Portfolio Performance Measures for Sustainable Investing

Anatoly B. Schmidt

Chapter 18 in Sustainable Investing:Problems and Solutions, 2024, pp 473-493 from World Scientific Publishing Co. Pte. Ltd.

Abstract: The portfolio performance measure generally used in classical finance is based on the volatility risk-adjusted return (Sharpe ratio). Unfortunately, applying this measure in sustainable investing may yield some confusion since portfolios with higher environmental, social, and governance (ESG) ratings may not outperform their ESG-neutral peers. Moreover, correlations between the corporate ESG ratings and stock returns in some portfolios can be negative. Since the ESG factors represent non-pecuniary risks, it is suggested in this work that socially responsible investors should include the ESG metrics explicitly in the portfolio performance measures. This idea is closely related to deriving optimal ESG portfolios (OESGPs) that are simultaneously optimized in terms of their return, volatility risk, and ESG value. Another important issue discussed here is that investors may prefer ESG ratings customized according to their preferences rather than simple averages of the E, S, and G categories that are offered by various ratings agencies. In this work, both problems are addressed using OESGPs formed with the constituents of nine major US equity sector Exchange-Traded Funds (ETFs). It is found that the main OESGP holdings are not very sensitive to the ESG metrics and hence can be promising leads for future investments.

Keywords: Sustainable Investing; Impact Investing; Corporate Social Responsibility; Materiality; Externalities; Sustainability; ESG; ESG Funds; ESG Factors; ESG Scores; SASB; SDG; DEI; Private Equity; General Partners; Active Ownership; Investment Stewardship; Machine Learning; Natural Language Processing; Large Language Models; Transition Economy; Climate Risk; Net-zero Investing; Divestment; Greenhouse Gas Emissions; Scope 3 Emissions; Modern Portfolio Theory; Venture Investments; Carbon Dioxide Removal; Carbon Credits; Fuel Production; Portfolio Management; Market Sentiment; Factor Investing; Portfolio Optimization; Post-investment Management; Digital Transformation; Fixed Income; Portfolio Performance Measures (search for similar items in EconPapers)
Date: 2024
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