How can you leverage ESG ratings uncertainty to optimise your portfolio?
Messaoud Chibane and Mathieu Joubrel introduce a measure of the degree of investors' social responsibility to the classic Markowitz portfolio optimisation approach in « The ESG-efficient frontier under ESG rating uncertainty ».
We use ESG ratings collected from asset managers' internal ESG rating models to examine the impact of ESG score uncertainty on the risk-return profile of socially responsible optimal portfolios:
- We introduce a parameter θ representing the investor's degree of responsibility, ranging from 0 (traditional Markowitz) to 1 (pure impact investor).
- We use the investor's degree of responsibility to adapt the weight of ESG performance and ESG uncertainty in the optimisation program.
- For a given target financial return, as the portfolio ESG consensus target increases, financial risk must increase to make up for the additional social impact utility.
- For highly responsible investors, incorporating ESG uncertainty into their optimisation program substantially lowers their expected return for low-risk portfolios.
- For investors with low social responsibility, the effect of ESG uncertainty is moderate for low-risk portfolios.
- Portfolios optimised using only the ESG consensus fail to get close to the impact investor portfolio, except when ESG uncertainty is high.
- Portfolio optimised using both ESG consensus and uncertainty tend to get similar ESG performances as the impact investor portfolio when θ > 50%, even in cases of low uncertainty.
The impact of ESG uncertainty on portfolio performance, both financial and extra-financial, varies with the investor's level of social responsibility, as represented by the parameter θ.
Our study provides a new framework to analyse the impact of ESG uncertainty on portfolio optimisation, offering insights into the relationship between investor responsibility, ESG targets, and portfolio performance.
Our results can be further validated by extending the scope of the analysis beyond French companies and extending the study's timeframe.