ESG Alpha of Equity Portfolios: Evidence from Europe and the UK

This article adds to the growing body of knowledge on the impact of non-financial environmental, social and governance (ESG) factors on long-term financial returns and investigates whether high portfolio ESG improves the quality of equity portfolios in terms of realized returns and risk. A best-in-class positive ESG screening method was deployed using Refinitiv ESG Scores to construct two polarised sets of portfolios, each with three portfolio ESG weightings (i.e., equal, value, and rank weightings). Fifteen years of daily returns from 2005 to end-2019 were analysed for the European continent split into seven regions based on the currency of exchange. Additionally, 2020, the abnormal COVID-19 year, was analysed as an acid test of the ESG alpha hypothesis. Overall, the tests offer empirical evidence that high portfolio ESG has the potential to enhance returns and/or reduce volatility over the long term and thereby improve the quality of portfolios. This evidence signifies the impact of the degree of equity portfolio ESG on performance. The Eurozone was a major exception to the test findings, as were the value weightings. Equal weighting stood out as the most coherent strategy for best-in-class positive ESG screened portfolios, both in terms of volatility and returns. Fama–French modelling yielded interesting region-specific insights for best-in-class positive ESG screening. The UK stood out as the most favourable region for beating the market with best-in-class positive ESG screening in the long run and passed the acid test of ESG outperformance during the identified black swan event for all three portfolio weightings in the short term.