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

Malm, Per LU (2022) NEKP01 20221
Department of Economics
Abstract
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... (More)
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. (Less)
Please use this url to cite or link to this publication:
author
Malm, Per LU
supervisor
organization
course
NEKP01 20221
year
type
H2 - Master's Degree (Two Years)
subject
keywords
ESG, Abnormal Returns, High Minus Low, Asset Pricing Model
language
English
id
9097217
date added to LUP
2022-10-10 11:29:00
date last changed
2022-10-10 11:29:00
@misc{9097217,
  abstract     = {{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.}},
  author       = {{Malm, Per}},
  language     = {{eng}},
  note         = {{Student Paper}},
  title        = {{ESG: The Relationship Between “Ethical” Investing and Abnormal Returns}},
  year         = {{2022}},
}