ESG-Investing Exam Dumps | Compared to an optimal portfolio that does not have any ESG restrictions a portfolio that optimizes for

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Question 26

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Question 26/136

Compared to an optimal portfolio that does not have any ESG restrictions a portfolio that optimizes for multiple ESG factors will most likely experience

A. lower active risk

B. higher active risk.

C. lower tracking error

Correct Answer: B

Compared to an optimal portfolio that does not have any ESG restrictions, a portfolio that optimizes for multiple ESG factors will most likely experience higher active risk. Active risk, also known as tracking error, measures the deviation of a portfolio's returns from its benchmark.
* Constraints and Limitations: Applying multiple ESG factors imposes constraints on the investment universe. This limitation can lead to deviations from the benchmark, as the portfolio may exclude certain stocks or sectors that are present in the benchmark.
* Sector and Stock Exclusions: By optimizing for ESG factors, the portfolio may exclude high-performing stocks or entire sectors that do not meet ESG criteria. This exclusion can increase the portfolio's active risk compared to a traditional optimal portfolio.
* Potential for Divergence: The focus on ESG factors can lead to a different composition of the portfolio relative to the benchmark, resulting in potential performance divergence and higher active risk.
References:
* MSCI ESG Ratings Methodology (2022) - Highlights the potential for increased active risk when integrating multiple ESG factors into portfolio optimization.
* ESG-Ratings-Methodology-Exec-Summary (2022) - Discusses the impact of ESG constraints on portfolio performance and tracking error.

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