The power of purpose: How ESG subcategories drive financial performance : A comprehensive analysis using the Fama-French Five-Factor model

Abstract: ESG investing is a hot subject in today’s world with socially responsible investments under management reaching 35.3 trillion in the beginning of 2020. Corporations today are highly affected by social and government pressure to take on corporate social responsibility. This rise in corporate social responsibility has led to a need for a deeper understanding of what lies beneath the ESG score and how this affect financial performance. In this study we disassemble the ESG score into its 10 subcategories and test how risk and financial return get affected by investing in a high scored portfolio compared to a low scored one. The study is carried out from the start of 2012 to the end of 2021. When testing our portfolios, the Fama-French five-factor model is applied, and we find results that shows that the alpha is positive and significant in 16 out of 20 portfolios. Our findings suggest that investing in low scored portfolios produce higher excess return than both the top portfolio and the market and that a portfolio consisting of low scored corporations have a higher Sharpe ratio in general than a portfolio consisting of high scored stocks. Furthermore, we find results indicating that for most of the ESG subcategories, investing in the portfolios with high ESG subcategory scores will provide significant excess return to the market.