In recent years, ESG (Environmental, Social, and Governance) has become the strategic focus of many investors, especially institutional investors. Although there is much ESG-related literature, relatively few analyse the relationship between ESG and stock returns. To contribute more data-driven studies to this field, Prof. Jie (Jay) Cao from the School of Accounting and Finance (AF) at The Hong Kong Polytechnic University (PolyU) investigated a vast number of databases. His team then classified institutions based on ESG scores, which were used to compare and contrast institutions’ performances.

Prof. Cao’s team discovered that socially responsible investors, who tend to focus on ESG performance instead of investment returns, react slower to mispricing signals. They also tend to favour large-cap stocks and have a lower turnover. In addition, their choice of stocks demonstrates lower sensitivity to earnings surprises. The research suggests that their increased focus on ESG may have an indirect but important influence on stock return patterns and the efficacy of mispricing signals, as this preference for ESG draws their attention away from mispricing signals.

However, it should be noted that some factors may affect the wider significance of this research. The authors advised readers that, “While the evidence provided in this paper is consistent with mispricing, we would recommend caution to those who would want to implement these insights in quantitative strategies going forward. The period that we study is special for a couple of reasons. The first is that ESG investing took off in this time period, so the implications of these investing strategies may not have been fully understood. The second, our results are significant only when the ability of hedge funds to offset the effect of socially responsible investors is significantly curtailed.” Nonetheless, Prof. Cao’s research offers a new direction at looking into how ESG preference affects market efficiency, thereby impacting corporate financing and investment behaviours.

Keywords: ESG preference, institutional trading, stock mispricing, stock return patterns

Research Paper: Cao, J., Titman, S., Zhan, X., & Zhang, W. (2023). ESG Preference, Institutional Trading, and Stock Return Patterns. Journal of Financial and Quantitative Analysis, 58(5), 1843–1877. https://doi.org/10.1017/S0022109022000916

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