Scientific Beta

In this paper, we show that there is no solid evidence supporting recent claims that ESG strategies generate outperformance. We construct ESG strategies that have been shown to outperform in popular papers. We assess performance benefits to investors when accounting for sector and factor exposures, downside risk, and attention shifts. Simple returns of ESG strategies look attractive, with annualised returns of up to almost 3% per year. But when accounting for exposure to standard factors, none of the twelve different strategies we construct to tilt to ESG leaders adds significant outperformance, whether in the US or in developed markets outside the US. 

In this paper, we show that there is no solid evidence supporting recent claims that ESG strategies generate outperformance. We construct ESG strategies that have been shown to outperform in popular papers. We assess performance benefits to investors when accounting for sector and factor exposures, downside risk, and attention shifts.

Simple returns of ESG strategies look attractive, with annualised returns of up to almost 3% per year. But when accounting for exposure to standard factors, none of the twelve different strategies we construct to tilt to ESG leaders adds significant outperformance, whether in the US or in developed markets outside the US. 75% of outperformance is due to quality factors that are mechanically constructed from balance sheet information.

ESG strategies do not offer significant downside risk protection either. Accounting for exposure of the strategies to a downside risk factor does not alter the conclusion that there is no value-added beyond implicit exposure to standard factors such as quality.

Recent strong performance of ESG strategies can be linked to an increase in investor attention. Flows into sustainable mutual funds show that attention to ESG has risen remarkably over the later period of our sample, from about 2013. We find that alpha estimated during low attention periods is up to four times lower than alpha during high attention periods. Therefore, studies that focus on the recent period tend to overestimate ESG returns.

We conclude that claims of positive alpha in popular industry publications are not valid because the analysis underlying these claims is flawed. Omitting necessary risk adjustments and selecting a recent period with upward attention shifts enables the documenting of outperformance where in reality there is none.

Our findings do not question that ESG strategies can offer substantial value to investors. Instead, they suggest that investors who look for value-added through outperformance are looking in the wrong place. It might be time to consider ESG strategies for the unique benefits that they can provide, such as hedging climate or litigation risk, aligning investments with norms, and making a positive impact for society. Investors would benefit from further research on these important questions.