Optimal ESG Portfolios: Which ESG Ratings to Use?

21 Pages Posted: 9 Jun 2021

See all articles by Anatoly B. Schmidt

Anatoly B. Schmidt

Finance and Risk Engineering, NYU Tandon School of Engineering

Xu Zhang

New York University (NYU) - NYU Tandon School of Engineering

Date Written: June 3, 2021

Abstract

The idea behind the optimal ESG portfolio (OESGP) is to expand the mean variance theory by adding the portfolio ESG value (PESGV) multiplied by the ESG strength parameter γ (which is investor’s choice) to the minimizing objective function (Pederson et al., 2019; Schmidt, 2020). PESGV is assumed to be the sum of portfolio constituents’ weighted ESG ratings that are offered by several providers. In this work we analyze the sensitivity of the OESGP based on the constituents of the Dow Jones Index to the ESG ratings provided by MSCI, S&P Global, and Sustainalytics. We describe discrepancies among various ESG ratings for the same securities and their effects on the OESGP performance. We found that the OESGP diversity decreases with growing γ. The dependence of the ESG tilted Sharpe ratio on γ may have two maximums. The 1st maximum exists at moderate values of γ and yields a moderately diversified OESGP. The 2nd maximum at large γ corresponds to a highly concentrated OESGP. It appears if portfolio has one or two securities with lucky combinations of high returns and high ESG ratings.

Keywords: portfolio choice, mean variance theory, ESG, Dow Jones Index

JEL Classification: G11, G12, G14, G24, G4, M14, Q01, Q5

Suggested Citation

Schmidt, Anatoly B. and Zhang, Xu, Optimal ESG Portfolios: Which ESG Ratings to Use? (June 3, 2021). Available at SSRN: https://ssrn.com/abstract=3859674 or http://dx.doi.org/10.2139/ssrn.3859674

Anatoly B. Schmidt (Contact Author)

Finance and Risk Engineering, NYU Tandon School of Engineering ( email )

NY
United States

Xu Zhang

New York University (NYU) - NYU Tandon School of Engineering ( email )

6 MetroTech Center
Brooklyn, NY 11201
United States

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