The Impact of ESG Rating on Portfolios

Abstract

This thesis aims to contribute to the existing literature on whether Environmental, Social and Governance (ESG) ratings have an impact on financial performance. The research constitutes of ESG ratings from the two ESG raters i.e., Refinitiv and Bloomberg which is among the most popular ESG raters used by investors in investment decision-making. The project covers the Nordic countries i.e. Denmark, Sweden, Norway and Finland. The sample period investigated runs from 2012 to 2021. The main objective of the thesis is to investigate whether high portfolios, consisting of companies with high ESG ratings, perform significantly differently than low portfolios, consisting of companies with low ESG ratings. The portfolios of this thesis consist of a high and a low portfolio based on ESG scores by Refinitiv and a high and a low portfolio based on ESG scores by Bloomberg. The portfolios are constructed as value-weighted based on the 30% highest rated companies and the 30% lowest rated companies. In order to study the relationship between ESG ratings and financial performance in the portfolios, the returns are evaluated using Sharp ratio, Treynor ratio and Jensens Alpha. Furthermore, by using the performance models CAPM, Fama & French tree-, and five-factor models and Carhart four-factor model the returns on the portfolios are tested. In order to test the robustness of the findings, the sample is reconstructed into portfolios with new cut-off percentages of 20% and 50%. Additionally, the sample period of the thesis is split into two subsamples, 2012 to 2016 and 2017 to 2021. The findings from the analysis provide evidence that both the high and low ESG rated portfolios provide significant alphas. The thesis concludes that portfolios consisting of companies with high ESG ratings perform on the same level as portfolios consisting of companies with low ESG ratings. Hereby neither of the portfolios are performing better than the other. However, the findings do show that investors have been able to generate abnormal returns by incorporating ESG ratings over the period from 2012 to 2021. It should be noted that the abnormal returns are between 0-1% which leads to the conclusion that ESG scores do not have an impact on financial performance.