The trade-off between ESG screening and portfolio diversification in the short and in the long run

Beatrice Bertelli () and Costanza Torricelli
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Beatrice Bertelli: University of Modena and Reggio Emilia

Journal of Economics and Finance, 2024, vol. 48, issue 2, No 3, 298-322

Abstract: Abstract This paper empirically investigates the performance of portfolio screening strategies based on ESG (Environmental, Social, Governance) scores, by testing three main hypotheses motivated by the introduction of sustainability considerations within portfolio theory: i) ESG screened portfolios overperform the benchmark in the long term only if the exclusion threshold is low; ii) ESG screened portfolios do not overperform the benchmark in the short term independently of the exclusion threshold; iii) ESG screened portfolios overperform the benchmark in terms of systemic risk in periods of financial distress. To this end, negative and positive screening strategies based on Bloomberg ESG disclosure scores and different screening thresholds are set up from the 559 stocks belonging to the EURO STOXX index in the period 2007–2021. The risk-adjusted performance of the ESG screened portfolios is compared with the benchmark-passive one based on Sharpe Ratio (SR) and alphas (from both a one-factor model and the Carhart four-factor model) so as to test performance over total and systemic risk respectively. Two main results emerge. First, we prove overperformance of screened portfolios only in the long run and in the presence of negative screening strategies with a low screening threshold. Second, we do not find clear evidence of over-compensation for systemic risk in all periods of financial distress, thus the alleged safe-haven property of ESG portfolios is not always there. Given the increasing attention for sustainability, our results have relevant implications for both individual investors and the asset management industry.

Keywords: Sustainable finance; Socially Responsible Investments (SRI); Environmental; Social; Governance (ESG); Positive and negative screening strategies; Portfolio performance measures (search for similar items in EconPapers)
JEL-codes: C32 G01 G11 M14 Q01 (search for similar items in EconPapers)
Date: 2024
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Citations: View citations in EconPapers (1)

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DOI: 10.1007/s12197-023-09652-9

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