Abstract
Our aim is to propose a methodology to derive an ESG risk rating for any alternative portfolio, from the ESG ratings of its constituents. To do so, we introduce the notion of ESG risk and define the ESG rating as the ratio between the portfolio’s ESG risk and its total risk. We show how both ESG and total risk can be computed with a variance-based formula. The empirical correlation matrix has to go through a prior shrinkage procedure to ensure that the ESG risk cannot be larger than the total risk. An important consequence of our methodology is that a fund trading an investment universe of poorly (resp. highly) ESG-rated instruments, should have a poor (resp. good) ESG rating. We test this methodology on the Lyxor Epsilon Global Trend Fund and observe that results are consistent with qualitative expectations.
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