ESG: The Relationship Between “Ethical” Investing and Abnormal Returns

Sammanfattning: This essay examines the relationship between ESG and abnormal returns and its implications on investing. To investigate this topic, I allocate stocks into zero-investment portfolios based on high and low ESG, using three different weighting methods, equal weighting, value weighting and portfolio optimization. The portfolios are then evaluated using the CAPM as well as the Fama-French three-factor and five-factor models. In addition, I also calculate the Sharpe ratios and mean ESG scores of each individual sub portfolio, as well as the mean excess return of each zero-investment portfolio. The sample consists of 510 US stocks and covers the period between August 2009 and November 2019. As a measurement for ESG, I use a score for each pillar and an overall ESG score. The results in general show that there is little to no impact of ESG on abnormal returns. There does seem to be some impact when we use value weighted portfolios. This might be due to a few outliers that either under- or overperform, as the abnormal returns persist even when controlling for the size effect. In practical terms this means that investors can generally expect adequate risk-adjusted returns even when preferring high ESG stocks. However, because of the indication that there may be outliers this should be taken with some degree of caution. Regarding the Fama and French factors there appears to be a presence of a value effect related to ESG. Broadly, low ESG stocks tend to be riskier as the high minus low portfolios indicate that they are more exposed to the factor loadings.