An economics-oriented explanation of ESG investing

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I did take some economics courses back in university, but these days, those concepts are foreign to this lawyer. But since sustainable investing is a big part of the ESG movement, they are important. Here’s the latest from Nawar Alsaadi:

The ESG efficient frontier is an elegant finance solution to the Values Adjusted Returns concept I talked about earlier this year. Those familiar with the world of finance are fully aware of the mean-variance efficient frontier theory and the tangency portfolio.

The ESG efficient frontier builds on the same idea of maximizing the Sharpe ratio but in this case it would be in relation to ESG information. This paper demonstrates that certain ESG data can maximize returns, or act as a predictor of future returns, especially governance data. The paper also talks about a type of a motivated ESG investor who might choose a slightly lower Sharpe ratio in return for a higher ESG rating, a more values driven investor as supposed to a more financially oriented investor.

For those more visually inclined, you can view a wonderful presentation of this concept by Lasse Pedersen, Professor of Finance, Copenhagen Business School and NYU Stern, Principal, AQR Capital Management on YouTube.