Environmental Portfolios—Evidence from Screening and Passive Portfolio Management

Julian Amon,Karl Weinmayer,Margarethe Rammerstorfer

doi:10.3390/su132212647

Julian Amon, Karl Weinmayer + Show 1 more

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https://doi.org/10.3390/su132212647

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Abstract

Environmental portfolios via screening or optimization with respect to ecological criteria are not clear-cut concepts. Often, they urge investors to reduce the asset universe, which is accompanied by diversification losses. In this article, we show that a simple passive asset selection strategy based on environmental criteria allows ecological investors to adjust their portfolios without compromising or even reducing risk-adjusted financial performance. In detail, we show that screening does not lead to a significant financial performance reduction. Moreover, we propose an asset selection based on an environmental criteria that improves the portfolios’ financial performance, and further improves its potential positive environmental impact. Our results suggest that a combination of a screening and an environmental-scoring-based asset allocation seems to be a viable option for environmentally responsible investors leveraging the advantages of both strategies. Furthermore, we construct a risk factor CMP (clean minus polluting) and document a significant factor loading when added to the Fama–French five-factor model, suggesting the existence of a risk premium based on a firm’s environmental performance.

Highlights

In recent years, many investors consider additional decision-making criteria besides risk and return, for example, environmental, social and governance (ESG) issues in their portfolio
The grey graph shows a clear superior performance compared to the other strategies
Screening activity is often seen as reducing the investors’ asset universe and, impacting the portfolios’ financial performance in a negative way due to diversification considerations. We investigate for both the US and Europe, simple passive portfolio strategies that rely on one hand on an sector-based negative screening of fossil fuel firms for the asset selection and on the other hand common on asset allocation strategies based on value-weighting and a naive allocation

Summary

Introduction

Many investors consider additional decision-making criteria besides risk and return, for example, environmental, social and governance (ESG) issues in their portfolio. While exclusion strategies are the most predominant strategies given by the assets under management (AUM), in terms on Euros invested, ESG integration shows the largest increase over the last few years. These practices aim to express the investors’ wish not to promote companies that fail to meet the investors’ individual preferences. The criteria that lead to an exclusion from the asset selection process can be based either on the type of industry (e.g., tobacco, weapons, or pornography) or on global issues and controversies (e.g., environmental, social or corporate governance) Given that this exclusion procedure affects the number of assets available in such portfolios, how does this activism affect the financial performance of the remaining “clean” portfolio?

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