ESG and Systematic Risk of Canadian Equity Mutual Funds

Abstract

Investment decisions based on responsible investment (RI) criteria, which incorporate environmental, social, and governance (ESG) factors into consideration are becoming increasingly important in today’s financial markets, both in terms of assets under management and number of investors. However, there is no consensus regarding the outperformance of RI relative to conventional investments from the viewpoint of ex-post performance. This research investigates the nature of return differential between responsible investing and conventional investing within the well-known risk-return paradigm. From the viewpoint of ex-ante equity risk premium, the Fama and French five-factor model (2015) combined with an ESG-related factor is applied to returns of 154 Canadian open-end equity mutual funds for the period January 2016 to June 2023. Empirical findings include that Canadian open-end equity funds tend to hedge the ESG-related systematic risk and exposure to ESG-related systematic risk is not significantly priced in the market.