Responsible investing: The ESG-efficient frontier --- Pedersen, H. Lasse, Shaun Fitzgibbons, and Lukasz Pomorski (2021) Flashcards
When managing your portfolio, you notice that your sustainable investments are outperforming your non-sustainable ones. Through what channels can ESG performance impact stock returns?
A) By influencing future profitability (return premium) or increasing investor demand (return discount).
B) By reducing a firm’s exposure to industry regulations and improving short-term gains.
C) By forcing firms to increase dividends as a means of compensating ESG investors.
D) By making companies more dependent on government subsidies, leading to higher stock volatility.
A
If high ESG performance correlates with future fundamentals, what does it imply about the investors in the market? (Refer to Responsible Investing: The ESG-Efficient Frontier.)
A) That ESG information is fully priced in, and there is no return advantage to ESG investments.
B) That some investors underestimate ESG’s impact on future firm profitability, creating an ESG return premium.
C) That ESG-focused firms are fundamentally less profitable, leading to lower long-term returns.
D) That government incentives entirely drive ESG stock valuations rather than actual firm performance.
B
The ESG-SR Frontier represents:
A) The maximum Sharpe Ratio (SR) achievable for a given ESG score.
B) The ideal balance between stock liquidity and ESG scores.
C) The percentage of market share held by sustainable firms.
D) The proportion of investment portfolios dedicated to ESG compliance.
A
What are the three types of investors in the framework proposed by Pedersen et al. (2021)?
A) Type-U (Unaware), Type-A (Aware), Type-M (Motivated).
B) Type-R (Risk-averse), Type-L (Leverage-seeking), Type-F (Fundamentalist).
C) Type-T (Trader), Type-B (Buy-and-hold), Type-D (Day trader).
D) Type-C (Conservative), Type-S (Speculative), Type-P (Passive).
A
What is a key finding of Pedersen et al. (2021) regarding ESG screening (excluding low-ESG stocks)?
A) It lowers overall Sharpe ratios by reducing diversification opportunities.
B) It always enhances portfolio performance, regardless of market conditions.
C) It has no measurable impact on portfolio performance.
D) It only works in emerging markets, not in developed economies.
A
Which of the following ESG components is found to provide the most useful information for stock selection?
A) Governance (G).
B) Environmental (E).
C) Social (S).
D) All ESG components contribute equally.
A
What happens to high-ESG stocks in a market dominated by Type-M investors?
A) They are overpriced, leading to lower expected returns.
B) They experience higher future returns due to their fundamental strength.
C) They are ignored, and their prices drop.
D) Their returns become completely uncorrelated with market fundamentals.
A
What happens when Type-U investors dominate the market?
A) High-ESG stocks remain undervalued, leading to higher expected returns.
B) ESG stocks trade at fair prices, eliminating any return premium.
C) ESG stocks consistently underperform due to lack of investor interest.
D) ESG-focused firms are forced to delist due to low market demand.
A
According to Pedersen et al. (2021), ESG scores affect asset prices because:
A) They inform investors about future firm profitability and shift investor demand.
B) They force regulators to impose higher corporate taxes on low-ESG firms.
C) They reduce volatility, ensuring stable long-term returns.
D) They eliminate the need for risk-adjusted portfolio construction.
A
What is a key assumption in the ESG-CAPM model developed in the paper?
A) That ESG scores convey meaningful information about firm fundamentals.
B) That only institutional investors consider ESG scores in decision-making.
C) That high ESG scores guarantee superior long-term returns.
D) That ESG investing is a temporary market trend with no structural importance.
A
According to the paper, high-ESG firms tend to:
A) Have more motivated employees and better governance.
B) Require additional government subsidies to stay competitive.
C) Exhibit extreme volatility due to investor speculation.
D) Struggle to compete against traditional firms in the long run.
A
What does the ESG-SR frontier reveal about stricter ESG constraints?
A) They can reduce financial returns beyond a certain threshold.
B) They always lead to higher Sharpe ratios.
C) They have no significant impact on investment outcomes.
D) They only affect emerging market investments.
A
If a stock’s ESG score predicts future profits, what is the expected market reaction?
A) Its price rises, reducing future returns.
B) Its price falls, increasing future returns.
C) Investors ignore ESG fundamentals entirely.
D) ESG scores only matter for niche investors, not the broader market.
A
What portfolio strategy maximizes risk-adjusted returns while integrating ESG?
A) The ESG-Tangency Portfolio.
B) The Equal-Weight ESG Portfolio.
C) The ESG-Screened Portfolio.
D) The Market-Neutral ESG Portfolio.
A
Why does G (Governance) contribute more to return predictions than E (Environmental) or S (Social)?
A) It correlates more strongly with future firm profitability.
B) It is the only factor that regulators strictly enforce.
C) Governance scores are fixed and do not change over time.
D) Firms with good governance avoid investor scrutiny.
A
