A Survey of the Academic Literature on ESG/SRI Performance

I couldn’t tell with any real certainty that there’s a prevailing academic consensus, but here is a summary of the distribution of studies:

Category 1: ESG/SRI investment strategies underperform

Socially Responsible Funds and Market Crises
August 2014
Journal of Banking and Finance
Abhishek Varma & John R.Nofsinger

• Methodology
  • Used a unique dataset of US domestic equity SRI funds for the period 2000-2011, and investigated the performance of SRI funds during crisis and non-crisis periods.
  • Empirically tested the hypothesis that SRI funds dampen downside risk for investors during poor economic conditions.
• Key Takeaways
  • Compared to conventional mutual funds, socially responsible mutual funds outperform during periods of market crisis.
  • However, according to the authors, this dampening of downside risk comes at the cost of under-performing during non-crisis periods.

The Price of Taste for Socially Responsible Investment
June 2017
Centre for Economic and International Studies Papers
Rocco Ciciretti, Ambrogio Dalò and Lammertjan Dam

• Methodology
  • Used a sample of 1,000 firms from the U.S., Europe, and Asia, between 2005 and 2014 to analyze a significant negative relationship between social responsibility scores and risk-adjusted returns.
  • Attempted to quantify the price SRI investors pay, in terms of lower risk-adjusted returns, due to their "taste" (their preference) for responsible assets.
• Key Takeaways
  • The cost of investor taste for ESG strategies amounts to 4.8% annually in risk-adjusted returns.
  • The results showing this underperformance are robust against different model specifications and test assets.

Does Corporate Social Responsibility Affect Mutual Fund Performance and Flows?
December 2016
Journal of Banking & Finance
Sadok El Ghoul & Aymen Karoui

• • Methodology
    • Used a unique dataset of US domestic equity SRI funds for the period 2000-2011, and investigated the performance of SRI funds during crisis and non-crisis periods.
    • Empirically tested the hypothesis that SRI funds dampen downside risk for investors during poor economic conditions.

The Opportunity Cost of Negative Screening in Socially Responsible Investing
May 2015
Journal of Business Ethics
Pieter Jan Trinks & Bert Scholtens

• Methodology
  • Investigated the impact of negative screening on the investment universe and on financial performance of sin stocks.
  • Employed a comparative analysis on 14 potentially controversial issues over the period 1991 through 2012, looking at 1,600 stocks for more than 20 years. They did not rely on broad industry classification, discarding complete industries by studying individual firm's controversial activities
• Key Takeaways
  • Practically all controversial cluster portfolios significantly outperform the market.
  • Investing in controversial stocks (sin stocks) in many cases result in additional risk-adjusted returns, whereas excluding them may reduce financial performance.
  • Some controversial issues can be financially more attractive than others.

Do Green Exchange-Traded Funds Outperform the S&P500?
January 2015
Journal of Accounting & Finance
Omid Sabbaghi

• Methodology
  • Empirical analysis of green index funds and their return dynamics.
  • Compared an equally-weighted portfolio of green ETFs (financial instruments that invest in companies exhibiting positive ESG and provide a low-cost approach to SRI) and compared its return performance to that of the S&P500 equity index using monthly data.
• Key Takeaways
  • The equally-weighted green portfolio outperforms the S&P500 prior to the financial market collapse of 2008.
  • However, consistent with recent research, these new financial instruments are highly volatile and subsequently underperform the S&P500 in the years following the financial market crash.
  • Investors should proceed with caution when encountering similar green-related financial instruments.

Performance Evaluation of U.S. Socially Responsible Mutual Funds: Revisiting Doing Good and Doing Well
April 2010
American Journal of Business
Edward Chang & Doug Witte

• • Methodology
    • o Looked at fund characteristics, as well as risk and performance measures, of all available socially responsible funds (SRFs) in the U.S. mutual fund industry over the preceding 15 years.

Sin Is In: An Alternative to Socially Responsible Investing?
May 2016
The Journal of Investing
Greg Richey

• Methodology
  • Used data from the Center for Research in Securities Prices covering the period May 1995 to May 2015, and analyzed the performance of a “vice” portfolio made up of 41 corporations against the market portfolio.
  • Analyzed the risk-adjusted returns of a portfolio constructed of firms from “sin” or “vice” related industries.
• Key Takeaways
  • The results indicate that a vice portfolio outperforms the market portfolio on a risk-adjusted basis, and the results are statistically significant.
  • However, more research needs to be done due to the dynamic nature of vice investing and the potential lack of diversification when limiting a portfolio to a few industries.

Do social factors influence investment behavior and performance? Evidence from mutual fund holdings
March 2015
Journal of Banking and Finance
Arian Borgers, Jeroen Derwall, Kees Koedijk and Jenketer Horst

• Methodology
  • Analyzed the holdings of U.S. equity mutual funds over the period 2004–2012 and measured the funds' exposure to sin stocks.
• Key Takeaways
  • The financial payoff associated with greater “sin” stock exposure is positive and statistically significant.
  • However, this becomes non-significant when the definition of socially sensitive investments is broadened.

Assessing Risk through Environmental, Social and Governance Exposures
February 2017
Jeff Dunn, Shaun Fitzgibbons and Lukasz Pomorski of AQR Capital Management

• • Methodology
    • Assessed the risk side of ESG exposures to find out whether investors can incorporate ESG considerations in an investment strategy to tilt towards safer stocks.

Corporate Sustainability in Asset Pricing Models and Mutual Funds Performance Measurement
December 2015
Financial Markets and Portfolio Management
Thomas Walker, Kerstin Lopatta and Thomas Kaspereit

• Methodology
  • Examined whether corporate sustainability is relevant factor in multi-factor asset pricing models, and constructed a sustainability factor to analyze portfolio performance.
• Key Takeaways
  • There is no sustainability premium, which has practical implications for mutual funds that are managed in accordance with sustainability criteria based on performance criteria.
  • Common factors already well explain the returns of the five test portfolios, and the sustainability factor has no ability to explain ex-ante (expected) stock market returns.
    
    

Category 2: ESG/SRI outperforms on a risk-adjusted basis

Sustainable Investing Research Suggests No Performance Penalty
November 2016
Morningstar Manager Research
Jon Hale

• Methodology
  • Summarizes the findings of academic studies on sustainable investing, supplementing it in a couple of instances with performance data on sustainable and responsible funds and indexes.
• Key Takeaways
  • Sustainable/responsible funds and indexes perform on par with comparable conventional funds and indexes, despite theory suggesting otherwise.
  • Companies with higher ESG scores and ratings can outperform comparable firms in both accounting terms and stock market terms.
  • A focus on company-level ESG factors rather than exclusionary screening can lead to better risk-adjusted performance at the portfolio level.

ESG for All? The Impact of ESG Screening on Return, Risk, and Diversification
Spring 2016
Journal of Applied Corporate Finance
Tim Verheyden, Robert G. Eccles, and Andreas Feiner

• • Methodology
    • Focused on the ESG investment process that precedes the actual picking of individual stocks that is typically carried out by fund managers—namely, the establishment of the universe of stocks from which the selections are made (the ESG ""screening"" process).
    • Used two investment universes, including large- and mid-cap stocks from both emerging countries and developed markets equities.

The effect of social screening on bond mutual fund performance
January 2016
Journal of Banking & Finance
Hans-Martin Henke

• Methodology
  • Measures the financial impact of screening for ESG criteria on corporate bond portfolios.
  • Used data from 2001-2014 to compare the risk-adjusted financial performance of 103 socially responsible bond funds in the US and the Eurozone with a matched sample of conventional funds.
• Key Takeaways
  • The risk-adjusted financial performance of socially responsible bond funds outperformed by 0.5 annually from 2001-2014.
  • This is mainly due to the exclusion of corporate bond issuers with poor corporate social responsibility activities.

ESG Integration: Value, Growth and Momentum
June 2017
17th Colloquium on Financial Markets Conference Paper
Lars Kaiser

• Methodology
  • Examined whether ESG combined with active investment styles can raise sustainability performance without sacrificing financial performance.
  • Used data represented different index providers and ESG rating agencies, different ESG screening strategies, two types of weights for the construction of the ESG indices, and covering different investment regions (World, Europe and the US).
• Key Takeaways
  • Investing in value, growth and momentum strategies can raise a portfolio's sustainability performance without sacrificing financial performance.
  • By constructing size and industry-adjusted sustainability ratings and paying particular attention to characteristic differences of corporate governance aspects, ESG strategies can be integrated with a risk management approach.

ESG and Financial Performance: aggregated evidence from more than 2000 empirical studies
December 2015
Journal of Sustainable Finance & Investment
Gunnar Friede, Timo Busch, and Alexander Bassen

• • Methodology
    • An exhaustive review of academic research on sustainable investing, where all provided primary and secondary data of previous academic review studies is extracted to empirically examine findings on the financial effects of ESG criteria.
    • Summarized the results of 2,200 primary and review studies on ESG and corporate financial performance (CFP).

From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance
October 2014
Oxford University & Arabesque Partners
Gordon L. Clark, Andreas Feiner & Michael Veis

• Methodology
  • Analyzed whether sustainability leads to better stock performance based on a review of 41 studies, of which 33 (80%) document a positive correlation between good sustainability and superior financial market performance.
• Key Takeaways
  • Stocks of well-governed firms perform better than stocks of poorly-governed firms.
  • On the environmental dimension of sustainability, corporate eco-efficiency and environmentally responsible behavior are viewed as the most important factors leading to superior stock market performance.
  • On the social dimension, the literature shows that good employee relations and employee satisfaction contribute to better stock market performance.

Sustainable Investing: Establishing Long-Term Value and Performance
June 2012
Ethical Markets Investment Research
Mark Fulton, Bruce Kahn & Camilla Sharples

• Methodology
  • Examined the risk-adjusted performance of SRI fund managers by looking at more than 100 academic studies of sustainable investing around the world to closely examine and categorize 56 research papers, as well as 2 literature reviews and 4 meta studies.
• Key Takeaways
  • The key finding of this report is that ESG best-in-class focused funds should be able to capture superior risk-adjusted returns if well executed.
  • SRI fund managers, who have tended to use exclusionary screens, have historically struggled to capture this. However, ESG analysis at a securities level should be built into the investment processes of every serious investor.

Fund Characteristics and Performances of Socially Responsible Mutual Funds: Do ESG Ratings Play a Role?
August 2018
Journal of Accounting and Finance
Nandita Das, Bernadette Ruf, Swarn Chatterjee & Aman Sundner

• • Methodology
    • The authors examine risk-adjusted performance and differential fund flows to socially responsible mutual funds during market cycles.
    • Used fund performance metrics from the Morningstar database covering the period from 2005 to 2016

The Influence of Primary Study Characteristics on the Performance Differential Between Socially Responsible and Conventional Investment Funds: A Meta-Analysis
December 2012
Journal of Business Ethics
Sebastian Rathner

• Methodology
  • Empirical study that used 25 studies with more than 500 observations are in a meta-analysis to examine the performance of socially responsible investment (SRI) funds.
• Key Takeaways
  • SRI funds outperform relative to conventional funds.
  • The focus on U.S. SRI funds increases the probability of a significant outperformance.
  • The time period influences the probability of a significant under- and outperformance of SRI funds as well, but based on the results of this paper, it is not possible to draw general conclusions on this variable.

Performance of socially responsible portfolios: The role of CSR exposures and CSR ratings
October 2018
Benjamin Hubel & Hendrik Scholz

• Methodology
  • Quantified the ESG risk exposures of firms using asset pricing models.
  • Used yearly constituents of the STOXX Europe Total Market Index from Thomson Datastream, which covers roughly 95% of free float market capitalization across 17 European countries.
• Key Takeaways
  • Portfolios with very pronounced ESG risk exposure exhibited substantially higher overall portfolio risk.
  • However, investors can manage this portfolio risk and harvest potential risk-adjusted performance benefits.

Category 3: Investors don’t sacrifice performance with ESG/SRI strategies

Is ESG an Equity Factor or Just an Investment Guide?
July 2018
Capital Fund Management
Andre Breedt, Stefano Ciliberti, Stanislao Gualdi and Philip Seager

• • Methodology
    • Used the MSCI ESG database, which contains monthly ratings for 16,799 worldwide companies, to determine the impact ESG investing has on risk-adjusted returns based on an asset-pricing model.
    • The study covered the period from January 2007 until October 2017.

Is Socially Responsible Investing (SRI) in Stocks a Competitive Capital Investment? A Comparative Analysis Based on the Performance of Sustainable Stocks
May 2018
CEGE Discussion Paper
Ann-Kathrin Blankenberg & Jonas F.A. Gottschalk

• Methodology
  • Developed two portfolios each consisting of 20 firms, one of conventional stocks and the other of sustainable stocks, covering the time period between 2002-2016.
• Key Takeaways
  • The risk-adjusted competitiveness of a sustainable portfolio does not perform significantly different than a conventional one.
  • The consideration of sustainable criteria does not influence the investment result negatively and could be applied by investors without the need to sacrifice returns.

Do 'Good Guys' Finish Last? The Relationship between Morningstar Sustainability Ratings and Mutual Fund Performance
August 2017
Steven D. Dolvin, Jon A. Fulkerson & Anna Krukover

• Methodology
  • Collected Morningstar data on all U.S. domestic mutual funds from January 2012 to December 2016, and examined funds that had ESG and Sustainability scores available.
• Key Takeaways
  • Funds with high 'Sustainability scores' have about the same risk-adjusted returns (i.e., alphas) as other funds.
  • Investors can follow a social mandate without sacrificing financial performance, particularly within the large-cap space.

The impact of screening strategies on the performance of ESG indices
July 2016
HAL Archives
Amélie Charles, Olivier Darné, Jessica Fouilloux

• • Methodology
    • Analyzed the effect of screening strategies on the performance of ESG indices using 17 ESG indices that are actively managed using risk-adjusted performance measures based on standard and tail risk measures.

The performance of socially responsible mutual funds: A volatility-match approach
May 2010
Review of Accounting & Finance
Javier Rodriguez

• Methodology

• o Analyzed a sample of socially responsible mutual funds (SRMFs) to matched to a sample of conventional funds during the 1997-2005 period.

• Key Takeaways
  • o No evidence was found of outperformance by socially responsible funds.
  • o The study also finds that the difference between the performance of SRMFs and conventional mutual funds is not statistically significant.

Socially Responsible Investing and the Performance of European Bond Portfolios
September 2018
Patricia Pereira, Maria C. Cortez & Florinda Silva

• Methodology
  • Investigated the performance of socially screened bond portfolios of 189 Eurozone companies between 2003 and 2016.
• Key Takeaways
  • The performance of high-socially rated bonds is not statistically different from that of low-rated bonds.
  • In the earlier stages of constructed portfolios of high-rated bonds, they outperformed portfolios of low-rated bonds, though over time this outperformance disappears.

Conclusion

There are more studies published recently that argue ESG/SRI investment strategies can deliver risk-adjusted returns to investors. Asset managers who are bringing ESG/SRI products to the market consistently argue that’s the case.

But the academic literature reveals we are still far from a consensus about ESG/SRI investment strategy performance.

Based on our market research, the perception of the academic research among advisors is that investors do not sacrifice performance or that the research is inconclusive about this issue. Only 15% of the respondents to our recent survey believed that investors will sacrifice performance. One of our overall conclusions from our market research was that there is an opportunity for asset managers to better educate advisors about the academic research on this topic.

But it’s too early to draw any conclusions using empirical tools for ESG/SRI performance across asset classes.

Marianne Brunet is an economic analysis manager at Advisor Perspectives.

Read more articles by Marianne Brunet