Title: Optimizing portfolios through ESG risk budgeting Authors:  Massimiliano Caporin - University of Padova (Italy) [presenting]
Monica Billio - University of Venice (Italy)
Sandra Paterlini - University of Trento (Italy)
Runfeng Yang - Central South University (China)
Abstract: A novel ESG risk budgeting framework is introduced for constructing ESG-optimal portfolios, focusing on managing ESG risk contributions rather than pursuing ESG performance. This framework is tailored for investors prioritizing ESG risk management over non-pecuniary ESG goals. We apply this framework to the European stock market from 2013 to 2022. We first compare optimization outcomes across various ESG risk targets and find significant risk-return trade-offs when actively managing ESG risk exposure. Additionally, we observe that the choice of ESG data provider influences the risk budgeting results under active risk management. Then, we apply the framework to evaluate the impact of ESG risk on the stock market. We find that the impact of ESG risk can be large in certain sector groups and during extreme ESG-related market events, though the impact remains limited. Our findings highlight the complexities involved in incorporating ESG factors into investment strategies.