Risk, Return, and Environmental and Social Ratings

We analyze the risk and return characteristics across firms sorted by their environmental and social (ES) ratings. We document that ES ratings have no significant relationship with average stock returns or unconditional market risk. Stocks of firms with higher ES ratings do have significantly lower systematic downside risk. Such reduction in downside risk delivers modest, yet non-trivial, gain in long-term returns of around 0.96% per annum. Realized firm news sentiment and institutional trading patterns are also consistent with these results. Our evidence suggests that investors who derive non-pecuniary benefits from ES investing need not sacrifice performance in the stock market.