Do leading ESG equity portfolios outperform peers and benchmark? An empirical analysis on portfolios constructed by constituents of the S&P 500 index.

Abstract

The purpose of this master thesis is to examine whether ESG-ratings based investing could lead to superior financial performance and further investigate whether the ESG portfolios could generate abnormal returns. It extends the existing literature on ESG by analyzing the relationship between ESG ratings and equity portfolios in a recent time span that included a financial crisis which emerged from the exogenous COVID-19 pandemic. Also, conclusions are derived regarding one portfolio comprised of firms without exhibiting any ESG rating. In this study, by utilizing MSCI ESG ratings, seven ESG portfolios and one Non-ESG portfolio were constructed with equal weights from the constituents of the S&P 500 for the period from 30/06/2017 until 30/06/2021. Comparisons were made in terms of absolute returns, volatility and risk-adjusted returns between the constructed portfolios and to the benchmark S&P 500 Equal Weight Index (S&P 500 EWI). Whether the constructed portfolios generated abnormal yields were examined in the context of the Capital Asset Pricing Model (CAPM) and the Fama-French Three Factor Model (FF3FM). The findings revealed that the portfolios with the best ESG ratings exhibited higher returns both in absolute and risk-adjusted terms relevant to the rest of the portfolios and the benchmark. From the regression models, only one of the constructed portfolios exhibited statistically significant positive monthly alpha of 0,247%. Hence, high-ESG oriented investors favoring portfolios with the best ESG ratings for the aforementioned period would fare better, but when accounting for the exposure to common factors, any benefit vanishes. Whether or not ESG-ratings based investing enhances investment returns, remains still an open question.