Annual ESG Portfolio Rebalancing and High Minus Low Returns

Summary

The document asks how to measure monthly returns for two S&P 500 equity portfolios formed from the highest- and lowest-scoring ESG companies. The proposed portfolios are reconstituted annually using the prior year’s ESG scores, and the author wants to explain the high-ESG portfolio’s excess returns with the Fama–French three-factor model plus an ESG high-minus-low factor.

The questions point to practical choices in portfolio construction: applying weights to monthly constituent returns between annual rebalances, handling firms that leave the index midyear, and defining a return difference between the high- and low-ESG portfolios. The document does not supply calculations or answers, so it provides no evidence on whether ESG scores predict returns or whether the added factor explains performance. Results would depend on the precise formation, weighting, and constituent-exit rules, which are left unspecified.

Key ideas

• The proposed comparison uses portfolios of firms with the highest and lowest ESG scores.
• The portfolios are rebalanced annually using ESG scores from the preceding year.
• Monthly portfolio returns require applying the portfolio weights to constituent returns during each holding period.
• An ESG high-minus-low factor could be formed from the return difference between the two portfolios.
• Index exits and portfolio formation rules can affect the measured returns and factor results.

Tags

# How to calculate returns of a portfolio with rebalancing?


# How to calculate returns of a portfolio with rebalancing?












I would like to compare the performance between a portfolio with the 30% of firms in S&P500 that have the highest ESG score to a portfolio with the 30% with the lowest ESG score. Then I would like to explain potential excess returns of the High-ESG portfolio by using the Fama-French 3 factor model + an additional factor that takes into account the ESG scores (high minus low ESG). I would like to rebalance each of the 2 portfolios once a year according to the ESG score of the year before. The data on returns is monthly data. I am using Stata for the analysis. Now my questions: I started calculating the portfolio weights of each company for each year in my analysis.

- How do I then calculate the monthly returns of each portfolio? Do I need to analyse the returns for each year separately?

- What if a company is excluded from the index in the middle of a year?

- How do I calculate a ESG high minus low factor similar to the other factors in the Fama French model?

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.