Does ESG Impact Really Enhance Portfolio Profitability?

Over the last few decades, a growing attention to the Social Responsibility topic has affected financial markets and institutional authorities. Indeed, recent environmental, social and financial crises have inevitably led regulators and investors to take into account the sustainable investing issue. However, the question of how Environmental, Social and Governance (ESG) criteria impact financial portfolio performances is still open. The aim of this study is to investigate the in-sample and out-of-sample effects of the ESG rating on the portfolio selection process and to analyze its impact in terms of portfolio profitability and risk, giving a look at the SRI regulatory framework developments over years. For this purpose, we consider a multi-objective portfolio optimization model, where we add to the classical Mean-Variance analysis a third non-financial goal represented by the ESG score. The resulting tri-objective optimization problem is formulated as a convex Quadratic Programming (QP) and consists in minimizing the portfolio variance with parametric lower bounds on the levels of the portfolio expected return and the portfolio ESG. We then provide an extensive empirical analysis over the period 2006-2020 using five real-world datasets from the major stock markets. To better examine the ESG impact on portfolio performance and to capture possible effects of SRI regulatory developments over the past 15 years, we conducted the out-of-sample performance analysis using both the full length of data available and two nonoverlapping subperiods, that approximatively cover the two commitment periods in which the Kyoto Protocol was structured with the Doha Amendment. Our empirical findings typically reveal the presence of two behavioral patterns for the 16 Mean-Variance-ESG efficient portfolios analyzed. Over the last 15 years we can distinguish two non-overlapping time windows on which the inclusion of portfolio ESG targets leads to different regimes in terms of portfolio profitability. When analyzing the entire period, from 2006 to 2020, we observed that only in the S&P500 and Dow Jones datasets the most sustainable portfolio strategies show better financial performances. Then, there does not appear to be a link between SRI regulatory developments and the ESG impact on portfolio profitability. However, when we separately considered the two subperiods, namely 2006-2013 and 2014-2020, we noted different regimes in terms of profitability-sustainability. Before 2014 the least sustainable portfolios provided better results on 4 out of 5 datasets. After 2014, when the second commitment period of the Kyoto Protocol started and when the Paris COP21 agreement was signed, the ESG impact on portfolio profitability became significant on 4 out of 5 datasets. Furthermore, we can note that the sustainability-focused strategies continue to show positive effects on the financial markets even during the recent Covid-19 pandemic crisis.