Responsible investing: the ESG-efficient frontier_Pedersen_2021 Flashcards
What is the problem with incorporating ESG factors in investment decisions?
There is no consensus on how ESG impacts performance and no theoretical framework on how to do that.
What is ESG-SR frontier?
It is maximum Sharpe ratio at each level of ESG, these portfolios are combinations of rf asset, tangency portfolio, min variance portoflio and the so-called ESG tangency portfolio
What are 3 types of investors Pederson considers?
Type - U (ESG unaware) are unaware of ESG scores and simply seek to maximize return per unit of risk.
Type - A (ESG-aware) have the same goal as U, but they use assets ESG scores to update their views on risk/return.
Type - M (ESG-motivated) are ready to sacrifice performance for high ESG, but still want maximum Sharpe ratio at each ESG level
In ESG-adjusted CAPM, when tupe U investors prevail?
High ESG delivers high expected returns (high ESG stocks are undervalued because U ignore useful ESG information)
In ESG adjusted CAPM, what happens when type A prevail?
Prices of high ESG stocks are bid up, eliminating premium.
What happens in ESG adjusted CAPM, when type M investors prevail?
High ESG stocks deliver low expected returns (M accept lower return for more ESG; high ESG stocks are overpriced)
How ESG impact return if they correlate with future fundamentals (profitability)?
ESG can be used to pick “better” stocks that will have higher return; this is positive effect (return premium)
How ESG can impact returns if correlate with investor demand?
High ESG stocks are sought by investors, which pushes their valuation up and expected return down; this is a negative effect (return discount)
What results authors find for E, S in ESG?
Results are mixed on correlation with future fundementals, and strong demand -> their theory predicts high valuations and low expected returns, which are low or insignificant returns.
What do authors find for the G?
Strong correlation with future fundamentals and also strong demand -> theory is inconclusive. Empirics reveal low valuations and high returns.
Does market fully incorporate information on G?
It does not, and G offered “guiltless saintliness” -> consider G in your portfolio
How authors classify E?
Low carbon intensity = carbon emissions/sales
How authors classify S?
non-sin stock = 1; sin stock = 0
How authors classify G?
Low acruals. Idea is that they indicate that firm is conservative in its accounting of profits and better-governed companies tend to adopt more conservative accounting processes.
How authors construct ESG efficient frontier?
They use E and G only, as it is impossible to use S as it is binary variable.
