Over the last decade, investing responsibly and deploying capital for “ethically” correct and sustainable growth has been quite a theme. We dedicated a few blogs to this theme and have a separate ESG category for trading strategies in our database. It is often easy to commit financial resources to noble ideas during liquidity abundance. However, how do these methodologies fare during crisis times, such as when the GFC (Global Financial Crisis) or COVID-19 hit? That’s the question that a new paper by Henk Berkman and Mihir Tirodkar tries to answer.

What are our expectations from the ESG theme on the portfolio management level? The question is whether ESG investing also offers some kind of “alternative alpha”, or outperformance against the traditional benchmarks. There are managers and academics who are enthusiastic and hope for the outperformance of the good ESG stocks. However, the academic research community is really split. Some academic papers show positive alpha for “Saints” (good ESG stocks); others show significantly positive alpha for “Sinners” (bad ESG stocks). So, how it’s in reality? Is it “Good to be Bad”? Or the other way around?

Environmental, social, and governance (ESG) investing is rapidly growing in popularity. As more investors grow interested in the ESG investing, the funds theoretically have more reason to highlight their engagement with the ESG-related activities. In the research paper by Andrikogiannopoulou et al. (2022), authors first use textual analysis to assess how and how much the funds talk about ESG-related topics in their prospectuses, and then they compare this measure with the funds’ actual ESG engagement. The discrepancy between the words in their prospectus (high rate of mentioning ESG investing-related topics) and the fund’s acts (not being as green as illustrated in the prospectus) allows the authors to identify the greenwashing funds and take a closer look at their performance.

Socially responsible investing, also known as ESG investing, is a recent trend in the world of portfolio management. More and more investors have started to look into the Environmental, Social, and Governance scores of the companies they invest in. However, one major problem with ESG scoring is that there is not one universal scoring system. Many companies sell ESG data, but the scores are not comparable, and additionally, the ESG data providers are not very transparent about how they create the ratings. These problems with ESG data mean we need to have a method to grade and merge the information from multiple providers.

Climate change is becoming a central topic among economists, investors, politicians and the general public as well. Scientists warn us that we have to act immediately, but it is not that simple because becoming environmentally friendly is not cheap, and we are somewhat reluctant even though we have only one Earth. Moreover, while fighting climate change might be seen as a cost for developed economies, less developed economies frequently do not have many alternatives to fossil fuels.

ESG scores are the modern trend in the financial markets, and while this sustainable investing has its critics, it seems to become a regular part of the markets. Frequently, and probably rightfully, ESG is criticized for the lack of commonality across various “scorers”, and as a result, there might be a large dispersion among the score of one firm. The reason is that the score usually consists of different metrics and aggregation methodology. Apart from this “long-term” score, investors can easily recognize the “short-term” score, which can be proxied by negative incidents such as pollution, poor social aspects, social or governance scandals and so on. Moreover, these incidents could be more informative about (un)sustainable practice compared to ESG scores. These ESG incidents are studied by the novel research of Simon Glossner (2021). Using incidents news, the author provides interesting results that mainly support proponents of sustainable investing. Poor ESG performance proxied by incidents predicts more incidents in the future, lower profitability which should subsequently spill to negative performance in future. For example, portfolios consisting of negative incidents stocks significantly underperform the market for both US and European stocks. Therefore, this research paper is a compelling addition to the literature that, apart from social aspects, connects ESG also with performance.