What is it about?
Constructing ESG-screened portfolios aims to reduce the aggregate ESG-risk at the portfolio level by excluding low ESG-score constituents from the selection universe. But ESG-screening imposes limits on potential diversification as well as alters risk exposures to systematic factors. Then, how does ESG-screening impact the factor-risk-adjusted performance of portfolios? To answer the question, we construct ESG-screened portfolios consisting of US equity mutual funds according to their returns-based ESG-scores. Then we conduct a performance contribution analysis for the sample period from 1999 to 2018.
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Why is it important?
We may consider that ESG-investors buy downside protection against the systematic ESG-risk. Once investors strategically choose risk exposures against conventional systematic factors, the realized factor-risk-adjusted performance of ESG-screened portfolios would turn out to be positive (adverse) when ESG-events trigger more (less) severe losses than initially expected. The result of performance contribution analysis suggests that investors need to treat the concentration level of ESG-screening as a search parameter to balance the costs and benefits of ESG-screening. The benefit of decreasing ESG risk seems to outweigh the cost of increasing diversifiable risk until about 50% of low score funds are excluded from the eligible universe. The risk contribution rises rapidly after P30, implying that the cost of limited diversification grows fast with a higher concentration of ESG-screening.
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This page is a summary of: ESG-screening and factor-risk-adjusted performance: the concentration level of screening does matter, Journal of Sustainable Finance & Investment, October 2020, Taylor & Francis,
DOI: 10.1080/20430795.2020.1837501.
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ESG-screening and factor-risk-adjusted performance: the concentration level of screening does matter
Jin, I. 2020. “ESG-screening and factor-risk-adjusted performance: the concentration level of screening does matter,” Journal of Sustainable Finance & Investment, DOI:10.1080/20430795.2020.1837501
Is ESG a systematic risk factor for US equity mutual funds?
Jin, I. 2018. “Is ESG a systematic risk factor for US equity mutual funds?” Journal of Sustainable Finance & Investment, 8 (1): 72-93. DOI: 10.1080/20430795.2017.1395251
The concentration level of ESG-screening does matter.
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