Can ESG Investing Beat the Market and Improve Portfolio Diversification? Evidence from China

Abstract

Over the past decade, ESG investment has become an important criterion for the Chinese economic activities, including its capital market where ESG integration in asset management has become a hot topic among investment professionals. In this paper, we study the case of ESG investing in China through examining the performance of equity indices that are selected by an ESG screening process and comparing their main risk-return characteristics against those of conventional equity market benchmark indices, in order to provide further understanding on how ESG plays a role in China’s capital market. Specifically, we address three key issues that are of particular concerns to most investors: (i) Can equity indices based on ESG screening outperform their market benchmarks? (ii) Can ESG equity indices be replicated by reference indices? and (iii) Can ESG equity indices improve portfolio diversification? Overall, we find that investing in ESG equity indices can increase risk-adjusted returns and improve portfolio diversification for the case of China.

Keywords:

• ESG investing;
• return;
• risk;
• diversification;
• China

JEL CLASSIFICATION:

• G11
• Q56

Notes

1 The SHSE Social Responsibility Index (000048.SH) selects 100 stocks that are ranked by social contribution value per share from the SHSE Corporate Governance Index as the constituents, which is weighted by free float market capitalization.

2 See, for example, Flaherty and Li (2004), where the authors use the Sharpe measure to analyze the performance of different indices in both the Shanghai Stock Exchange and the Shenzhen Stock Exchange. Chang, Fung and Lai (2010) calculate Sharpe ratio to examine the performance of China-focused mutual funds. Shum and Tang (2010) apply the Sharpe ratio to study the risk and return characteristics of the stock markets in the BRIC (Brazil, Russia, India, and China).

3 According to the latest China Sustainable Investment Review by China Social Investing Forum (CSIF 2009), the strategy types of ESG investing includes ESG select, corporate governance select, green and low carbon select, energy conservation and environment protection theme. We focus on the strategy type of “ESG select” in our study.

4 The China Securities Index (CSI) company offers CSI ESG indices, including CSI ESG 300 Index (931463), CSI ESG 100 Leading Index (931168), and CSI ESG 120 Strategy Index (931476). But they were offered quite recently, with official launch dates being 2020-04-30, 2019-06-27, and 2020-04-30, respectively. So we do not include them in our study.