The expected returns of ESG excluded stocks. The case of exclusions from Norway's Oil Fund

by Erika Berle, Wanwei (Angela) He and Bernt Arne Ødegaard

Apr 2022

What are the consequences of widespread ESG-based portfolio exclusions on the expected returns of firms subject to exclusion? We consider two possible theoretical explanations. 1) Short-term price pressure around the exclusions leading to correction of mispricing going forward. 2) Long term changes in required returns. We use the exclusions of Norwegian Government Pension Fund Global (GPFG --``The Oil Fund'') to investigate. GPFG is the world's largest SWF, and its ESG decisions are used as a model for many institutional investors. We construct various portfolios representing the GPFG exclusions. We find that these portfolios have significant superior performance (alpha) relative to a Fama-French five factor model. The sheer magnitude of these excess returns (5\% in annual terms) leads us to conclude that short-term price pressure can not be the only explanation for our results, the excluded firms expected returns must be higher in the longer term.

Keywords: ESG investing; Exclusion; Oil Fund

JEL Codes: G10; G20