Morningstar - Q2 2021 - 51

Note how as we move from Investor No. 1 to
Investor No. 4, the holdings on the ESG-positive
stock increase and the holdings on the
ESG-negative stock decrease. This shows how both
pecuniary ESG awareness and nonpecuniary
preferences have an impact on the ESG exposure
of a portfolio.

Trade-Offs
The PAPM is a powerful and flexible model that
allows us to incorporate both differing
economic pecuniary views and nonpecuniary
preferences. It is, therefore, especially well-suited
to address the impact on both pecuniary and
nonpecuniary ESG factors in a single model

EXHIBIT 4

Investor Portfolios Under Alternative ESG Assumptions

Paul D. Kaplan, Ph.D., CFA, is director of research with
Morningstar Canada. He is a member of the editorial board
of Morningstar magazine.

ESG-Unaware Views, No Nonpecuniary ESG Preferences

Cash

0.00

ESG Neg. Stock

The author thanks Ryan Murphy and Thomas Idzorek for
their helpful edits and comments.

50.30

ESG Pos. Stock

-40%

20

0

49.70
40

20

60

80

100

Different ESG Views, No Nonpecuniary ESG Preferences
ESG-Unaware

Cash

18.96
ESG Neg. Stock

Kaplan, P.D. 2018a. " Build Bridges, Not Walls. " Morningstar
magazine. April/May.

78.09
23.03

ESG Pos. Stock

40.88

Kaplan, P.D. 2018b. " The Popularity Asset Pricing Model. "
Morningstar magazine. June/July.

58.01
20

0

References
Idzorek, T.M., Kaplan, P.D., & Ibbotson, R.G. 2020. " The
Popularity Asset Pricing Model. " Working paper. December.
Ibbotson, R.G., Idzorek, T.M., Kaplan, P.D., & Xiong, J.X.
2018. Popularity: A Bridge Between Classical and Behavioral
Finance. Charlottesville, VA: CFA Institute Research
Foundation.

ESG-Aware

-18.96

-40%

that addresses how these factors affect asset
prices and investor portfolios. The model
that I presented here demonstrates the impact of
both ESG views and preferences. Furthermore,
it shows the possible trade-offs between
nonpecuniary ESG exposure and pecuniary
risk-adjusted expected return that investors may
need to make. Recognizing the distinct
impacts of ESG views and preferences and the
pecuniary/nonpecuniary trade-off are the
main lessons from the ESG version of the PAPM. K

20

40

60

80

100

Kaplan, P.D. 2019. " A Matter of Opinion. " Morningstar
magazine, Winter.

Different ESG Views and Nonpecuniary Preferences
#1. ESG-Unaware, No ESG Preferences
#2. ESG-Unaware, ESG Preferences

Cash

Pedersen, L.H., Fitzgibbons, S., & Pomorski. L. 2020.
" Responsible Investing: The ESG-Efficient Frontier. " Journal
of Financial Economics.

#3. ESG-Aware, No ESG Preferences
#4. ESG-Aware, ESG Preferences

-35.04

Rekenthaler, J. 2019. " Putting a Price on Popularity. "
Morningstar magazine. Summer.

-2.57
2.57
35.04
ESG Neg. Stock

101.32
54.17
46.50
-0.65

ESG Pos. Stock

33.72
48.40
50.93
-40%

20

0

20

40

65.61
60

80

100

Source: Morningstar.

morningstar.com/lp/magazine

51
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Table of Contents for the Digital Edition of Morningstar - Q2 2021
