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Factor exposures and diversification: Are sustainably screened portfolios any different?

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Abstract

We analyze the performance, risk, and diversification characteristics of global screened and best-in-class equity portfolios constructed according to Inrate’s sustainability ratings. The financial performance of sustainably high-rated portfolios is similar to the risk-adjusted market performance in terms of abnormal returns of a five-factor market model. In contrast, low-rated portfolios exhibit negative abnormal returns. Firms with high sustainability ratings show lower idiosyncratic risk and higher exposure toward the high-minus-low and the conservative-minus-aggressive factor.

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Notes

  1. The United Nations, under the stewardship of the World Commission on Environment and Development, addressed the term of sustainability in the 1987 report ‘Our Common Future,’ which came to be known as the Brundtland Report, and gave it the following commonly accepted definition: Sustainable development is a development that meets the needs of the present without compromising the ability of future generations to meet their own needs (World Commission on Environment and Development 1987; Staub-Bisang 2012).

  2. Agenda 21—‘21’ stands for the twenty-first century—is the action plan of the United Nations to concretize the steps necessary to implement sustainable development in various levels of society (e.g., governments, NGOs, businesses). It is the result of the first UN Conference on Environment and Development in Rio de Janeiro in 1992 (Pufé 2014).

  3. Many similar terms are used to describe the efforts of firms in terms of sustainability, which include corporate sustainability, corporate responsibility, and corporate citizenship.

  4. The use of these broadly defined concepts to assess the extra-financial information of investments is well established (Eccles 2010), even though the scope of criteria and types of indicators used to vary and depend on the institution and the country (United Nations Principles for Responsible Investment 2017; Eurosif 2018).

  5. A paper written by Schwegler (2018) can be found online under https://www.inrate.com/cm_data/inrate_methodology_paper_newdesign_02.pdf. Additional information on Inrate’s rating methodology can also be found under https://www.inrate.com/en/esg-impact-ratings.html.

  6. The data is from mba.tuck.dartmouth.edu/pages/faculty/ken.french.

  7. The unrestricted universe includes firms from 49 countries.

  8. Australia, Austria, Belgium, Canada, Germany, Denmark, Finland, France, Great Britain, Greece, Hong Kong, Ireland, Italy, Japan, the Netherlands, Norway, New Zealand, Portugal, Singapore, Spain, Sweden, Switzerland, USA.

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Acknowledgements

We thank Markus Schmid (the editor) and two anonymous referees for their comments that helped us to improve the article. Furthermore, we thank Inrate AG for kindly providing us with the important ESG dataset for the paper.

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Gougler, A., Utz, S. Factor exposures and diversification: Are sustainably screened portfolios any different?. Financ Mark Portf Manag 34, 221–249 (2020). https://doi.org/10.1007/s11408-020-00354-4

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