Hoepner (2010)

Hoepner, Andreas G. F. “Portfolio diversification and environmental, social or governance criteria: Must responsible investments really be poorly diversified?” Working paper (School of Management, University of St. Andrews), December 2010.

From the author’s abstract: “We develop a simple theoretical model based on the three main drivers of portfolio diversification ((1) number of stocks, (2) weighted average correlation of stocks, (3) weighted average specific risk of stocks) and recent robust evidence on the significantly negative relationship between a firm’s ESG rating and its specific risk. Our theory argues that while the inclusion of ESG criteria into investment processes likely worsens portfolio diversification via the first and second driver, it similarly likely improves portfolio diversification through a reduction of the average stock’s specific risk. This positive effect of ESG criteria probably leads best-in-class ESG screened funds to be better diversified than otherwise identical conventional funds. With our simple theory, we aim to open a debate on the question, if (and when) the inclusion of ESG criteria into investment portfolios really worsens their diversification.“

Link: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1599334