Sustainability as a Defensive Strategy: ESG, Risk Exposure, and Returns in US Stocks

Abstract

We analyzed the relationship between environmental, social, and governance (ESG) metrics, financial risk, and expected returns in the US stock market, using data from S&P 500 companies over the period from 2007 to 2022 using aggregate ESG scores from Refinitiv (LSEG). We employed an empirical approach that combines portfolio analysis based on ESG and ESG‐Momentum quintiles, traditional and tail risk measures (standard deviation, Value at Risk, and Expected Shortfall), higher order moments of return distributions (skewness and kurtosis), as well as cross‐sectional regressions using the method of Fama and MacBeth. We show that ESG scores, in isolation, do not exhibit significant predictive power over future returns. However, firms with high ESG performance are consistently associated with lower risk exposure, reflecting a more conservative and resilient profile. The ESG‐Momentum factor, although it does not consistently deliver superior returns, has shown greater stability and lower sensitivity to extreme losses. The findings suggest that ESG metrics add value primarily by mitigating financial risk rather than enhancing return potential. Thus, ESG functions as a strategic risk management mechanism that reduces firms' exposure to downside and tail risks. These results offer practical implications for investors and portfolio managers seeking defensive strategies with a sustainability focus.