SRI in the Nordic Countries – a profitability analysis

Abstract

The world is facing challenges with climate change. People are willing to advocate a good cause and fight against rising temperatures, as well as many societal and governmental issues. This has created a demand for more sustainable investment solutions and solid CSR practices. Therefore, socially responsible investing (SRI) has become very popular during recent years, for example, the US is capturing every fifth dollar invested under professional management.

In this study, three Nordic (Danish, Finnish, Swedish) stock portfolios are constructed: an environmentally, socially and governmentally (ESG) responsible portfolio and its matched conventional counterpart (non–ESG) and a Nordic large cap portfolio as a benchmark. These portfolios are examined to find any differences in the performance. The methods used are the CAPM and the Fama–French five factor model. The time period is split according to the financial crisis to see if there are any differences in performance during the crisis or normal times.

Two hypotheses are tested. Firstly, some of the previous studies suggest that ESG stocks act as a buffer in an economic downturn. The first hypothesis is in accordance. However, only weak evidence can be found to support the hypothesis that the ESG portfolio performs better in comparison to the conventional one during the financial crisis. Thus, the first hypothesis can be rejected due to the lack of statistical significance.

Secondly, many studies find the investment universe of the SRI investors to be limited, which may lead to lower profits. Therefore, the second hypothesis examines whether the conventional portfolio performs better compared to its responsible counterpart. It can be stated that at least during normal times, strong evidence can be found to support this hypothesis. The conventional portfolio yields an economically and statistically significant annual alpha of 7.7 percent for the whole time period examined, while the alpha for the ESG portfolio is smaller in size and not statistically significant.

However, the results should be taken with precautions, since the alpha for the non–ESG portfolio is large and negative in the crisis period, although lacking the statistical significance. For further research, it might be beneficial to use weekly data in order to confirm the negative alpha for the crisis period and the possible shielding effect for the ESG portfolio during the crisis.