Is There A Risk Premium in ESG Investing in India?

Abstract

Research Question: To check whether the ESG scores of Indian companies impact their share prices and risk-adjusted returns. Motivation: Increased awareness about sustainability has sensitised both institutional and individual investors regarding ESG activities of their portfolio firms. They identify these activities as sources of both opportunity and risk There are conflicting perspectives on ESG and stock returns and a pressing need to clarify the ESG disclosure implications on investment performance and risk, more so due to the growing monitoring by exchanges, regulators, and institutional investors. Idea: The study aims to check if the nonfinancial information in ESG scores can be a source of risk premium (or alpha) for investors, especially after accounting for factors such as size, value, and momentum. The study constructs a positive-screened, negative-screened, and hedged portfolio to capture the alpha based on ESG strategies. Data: The study employs Bloomberg’s ESG composite score data between April 2010 and February 2020 on NSE 500 companies, including companies that, by regulation, were required to report ESG disclosures in the period of study. Method/Tools: Two mutually exclusive portfolios with differing ESG profiles were formed to construct the high- and low-ESG-rated portfolios. A third portfolio, the difference/hedged portfolio, is formed by subtracting the monthly returns of the low-ESG-rated portfolio from those of the high-ESGrated portfolio (H-L). The study aims to contrast the returns of companies with high and low ESG scores, and of hedged portfolio. The raw and riskadjusted returns of the hedged portfolio were then examined. Findings: The findings of the study highlight that in the Indian context, ESG-based investment strategies generate negative alpha and predict lower future returns. The findings of the study have several implications for investors and policymakers. Institutional investors with a mandate to invest in high-ESG firms may not be able to generate positive long-term risk-adjusted returns. It must also be useful for policymakers trying to push ESG-based strategies among asset managers like pension funds. Contributions: The current study add to the existing ESG literature in Indian stock market context and highlight that ESG based stock selection doesn’t create value but may satisfy nonpecuniary motives of investors.