Why might ESG factors increase returns?

Many investors today seek more than impact from their ESG portfolios. They want returns too.

By now, there are literally thousands of papers asking whether ESG adds to – or detracts from – expected returns. But there is no consensus, and nor is one to be expected, because there is little agreement about which companies are “better” or “worse” from an ESG perspective.

Even more fundamentally, there is no particular reason why “good” companies should generate better returns; after all, capitalism is a system of economics, not ethics.

In this paper, we take a different approach. We ask whether particular activities of companies that are especially relevant to ESG investors can add to expected returns, and if so, why.

From the many available measures of ESG, we select three for closer examination that seem to be associated with positive returns – R&D, carbon intensity and worker safety.

Generally, expected excess returns are a reward either for taking risk or for using information more efficiently than other investors. We find that our three selected features are no different – and thereby gain further insights into what types of ESG measures are most likely to generate excess returns.