A Framework for ESG Considerations in Portfolio Design

July 01, 2009
  • Contributors:

    Jeff Dunn
  • Topic:

    Other Research

AQR White Paper

It is often argued that the world is changing and that Environmental, Social and Governance (ESG) issues could pose a significant risk or potential opportunity for pension assets. This argument may have merit, but it rarely leads to actionable steps or clarity of direction. In some sense it is a call to arms against an unknown enemy. The inherent breadth and ambiguity of issues has resulted in the integration of ESG considerations into portfolio design remaining largely a philosophical push without clarity on the direct and indirect effects on shareholder value.

This paper proposes a simple framework to consider the role ESG issues may play in investment decisions. This framework allows investors to disentangle ESG considerations and provides a clearer path for further investigation of how ESG policies affect shareholder value and how they may be appropriately included in the investment decisions of both investors and fiduciaries.

As a first step, we identify three distinct avenues by which ESG consideration may affect fund investment performance.

  • Systemwide changes in ESG management: The impact on portfolio returns resulting from changes in ESG management on the economy as a whole.
  • Company-specific changes in ESG management: The impact on portfolio returns resulting from changes in ESG management of individual companies.
  • Investing in ESG leaders: The impact on portfolio returns of owning better run companies, or a return premium for “good” ESG management.


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