Scientific Beta

In this article, 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.

Does investing in sustainability (or ESG) generate alpha? The answer to this question is not trivial because there is no consensus on the definition of sustainability. This exposes performance assessment to the critique of selecting an arbitrary definition of sustainability. To avoid arbitrary definitions, we adopt the perspective of the average ESG investor. We extrapolate the most relevant sustainable investment approaches from the perspective of the average ESG investor using a portfolio that replicates the market of real-world sustainable investment products. For this we construct a novel dataset of exchange-traded funds that follow systematic ESG investing strategies in the US equity market (sustainable ETFs). We then assess the performance of sustainable investing using a value-weighted portfolio of the sustainable ETFs over a period of ten years. We find that sustainable investing does not deliver higher returns than standard index funds. Widely discussed periods of outperformance, such as the year 2020, can be explained in large part by industry effects, such as a tilt toward technology stocks. Periods of outperformance are offset by corresponding periods of underperformance, leaving ESG investors with returns of −0.2% compared with the market index and −0.7% compared with a benchmark with matching industry exposure. Removing the contribution of the outlier year 2020, the industry-adjusted underperformance becomes marginally significant.

Key findings:

  • We assess the "real-world" performance of sustainable investing using a value-weighted portfolio of passive ESG ETFs, allowing us to avoid the confounding effects of arbitrarily selected sustainability metrics and the influence of fund managers' skills.
  • Over a ten-year period, we find that sustainable investing tilts delivered a negative, although insignificant, underperformance relative to a set of comparable benchmarks.
  • Widely discussed periods of outperformance, such as the year 2020, represent an outlier that appears to be driven in large part by industry effects, such as a tilt towards technology stocks. Removing the industry contributions and the effect of this outlier year, the underperformance becomes marginally significant.