Assessing Risk Through Environmental, Social and Governance Exposures

Jeff Dunn, Shaun Fitzgibbons and Lukasz Pomorski
Vol. 16, No 1, 2018

We discuss risk and return implications of incorporating environmental, social and governance (ESG) considerations in an investment strategy and argue that ESG exposures may be informative about the risks of individual firms. We show empirically that stocks with worst ESG exposures have volatility that is up to 15% higher, and betas up to 3% higher, than stocks with the best ESG exposures. We also find that ESG scores may help forecast future changes to risk estimates from a traditional risk model. Controlling for the contemporaneous risk model estimates, we show that poor ESG exposures predict increased future statistical risks.