On ESG: Theory and Empirics
Paper Session
Sunday, Jan. 9, 2022 3:45 PM - 5:45 PM (EST)
- Chair: Stuart Gillan, University of North Texas
The Cost of ESG Investing
Abstract
Even against increasing interest in socially responsible investing mandates, we find that implementing ESG strategies can cost nothing. Modifying optimal portfolio weights to achieve an ESG-investing tilt negligibly affects portfolio performance across a broad range of ESG measures and thresholds. This is because those ESG measures do not provide information about future stock performance, either in relation to risk or mispricing, beyond what is provided by other observable firm characteristics. That the stock market does not reflect significant equilibrium pricing of ESG information is rationalized in a model of responsible investing wherein investors differ in which ESG-related criteria are used to weight their portfolios.Quantifying the Impact of Impact Investing
Abstract
We propose a quantitative framework for assessing the financial impact of any form of impact investing, including socially responsible investing (SRI), environmental, social, and governance (ESG) objectives, and other non-financial investment criteria. We derive conditions under which impact investing detracts from, improves on, or is neutral to the performance of traditional mean-variance optimal portfolios, which depends on whether the correlations between the impact factor and unobserved excess returns are negative, positive, or zero, respectively. Using Treynor-Black portfolios to maximize the risk-adjusted returns of impact portfolios, we propose a quantitative measure for the financial reward, or cost, of impact investing compared to passive index benchmarks. We illustrate our approach with applications to biotech venture philanthropy, divesting from “sin” stocks, investing in ESG, and “meme” stock rallies such as GameStop in 2021.Dissecting Green Returns
Abstract
Green assets delivered high returns in recent years. This performance reflects unexpectedly strong increases in environmental concerns, not high expected returns. German green bonds outperformed their higher-yielding non-green twins as the “greenium” widened, and U.S. green stocks outperformed brown as climate concerns strengthened. To show the latter, we construct a theoretically motivated green factor—a return spread between environmentally friendly and unfriendly stocks—and find that its positive performance disappears without climate-concern shocks. A theory-driven two-factor model featuring the green factor explains much of the recent underperformance of value stocks. Our evidence also suggests small stocks underreact to climate news.Sustainable Systematic Credit
Abstract
Interest in sustainable investing has exploded in recent years, initially focused on public equity markets, but now evolving into fixed income. We assess various aspects of sustainable investing for developed market corporate bond markets (both Investment Grade and High Yield). Using a representative set of sustainability measures spanning environment, societal and governance (ESG) constructs we find: (i) credit spreads are only marginally associated with ESG measures, (ii) ESG measures are only marginally associated with standard return forecasting measures for corporate bonds, (iii) ESG measures are not reliably associated with future credit excess returns, and (iv) ESG measures are negatively associated with the future volatility of credit excess returns. While the direct investment impact of sustainability is modest, there is still considerable interest from asset owners to ensure credit allocations are sustainable. We find that it is possible to incorporate (i) both static and dynamic exclusion screens, (ii) positive tilts toward more sustainable issuers, and (iii) economically meaningful reduction in carbon intensity, with minimal portfolio distortions. Thus, a well-implemented systematic approach has the potential to offer attractive risk-adjusted returns in a sustainable manner.JEL Classifications
- G0 - General