describeweighted-average carbon intensity and attributed emissionsasportfolio-level ESG measures. Theyaggregatecountry-level carbon intensities of sovereign issuersweighted by portfolio exposures. While the data reflects country-level emissions, the metric itself is reported at theportfolio levelto provide an integrated ESG exposure picture.

Voting policies are critical inactive equity(due to direct share ownership) and important even inpassive/index fundsfor stewardship purposes. In contrast,active fixed-incomeinvestments rarely involve voting rights, making them the asset class where voting policies are least likely to be relevant.

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.