Optimal Strategies for ESG Portfolios

Abstract

Previous research has provided evidence that in the last decade, investing according to screening based on environmental, social, and governance (ESG) criteria would have allowed investors to considerably improve the ESG quality of their portfolio without deterioration of its financial performance. However, a drawback of such a screening process is that it may generate undesirable regional, sectoral, and risk factor exposures. In this article, the authors propose an investment strategy that maximizes the ESG quality of the portfolio while maintaining regional, sectoral, and risk factor exposures within stated limits. They provide evidence that such a portfolio would have produced risk-adjusted performance at least as high as the standard MSCI benchmark for a wide range of ESG criteria and regions over the 2007–2018 investment period.

TOPICS: ESG investing, analysis of individual factors/risk premia, risk management, performance measurement

Key Findings

• ▪ The authors show that improving the environmental, social, and governance (ESG) score of a portfolio through screening can generate undesirable regional, sectoral, and risk factor exposures.

• ▪ They describe an investment strategy that maximizes the ESG quality of the portfolio while maintaining regional, sectoral, and risk factor exposures within stated limits.

• ▪ Such a strategy would have produced a risk-adjusted performance at least as high as the standard benchmark for a wide range of ESG criteria and regions over the 2007–2018 investment period.