The Self-Financing Portfolio with ESG Criteria (2010-2020)
Master's Thesis · ~100 pages · English
Abstract
This thesis examines self-financing portfolios incorporating Environmental, Social, and Governance criteria during 2010-2020. The analysis tests whether ESG-based long-short strategies generate statistically significant risk-adjusted returns after accounting for transaction costs. Using ESG ratings and equity returns, portfolios went long high-ESG assets while shorting low-ESG equivalents. Fama-French factor models isolated "Green Alpha" from broader market movements. Key finding: while gross returns showed promise, implementation costs significantly eroded theoretical arbitrage profits due to high portfolio turnover requirements.
1. Background of the Study
The 2010-2020 decade marked a paradigm shift from shareholder-centric investing toward stakeholder-inclusive models integrating ESG criteria. The post-2008 financial crisis prompted investors to reassess non-financial risks' relationship to long-term asset performance, making sustainability integration a focal point for academic research and industry practice.
This transformation reflects broader societal recognition that environmental degradation, social inequality, and governance failures pose material risks to portfolio returns. Asset managers increasingly acknowledge that ESG factors serve as leading indicators of operational efficiency, regulatory exposure, and reputational resilience.
2. Theoretical Framework
The theoretical foundation spans Modern Portfolio Theory, Asset Pricing Theory, and Environmental/Social/Governance economics. Self-financing strategies define zero-net-investment trading where purchase costs equal short-sale proceeds.
ESG applications typically rank securities by ESG scores, taking long positions in top deciles and short positions in bottom deciles. This methodology isolates the return premium (or discount) associated with sustainability characteristics while controlling for capital requirements.
3. Key Research Questions
RQ1: Do ESG-based self-financing portfolios outperform traditional benchmarks regarding risk-adjusted returns?
RQ2: How do transaction costs affect self-financing ESG strategy profitability?
RQ3: To what extent do different factor models (CAPM, FF3, FF5) explain ESG portfolio returns?
RQ4: Did performance shift following major regulatory announcements (e.g., EU Action Plan)?
References
- [1]Fama, E. F., & French, K. R. (2015). A five-factor asset pricing model. Journal of Financial Economics, 116(1), 1-22.
- [2]Berg, F., Kölbel, J. F., & Rigobon, R. (2022). Aggregate confusion: The divergence of ESG ratings. Review of Finance, 26(6), 1315-1344.
- [3]European Commission. (2018). Action Plan: Financing Sustainable Growth. Brussels.
- [4]Friede, G., Busch, T., & Bassen, A. (2015). ESG and financial performance: Aggregated evidence from more than 2000 empirical studies. Journal of Sustainable Finance & Investment, 5(4), 210-233.
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