Are ESG investments a sustainable investing strategy?

Abstract

Sustainable investments are rapidly growing, and screening of Environmental, Social, and Governance (ESG) scores is a popular method to assess sustainable companies. With the increased usage of this method, the question arises; is screening of ESG scores a sufficient method to allocate investments to companies with top sustainable performance? This study investigates the relation between ESG scores and sustainable performance in the S&P 500 over five years from January 2015 to December 2019. Four ESG portfolios are constructed to examine sustainable performance; two portfolios consisting of companies with high ESG scores and two portfolios with low ESG scores. These portfolios are compared on 10 sustainability metrics. In addition, the relationship between the ESG score and stock return is investigated using the Carhart four-factor model. We find significant support that the top ESG portfolios perform better on most sustainability metrics, although not on all. The results imply that screening of ESG scores is a sufficient method to allocate investments to companies with top sustainable performance. Hence, it can be used for investors to make informed investment decisions and contribute to a more sustainable society. Further, we find a negative relation between ESG score and stock return; the coefficient for the ESG score is significant and negative, although relatively small, and the top portfolios perform slightly worse than the bottom portfolios when comparing the risk-adjusted alphas.