Comparative Analysis of Active and Passive ESG Funds in Europe during Volatile Times

Abstract

This thesis examines the performance of actively and passively managed ESG equity funds dom iciled in Europe from 2016 to 2023, with a particular focus on risk-adjusted returns during dif ferent market conditions. The study evaluates whether actively managed ESG funds justify their higher expense ratios by delivering superior performance compared to passive ESG funds. Using a comprehensive dataset of European-domiciled ESG equity funds, two portfolios, active and passive are constructed and assessed using multiple risk-adjusted metrics, including the Sharpe ratio, Sortino ratio, Jensen’s alpha, and multifactor regression models such as the CAPM, Fama French three-factor, and Carhart four-factor models.

The results indicate that actively managed ESG funds do not consistently outperform passive ESG funds on a risk-adjusted basis. In fact, the active portfolio often exhibits higher downside risk, as measured by Value-at-Risk and maximum drawdown, without delivering compensating returns. These findings suggest that the higher fees associated with active ESG management are not justified by superior performance. This underperformance can be attributed to closet index ing, where funds labeled as active closely replicate benchmark indices without offering genuine active management. However, as the study does not directly measure active share, further re search is needed to determine whether the lack of outperformance is due to limited managerial skill or insufficient deviation from passive benchmarks. The thesis also discusses the implications of ESG constraints on portfolio construction, noting that the exclusion of certain sectors or in dustries may reduce diversification opportunities and make active ESG portfolios more sensitive to market fluctuations and sector-specific risks.

These findings have practical relevance for investors, fund managers, and financial advisors. For those seeking sustainable investment options, passive ESG funds may offer a more cost-efficient and risk-conscious alternative. The results indicate that, as transparency and cost-efficiency be come increasingly important in the market, active strategies often fail to provide sufficient value to justify their higher fees.