ESG Investing: An analysis on the performance of sustainable ETFs

Abstract

In recent decades the financial markets have seen the expansion of ESG investing, as financial institutions and individuals progressively recognize the environmental, social and governance issues, i.e., ESG factors, translating into potential risk factors that can not only affect the overall business structure but also the returns on their investments. Parallel to this increase in the awareness of the overall population, investors across the globe have also been in highly demand for passive investments in the form of Exchange Traded Funds (ETFs). Both were initially considered as a trend in the financial sector but nowadays, it is fully incorporated in the practices of both asset managers and institutional/retail investors. This study analyses the performance of European domiciled ETFs, focused on European equity, with high ESG ratings, and compares them against low ESG rating ETFs to assess if the ESG factors can indeed produce significant better results for investors. For this research it will be used monthly data considering a sample period from 31st of October 2016 to the 31st of October 2020, i.e., 4 years. As a measure of ESG, the Morningstar Sustainability Rating will be employed on this study to divide the ETFs in two portfolios: the sustainable and unsustainable portfolios. Afterwards, the alphas of each portfolio will be obtained by employing 4 different factor models: the CAPM, the Fama-French 3-factor model, the Carhart 4-factor model and the Fama-French 5-factor model. The results obtained were unable to provide a clear evidence to support the outperformance of sustainable ETFs over unsustainable ETFs. However, this research indicated that from all the factor considering models studied, the Fama-French 5-factor model revealed to have the biggest power of explanation regarding the returns of both sustainable and unsustainable ETFs.