Scientific Beta

In this paper, we identify five forces that drive ESG investment returns. Our analysis of these five forces delivers a clear conclusion: obtaining positive alpha from ESG investing appears to be a long shot. Of all these forces that influence returns, not one is unambiguously positive.

Environmental, social and governance (ESG) providers commonly claim that ESG investors can both do good and do well as ESG investment options deliver outperformance for investors. Academics who have reviewed the empirical literature on ESG investing come to a different conclusion: the evidence derived from data on portfolio returns does not support the claim that ESG investing delivers positive alpha. Instead, the evidence is decidedly mixed. A common argument is that, in addition to evidence from returns, investors should consider the economic mechanisms underlying portfolio returns to develop their investment strategy. To complement reviews of the literature on ESG portfolio returns, we review the literature on the main economic mechanisms driving ESG performance. Our review covers both the theoretical plausibility of the main mechanisms and empirical evidence concerning these mechanisms. In line with reviews on the empirical evidence, our review of the economic mechanisms also shows that claims of positive ESG alpha do not find much support in the academic literature.

The analysis in this paper complements earlier work which shows that claims of ESG outperformance in popular papers are not valid when conducting proper risk adjustments (Bruno, Esakia and Goltz, 2021). Given the limitations of empirical analysis, in this paper, we take up the question of economic plausibility of ESG alpha.