Forming ESG-Oriented Portfolios: A Popularity Approach

The Journal of Investing 30th Anniversary Special Issue 2022, 31 (4) 63-75; DOI: https://doi.org/10.3905/joi.2022.31.4.063

Posted: 8 Jun 2022

See all articles by Thomas M. Idzorek

Thomas M. Idzorek

Morningstar Investment Management

Paul D. Kaplan

Morningstar Canada

Date Written: May 20, 2022

Abstract

Key theories of financial economics seem to be at odds with one another and with observed personalized portfolios. The Popularity Asset Pricing Model serves as a unifying theory by allowing for both rational and irrational investors, individual risk and return expectations, a multitude of pecuniary and non-pecuniary characteristics to impact asset prices, and investors to derive utility from non-pecuniary characteristics. The authors develop a benchmark-relative fund-of-funds alpha-tracking error utility function that directly incorporates an investor’s non-pecuniary preferences, including environmental, social, and governance–oriented preferences. Maximizing the utility function leads to a personalized portfolio that tilts toward characteristics that the investor likes and away from characteristics the investor dislikes while maximizing alpha and minimizing tracking error.

Suggested Citation

Idzorek, Thomas and Kaplan, Paul D., Forming ESG-Oriented Portfolios: A Popularity Approach (May 20, 2022). The Journal of Investing 30th Anniversary Special Issue 2022, 31 (4) 63-75; DOI: https://doi.org/10.3905/joi.2022.31.4.063, Available at SSRN: https://ssrn.com/abstract=4118745

Thomas Idzorek (Contact Author)

Morningstar Investment Management ( email )

22 W Washington Street
Chicago, IL 60602
United States

Paul D. Kaplan

Morningstar Canada ( email )

1 Toronto Street
Suite 500
Toronto, Ontario M5C 2W4
Canada

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