The Trade-Off between ESG Screening and Portfolio Diversification in the Short and in the Long Run

This paper investigates the performance of portfolio screening strategies based on ESG (Environmental, Social, Governance) scores, by testing three main hypotheses motivated by introducing Corporate Social Responsibility (CSR) considerations within portfolio theory: i) ESG screened portfolios with low exclusion thresholds overperform the benchmark in the long term; ii) ESG screened portfolios do not overperform the benchmark in the short term independently of the screening threshold and the phase of the economic cycle; iii) ESG screened portfolios have lower systemic risk compared to the benchmark. To this end, negative and positive screening strategies based on Bloomberg ESG disclosure scores and different screening thresholds are set up from the 559 stocks belonging to the EURO STOXX index in the period 2007-2021 and over four short-term subperiods including two crises (2008 global recession and 2020 Covid-19 pandemic). The risk-adjusted performance of the ESG screened portfolios is compared with the benchmark-passive one based on Sharpe Ratio and alphas (from both a one-factor model and the Carhart four-factor model) so as to test performance over total and systemic risk respectively. Three main results emerge. First, we prove overperformance of screened portfolios in the long run only and in the presence of negative screening strategies. Second, we show no overperformance in the short run even in period of financial crises thus contesting the alleged safe-haven property of ESG portfolios. Finally, comparative performance of ESG screened portfolios with respect to the benchmark passive strategy does not improve when we consider a measure of systemic risk