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Thesis Topic
The self-financing portfolio with additional consideration of sustainability aspects between 2010 and 2020 - A performance analysis
This master's thesis examines the construction and performance of self-financing portfolios that incorporate Environmental, Social, and Governance (ESG) criteria during the period 2010-2020. The research provides a rigorous empirical analysis of whether ESG-based long-short strategies can generate risk-adjusted returns after accounting for transaction costs.
Abstract
The decade spanning 2010-2020 witnessed a fundamental paradigm shift in global financial markets toward integrating Environmental, Social, and Governance (ESG) criteria into portfolio construction. This thesis evaluates the risk-adjusted performance of self-financing portfolios constructed using ESG rankings, specifically testing whether such strategies generate statistically significant positive returns after accounting for transaction costs and standard risk factors.
Using a comprehensive dataset of ESG ratings and equity returns, we construct long-short portfolios that go long high-ESG assets and short low-ESG assets. The analysis employs Fama-French factor models to isolate the "Green Alpha" from broader market movements. Our findings reveal that while gross returns show promise, the implementation costs significantly erode the theoretical arbitrage profits, particularly due to the high turnover required to maintain ESG factor exposure.
Sample: Introduction (Chapter 1)
1.1 Background of the Study
The decade spanning from 2010 to 2020 witnessed a fundamental paradigm shift in global financial markets, characterized by the transition from a purely shareholder-centric model to one that increasingly integrates broader stakeholder considerations. This period marked the maturation of Environmental, Social, and Governance (ESG) criteria from niche investment styles into central components of institutional portfolio construction.
While the theoretical underpinnings of sustainable finance have existed for decades, the post-2008 financial crisis era provided the necessary catalyst for investors to re-evaluate the relationship between non-financial risks and long-term asset performance. Consequently, the integration of sustainability risks into asset management has become a focal point for both academic inquiry and industry practice, driven by the premise that ESG factors are material to financial performance.
The evolution of sustainable investing during this timeframe was not merely a change in investor sentiment but was underpinned by significant structural changes in market mechanisms and regulatory frameworks. The traditional dichotomy between profit maximization and social responsibility, often framed as a dilemma between shareholder value and long-term business sustainability, began to dissolve. Investors increasingly sought to capture "Green Alpha"—excess returns attributed to superior sustainability performance—while simultaneously mitigating tail risks associated with environmental regulation and social controversies.
1.2 Theoretical Framework
The theoretical foundation of this research lies at the intersection of Modern Portfolio Theory (MPT), Asset Pricing Theory, and the burgeoning literature on Environmental, Social, and Governance economics. To evaluate the self-financing portfolio, one must first establish the validity of the factor models used to explain returns and then overlay the sustainability constraints.
A self-financing trading strategy is defined as a portfolio construction method where the cost of purchasing assets is entirely funded by the proceeds from selling other assets short, resulting in a zero net investment at the inception of the trade. In the context of ESG, this typically involves ranking the investment universe by ESG score, taking a long position in the top decile (High ESG), and taking a short position in the bottom decile (Low ESG).
Key Research Questions
- RQ1: Do ESG-based self-financing portfolios outperform traditional benchmarks in terms of risk-adjusted returns?
- RQ2: How do transaction costs affect the profitability of self-financing ESG strategies?
- RQ3: To what extent do different factor models (CAPM, FF3, FF5) explain the returns of ESG portfolios?
- RQ4: Did performance shift following major regulatory announcements (e.g., EU Action Plan)?
Citation Sample
All 51 citations in this thesis are verified against academic databases. Here are some examples:
- Fama, E. F., & French, K. R. (2015). A five-factor asset pricing model. Journal of Financial Economics.
- Berg, F., Kölbel, J. F., & Rigobon, R. (2022). Aggregate confusion: The divergence of ESG ratings. Review of Finance.
- European Commission. (2018). Action Plan: Financing Sustainable Growth. Brussels.
- Friede, G., Busch, T., & Bassen, A. (2015). ESG and financial performance. Journal of Sustainable Finance & Investment.
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