Have Investors Paid a Performance Price? Examining the Behavior of ESG Equity Funds

Abstract

The academic and practitioner literature provides a variety of contradicting theories as to expected consequences of environmental, social, and governance (ESG)-related factors on the risk and return of equity securities. In light of these heterogeneous expectations, this article sets out to empirically investigate the performance characteristics of investable ESG equity funds to assess whether support for a particular direction in performance impact can be found. The dataset comprises index and active equity mutual funds and exchange-traded funds with a US investment focus that indicate the use of ESG factors in their investment process and extends over a period of 15 years (2004–2018). The empirical results are rather mixed. The authors find substantial cross-sectional dispersion in performance among funds. After controlling for style factor exposures, the majority of funds in any of the tested ESG categories does not produce statistically significant positive or negative gross alpha. An industry-based performance contribution analysis reveals that systematic differences in allocations relative to the broad market exist. However, their median contribution to performance is close to zero over time. Overall, return and risk differences of ESG funds can be significant but appear to be mainly driven by fund-specific criteria rather than by a homogeneous ESG factor. As a result, investors would be better served by assessing investment implications on a fund-by-fund basis.

TOPICS: ESG investing, mutual fund performance, passive strategies, portfolio theory

Key Findings

• • The majority of environmental, social, and governance (ESG) equity funds in any of the tested categories do not produce statistically significant positive or negative gross alpha.

• • Systematic differences in industry allocations relative to the broad market exist, but their median contribution to performance is close to zero over time.

• • Mixed and substantial cross-sectional dispersion in performance among ESG funds suggests that both the direction and magnitude of any risk or return impact is best assessed on a fund-by-fund basis.