The Cost of Socially Responsible Investing (SRI) : Risk-Adjusted Evidence from European ESG Funds

Abstract

This thesis examines the question of whether or not environmental, social, and governance (ESG) investing bears a quantifiable financial cost in comparison to standard measures. Although ESG integration has taken a structural dimension in the world of capital markets, academia has been divided on whether sustainable ways of investing increase, decrease, or merely redistribute risk-adjusted returns. This paper determines the performance of 58 ESG funds using different asset pricing specifications, such as the Capital Asset Pricing Model (CAPM), the Fama-French three-factor model, and the Fama-French five-factor model. The panel fixed effects regressions used to control unobserved fund heterogeneity, and interaction terms during the period of crisis analyze the performance in the COVID-19 market shock. The measure of robustness is done on fund-clustered standard errors. The findings suggest that ESG funds exhibit negative abnormal performance, which is partially attenuated under the three-factor model, as proposed by the CAPM. Nevertheless, negative alpha does survive under the five-factor specification and implies that we cannot entirely blame underperformance on conventional factor exposures. ESG funds have high positive returns on profitability and size variables, which represent structural portfolio biases. Where systematic risk exposures are adjusted, there is no statistically significant crisis-period alpha. Generally, the results indicate that differences in the performance of ESG funds are primarily structural and exposure-related, rather than being attributed to long-term managerial inefficiency. ESG investing seems to have a small financial price, which is model-dependent and is mainly described by systematic factor properties and not in the smooth generation of abnormal returns.