The Impact of Environmental (E), Social (S), Governance (G), and ESG Engagement on Financial and Risk-Return Performance: A Quantitative Case Study of Exchange-Traded Funds (ETFs)

Abstract

The literature on the impact of ESG engagement on the firms’ financial performance or return on investment provides mixed results, some come up with positive impact, some with negative impact, some with different impact during different economic swings, and some report no impact. Most authors have studied individual companies’ financial performance versus ESG ratings and not diversified portfolios. In this research study, we examined the separate impacts of Sustainalytics -Morningstar E, S, G, ESG, and carbon risk scores on two financial performance indicators (return on invested capital and sales growth) and two risk-return performance indicators (Jennsen Alpha and Sharpe Ratio) of 100 randomly selected U.S. based equity ETFs. We applied the path analysis method of structural equation modeling (SEM) to analyze the data. Our findings showed that whereas the distinct metrics E, S, and G had mixed impacts on the selected performance metrics, the overall ESG risk score had significant impacts on all the financial and risk-return performance indicators. The findings of this research might encourage investors to increase the share of low ESG risk ETFs in their portfolios which in turn pushes the companies to improve their ESG engagement, a win for the environment and entire society.