Evaluating Benchmarking Choices for ESG Investment Portfolios

As a charterholder working at a wealth management firm, you have been tasked with evaluating the performance of a newly set-up ESG-focused investment portfolio. This portfolio consists primarily of companies recognized for their strong environmental, social, and governance standards. The portfolio manager has proposed using a benchmark that consists of a custom index of ESG companies weighted by market capitalization.

However, you notice that the proposed benchmark underrepresents certain sectors such as renewable energy and technology while overweighting traditional industries like utilities and consumer staples. Additionally, the portfolio manager has suggested performance measurement using the Sharpe ratio, despite acknowledging the presence of significant market volatility.

Discuss the implications of these benchmark choices on the performance evaluation of the ESG-focused portfolio, considering the potential biases that may arise from the sector allocation and the chosen performance metric. Furthermore, recommend a more ideal approach to benchmarking this type of portfolio and justify your recommendations based on performance evaluation standards.