Environmental, social and governance (ESG) investing does not add outperformance, according to a research paper by Scientific Beta, as firms are failing to consider estimation risk.
In its paper ‘Honey, I Shrunk the ESG Alpha: Risk-Adjusting ESG Portfolio Returns’, the organisation said investors who were looking for added value through ESG outperformance were “looking in the wrong place”.
Contrary to many findings over the last few years, Scientific Beta said while many ESG strategies did have positive returns, when these returns were adjusted for risk, the alpha shrank to zero. Instead, the return was captured by sector biases and exposures to equity style factors.
It also claimed fund promoters were taking advantage of increased investor attention in ESG in recent years. The estimated alpha during period of ESG inattention was four times lower than during high interest periods, indicating recent funds were overestimating ESG return.
Dr Noel Amenc, chief executive of Scientific Beta, said: “Omitting necessary risk adjustments and selecting a recent period with upward attention shifts enables outperformance to be documented where in reality there is none.
“Investors should ask how ESG strategies can help them to achieve objectives other than alpha such as aligning investments with their values and norms, making a positive social impact and reducing climate and litigation risk.
“By relying on biased research results, which as such as have no value, the promoters of alpha in ESG investing are taking the great risk of disappointing investors on this supposed outperformance and diverting them in time from an investment theme that is important for sustainable economic development.”
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