Do Socially Responsible Investments Pay Off? Performance Test of ESG-screened Portfolios

Rikke Jørgensen & Lise-Lotte Lund Gregersen

Student thesis: Master thesis


This thesis investigates how ESG affects stocks performance. Previous research used Carhart’s four-factor model to investigate the performance of socially responsible investments. Instead, this thesis uses Fama & French’s five-factor model to see if high ESG-rated stocks show exposure to the quality factors. We use three performance measures; the average excess return defined as the average return minus the risk-free rate, Sharpe Ratio, and alpha. The data comprises daily stock returns from 2005-2019 and yearly ESG-data on 882 stocks, which are or have been a part of the S&P 500 index. In the first part of the analysis, four portfolios are created based on the 10 % highest average ESG-, E-, S- and G-scores. The portfolios generate significant positive alphas, and they all prove to have higher average excess returns and superior Sharpe Ratios compared to the market. The portfolios don’t show any exposure to the quality factors, so there’s no evidence that stocks with high ESG-scores are quality stocks according Fama & French’s definition. In the second part of the analysis, different screening processes and cut-off percentages are used. All portfolios generate significant positive alphas, and the portfolios with the lowest ESG-scores perform the best. Again, all portfolios perform better than the market measured on average excess return and Sharpe Ratio. Looking at a joint positive and negative screened portfolio, it generates a higher alpha than the positive screened portfolio, which is surprising since the “Sin Stocks”-theory suggests otherwise. Only the positive screened portfolio with the lowest ESG-scores shows exposures to the quality factors. The portfolios’ underlying accounting data are investigated. A re-semblance between high ESG-scores and quality is detected since the stocks in the High portfolios showed more robust profitability, lower investment growth, and a more stable P/E. We made a robustness check and tested the data on different subperiods. In shorter subperiods, the portfolio with the highest ESG-scores performs better in the crisis. When the period is split into two, the portfolio with the lowest ESG-scores is again superior, which follows previous conclusions. The overall conclusion is that ESG has a positive effect on stocks performance. However, the port-folios with the lowest ESG-scores perform better, which is surprising since we expected the opposite. Hence, Socially Responsible Investors will achieve a lower alpha by investing in portfolios with high ESG-rated stocks.

EducationsMSc in Finance and Accounting, (Graduate Programme) Final Thesis
Publication date2020
Number of pages174