ESG Constraints and Portfolio Efficiency: A Review of Risk–Return Trade-offs in Modern Asset Allocation

Abstract

ESG (Environmental, Social, and Governance) investing has become an important trend in global financial markets, as more investors consider sustainability factors alongside financial performance. However, research findings on how ESG constraints affect portfolio efficiency remain inconsistent. Some studies suggest that ESG integration does not harm risk-adjusted returns, while others argue that adding sustainability requirements may limit diversification and shift the efficient frontier. This paper reviews academic studies and industry reports published between 2010 and 2025 to examine how ESG constraints influence portfolio optimization under modern asset allocation models. The selected studies were organized into three thematic sections. The review finds that ESG integration generally does not significantly reduce long-term risk-adjusted returns, although its effect on the efficient frontier remains debated. Differences in ESG rating systems and regional regulatory environments contribute to these mixed results. Future research should focus on improving ESG measurement consistency and expanding empirical analysis in emerging markets.