ESG Intergration into the Investment Process

Abstract

Since Markowitz’s Portfolio Theory the financial world has been described by two variables: return and risk. According to traditional finance, a rational investor should take a financial decision based only on these two variables. However, once again, reality makes economic theory obsolete. Empirical evidence shows that investors are not only concerned about how much money they will gain and how much money they are going to risk: the sustainability dimension has a profound impact on their investment decision. Financial theory must take into consideration a third sustainability-related variable. The most common and widest used proxy variable for sustainability is the ESG score. The contribution of this master’s thesis is fourfold: first, it discusses the foundations of sustainable finance, trying to give a definition to the concepts of sustainable and responsible finance, corporate social responsibility, sustainable and responsible investing, and ESG score; second, it performs a literature review of the most influential studies on ESG integration into the investment process; third, it develops a method – a multi-stage tracking error model – that theoretically avoids previous models’ limitations; fourth, it provides a practical application of the model using a sample of the 50 companies included in the Euro Stoxx 50 for a 5-years time period.