The yearly average return for the Nordic portfolio is on average 13%, with years like 2011 and 2018 being the only two years of negative returns of the portfolio. The reason behind the massive loss in 2011 can be ex-plained in the historical debt crisis in 2011 as the US long term debt rating was downgraded from AAA to AA+ by Standard & Poor’s, and the EU’s debt crisis with countries as Spain and Italy were growing while in-vestors were doubting the debt rating of AAA for Frances long term debt rating. This debt crisis was the after-shock of the previous financial crisis, as it increased the amount of debt through massive fiscal policies created by the governments. Overall, this chain of effects throughout the year in 2011 created massive disbelief in the stock market across the world, whereas European stock markets participated in that event (Investopedia, 2020).
The year 2018 raises a point of interest, as the European stock market took a downfall that hasn’t been seen since 2011. This can be seen in the STOXX Europe 50 as they fell by 15%, as investors were worried about the budget crisis in Italy, Brexit and social issues in France starting to rise. In addition to this, there were sev-eral chain effects of an ongoing trade war between the US and China. However, looking at the portfolio, there is not the same trend as it only fell by 1,6% where the ESG component being the one dragging the overall portfolio return down, as we are shorting the ESG Laggers and bringing the overall contribution from this portfolio further down (Business Insider, 2018).
Table 4: Yearly performance and representation in the Nordic Portfolio
(Authors’ own creation, 2021).
Even though it shows that investors believe in high rated ESG companies, this portfolio combination also shows that investors don’t have disbelief in ESG Laggers. The overall performance from the ESG Laggers is higher than the ESG Leaders, and while as it is being shorted then it is bringing down the average return of the portfolio for the Nordic companies.
Table 5: Movement of ESG Score and representation in the Nordic Portfolio
(Authors’ own creation, 2021).
In addition to this then it can be seen that the top percentile limit for ESG Leaders have been at a steady rate, meaning that there is not any indication of a trend of ESG Leader companies across the Nordic in total have
Year Average Return Number of companies Average Return Number of companies Average Return Number of companies 2011 -22,7% 106 -23,9% 10 -33,5% 12 2012 26,6% 108 17,1% 10 18,7% 14 2013 26,4% 109 20,9% 11 40,9% 14 2014 11,3% 118 18,9% 12 9,5% 12 2015 22,5% 121 9,2% 12 47,2% 13 2016 15,4% 135 8,6% 14 13,2% 14 2017 16,4% 232 20,1% 24 28,7% 24 2018 -1,6% 241 -1,8% 24 7,4% 25 2019 23,3% 241 21,7% 24 24,3% 25 Average 13,0% 157 10,1% 16 17,4% 17
Portfolio ESG Leaders ESG Laggers
Year Number of Companies Average ESG Score 90th Percentile Score Number of Companies Average ESG Score 10th Percentile Score
2011 10 80,2 76,7 12 14,8 25,1 2012 10 79,4 74,0 14 18,7 29,4 2013 11 79,1 75,4 14 18,9 30,4 2014 12 78,7 75,4 12 16,6 23,9 2015 12 82,1 76,6 13 16,8 23,2 2016 14 81,1 77,1 14 20,8 30,3 2017 24 79,7 74,2 24 15,1 21,9 2018 24 82,6 76,1 25 15,6 22,0 2019 24 82,4 75,6 25 15,6 22,0 Average 16 80,6 75,7 17 17,0 25,4
ESG Leaders ESG Laggers
been increasing their combined score. However, the bottom percentile limit for the ESG Laggers shows twice that the worst ESG score performing companies are increasing their combined score, but in the end, have a lower score than they started with. What is worth bringing into consideration is companies who join the port-folio later may start with lower ESG score due to first time ratings. The highest increase of new companies is in between the years 2016 and 2017, which is also the years where the average score and percentile score for ESG Leaders and Laggers are decreasing by the highest amount. It then shows a small increase from 2017 to 2019 for both groups indicating that overall, the companies across the Nordics are focusing on a more ESG minded future.
The overall performance of the portfolio is represented in the graph below, whereas the ESG constructed port-folio is heavily impacted by the generated returns from ESG Laggers. One of the surprising movements for the ESG portfolio is its increasing return in ultimo 2011, where the constructed Nordic portfolio and STOXX Eu-rope 600 has an overall downturn. Since it is the only period in the total holding period containing a financial crisis, it is worth noticing that ESG Leaders are more suited and are performing better in a bad economic crisis against ESG Laggers and the market. Compared to 2018, there is also a slight indication in the portfolio move-ments supporting this argument, since the market and constructed Nordic portfolio experience a loss with the bad times in the economic markets, whereas the ESG portfolio itself is slightly increasing returns.
The Nordic portfolio average Sharpe ratio and information ratio indicates a strong performing portfolio as it gives a high excess return for the extra risk-taking, whereas the negative Sharpe ratio and information ratio at the ESG portfolio shows the negative effect on the overall excess return on the Nordic portfolio (Appendix 17).
Figure 7: Visual Presentation of Nordic Portfolio Performance
(Authors’ own creation, 2021).
The overall goodness of fit for the regression of the Nordic portfolio shows a 𝑅2= 0,743 and an adjusted 𝑅2= 0,733, which indicates a strong linear relationship between the regressors of the model and shows that 74,3% of the variance can be explained by the created portfolio regressors. It should also be noted that the de-grees of freedom are 107, which will be the case for all the following regressions as well.
Table 6: Nordic Portfolio Regression
(Authors’ own creation, 2021).
Looking at the regression results for the Nordic portfolio, it shows p-values in each of the regressors at a 5%
significant level, making them statistically significant. The market premium and High minus Low portfolio have 𝑝 < 0,001, making it statistically significant on a 1% level. In the portfolio of ESG Leaders minus Lag-gers, we see a 𝑝 = 0,008 together with the constants 𝑝 = 0,004, making them statistically significant on a 1%
level. At last, the portfolio combination of Small minus Big has 𝑝 = 0,014, making it statistically significant on a 5% level. This means that the individual portfolio has strong evidence against the hypothesis that there is no relationship between the individual portfolios and the excess return of the Nordic companies.
This makes the coefficients more reliable for interpretation. Starting with the market premium, we see that the 𝛽𝑅𝑀𝑅𝐹= 0,919 and taking the theory from CAPM single regressor formula to estimate the expected return of equity then we see a combined portfolio is less volatile than the market and making it less risky as it is less than one and showing a portfolio moving slower than the market average. The Small minus Big and High mi-nus Low shows both coefficients value below one with respectable values of 𝛽𝑆𝑀𝐵 = 0,262 and 𝛽𝐻𝑀𝐿= 0,268. This supports the theory of small companies outperforms the big companies measured on the market capitalization and that the excess return was achieved by the small companies. It also shows that excess return was achieved through the portfolios high book to market value. Looking at the last regressor of ESG Leader minus Laggers, it achieves a coefficient of 𝛽𝐸𝑆𝐺 = −0,134. This can be interpreted that the ESG score based on last year performance of the portfolio created excess return through the portfolios ESG Laggers. However,
it shows a negative effect which means the higher the ESG score of the created portfolio will reduce the over-all risk and reduce the expected return of equity.
Table 7: VIF Test of Nordic Portfolio regression
(Authors’ own creation, 2021).
Even though the regression showed low levels of p-values for all the regressors indicating there might not be a case for multicollinearity, then a VIF test has been made to test the variance of each coefficient. Comparing the results with the rule of thumbs regarding VIF values, then it shows that all the regressors are being close to not being correlated as the all values circular close to being equal to one. However, there is a small range of variance on all regressors with a mean of 6%, which indicates that the variance can be 6% higher than it would be expected if there wasn’t any multicollinearity. These results support the assumption of homoscedastic in the regression on the Nordic portfolio.
Table 8: Test for normal distribution in Nordic Portfolio regression
(Authors’ own creation, 2021).
The next test for the validity of the regression is looking at if the data follow the normal distribution regarding the OLS assumptions. At first, through STATA, a prediction has been made to create all the residuals for this regression only to look at the normal distribution. It can be seen in the skewness and kurtosis values that the residuals below 0,500 making them not completely normal distributed and has a long tail for positive returns.
The kurtosis value of 0,250 indicates that the returns are almost normally distributed. However, the combined
score of 0,122 shows that there is a higher frequency of negative returns in residuals with the kurtosis value increasing its combined value.
To test the hypothesis of whether the created regressor of ESG Leaders minus Laggers has an effect on the ex-cess return of the Nordic portfolio, we test it with the two-sided test. The null hypothesis is that it is equal to zero, meaning that it doesn’t affect the excess return against the alternative hypothesis that it is different from zero, meaning that it does have an effect on the excess return. Taking the values from the regression to derive the 𝑡 to the student t distribution, we get the following formula.
𝐻0: 𝛽𝐸𝑆𝐺 = 0 𝐻1: 𝛽𝐸𝑆𝐺≠ 0
𝑡 =−0,134 − 0
0,049 = −2,706
By knowing that for a two-sided t-test, the critical value at the 5% significant level is ±1,982 and the critical value at the 1% significant level is ±2,623 with 107 degrees of freedom. With this information, it can be con-cluded that 𝑡 value is greater than both the critical values and can therefore reject our null hypothesis saying that ESG Leaders minus Laggers doesn’t affect the excess return in favour of the alternative hypothesis.