ESG PORTFOLIO OPTIMIZATION AND RISK ANALYSIS

Abstract

“How to do well, from doing good?” is a common question that many companies and investors are asking themselves these days. Because of the open nature of the question, it is difficult to evaluate the relative success companies achieve in their pursuit of this ideal. An emphasis has been placed on environmental, social, and governance (ESG) principles that aim to assess the “goodness” of any given company, considering a number of aspects that are not be covered in traditional financial analysis, but may have some influence on performance such as their response to climate change, supply chain management, ethical treatment of employees, and corporate culture. Understandably then, while ESG is frequently used terminology, what are the quantitative financial trade-offs of optimizing around these qualitative principles. This thesis explores reviews Modern Portfolio Theory as a means of evaluating various portfolios that consider ESG principles. Then, we will utilize ESG data to quantitatively compare various ESG criteria such as only investing in assets about a given score or only investing in assets who outperform their peers in some frame relative to the ESG principles. While the ESG-constrained portfolios expectedly performed poorer than the portfolios that did not consider ESG factors, the data finds that the realized difference in return was less the forecasted difference in return, motivating further research and analysis.