A new ESG risk metric

ESG Risk is the risk deriving from Environmental, Social and Governance factors impacting the performance of securities in a mutual fund. There is no satisfactory metric for ESG risk in the current literature and a new and rigorous approach to building fund portfolios is needed.

Given the peculiar nature of Etica Sgr’s business and the importance it places on the ESG aspects of its products, we thought it would be interesting to design a proprietary metric for ESG risk with statistical and predictive value, correlated with the traditional financial risk of the portfolio.

Starting from the concept of entropy and taking as input the weightings in the portfolio and the ESG scores of the securities, i.e. extra-financial evaluations of the companies and countries conducted by Etica Sgr’s Research Team, we were able to demonstrate a robust statistical correspondence between ESG risk and traditional portfolio financial risk (non-diversified VaR).

We believe this is a first major step towards the integration of ESG variables in the total calculation of investment risk, and a valuable contribution to determining asset allocation or defining new risk/return metrics when evaluating overall fund performance.

Responsible finance ESG Institutional investor
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