Sustainable optimal stock portfolios: What relationship between sustainability and performance?

The aim of this paper is to compare different strategies to combine sustainability and optimality in stock portfolios to assess whether there is an association between their average ESG (Environmental, Social, Governance) score and their financial performance and, if so, whether it depends on the specific strategy used. To this end, we confront the risk-adjusted performance of three ESG-compliant optimal portfolios resulting from: (i) optimizing on an ESG-screened sample, (ii) including a portfolio ESG-score constraint in the optimization on an unscreened sample, (iii) our original proposal of optimizing with an ESG-score constraint (so as to reach a target) over a slightly screened sample (so as to exclude companies with lowest sustainability). The optimization is implemented with Bloomberg ESG scores over a sample from the EURO STOXX Index in the period January 2007–August 2022 by minimizing portfolio residual risk. Two are the main conclusions from our results. First, we never find a significant negative association between portfolios’ average ESG score and performance independently of the strategy used. Second, we find a positive association when the first and the third strategy are implemented with a high screening level. To be noted that the relationship between the ESG score and the risk-return ratio in the initial investment set plays a relevant role. If, as in our dataset, this relationship is essentially convex, with an appropriate level of screening portfolios are composed only by stocks whereby a higher ESG score is associated with a higher risk-return profile.