Does ESG investing hurt financial performance? An analysis of the ESG-Efficient frontier and its practical applicability.

This bachelor thesis examines how the inclusion of ESG ratings in investment decisions affects the financial performance of the resulting portfolios. It also examines whether an investor should use ESG ratings as a filter or as a factor in mean-variance optimization to construct portfolios.

Mirko Zahnd, 2024

Art der Arbeit Bachelor Thesis
Auftraggebende VZ Depotbank AG
Betreuende Dozierende Höchle, Daniel
Keywords ESG; Portfolio choice; Sustainable investing; ESG-efficient frontier
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ESG (Environmental, Social, and Governance) investing has gained significant popularity in recent years. As more and more investors incorporate ESG factors into their investment decisions, it is important to understand their impact on financial performance and portfolio allocation. A useful tool to analyze the impact of incorporating ESG factors into investment decisions is the ESG/Sharpe-Ratio frontier introduced by Pedersen et al. (2021).
In this bachelor thesis, I apply their methodology to three different stock markets and analyze how higher ESG preferences affect portfolio allocation and portfolio performance. I also test the practical applicability of the Pedersen et al. (2021) approach. To this end, I compare the resulting ESG-optimized portfolios with simple market cap weighted portfolios containing only an ESG filtered subset of stocks. This is done on both an ex-ante and ex-post basis.
Using ESG ratings from three different providers — MSCI, Sustainalytics, and Bloomberg— for Swiss, European, and US stocks, I show that the ESG-optimized portfolios remain well diversified and the Sharpe ratio decreases only slightly when the weighted average ESG score is no more than one standard deviation above the mean of the respective ESG score of the underlying investment universe. However, when the portfolio is increasingly optimized towards the maximum ESG portfolio, the Sharpe ratio decreases significantly, which is due to the increasing volatility caused by the more concentrated portfolios. Furthermore, my analysis suggests that an investor with a higher ESG preference would be better off using an ESG filter before forming a market-weighted portfolio rather than relying on some sort of ESG-constrained mean-variance optimization. The filter approach is easier to apply, minimizes annual stock turnover and is unlikely to perform worse than an ESG-optimized portfolio in the medium to longer run.
Studiengang: Betriebsökonomie (Bachelor)
Vertraulichkeit: öffentlich
Art der Arbeit
Bachelor Thesis
Auftraggebende
VZ Depotbank AG, Zug
Autorinnen und Autoren
Mirko Zahnd
Betreuende Dozierende
Höchle, Daniel
Publikationsjahr
2024
Sprache der Arbeit
Englisch
Vertraulichkeit
öffentlich
Studiengang
Betriebsökonomie (Bachelor)
Standort Studiengang
Basel
Keywords
ESG; Portfolio choice; Sustainable investing; ESG-efficient frontier