Is green the new black? - An empirical study on the correlation of CSR initiatives and profitability on

Nordic mutual funds

Master’s Thesis 30 credits Programme: Master’s Programme in Accounting and Financial Management Specialisation: Financial Management

Department of Business Studies Uppsala University Spring Semester of 2021

Date of Submission: 2021-08-02

Carla Amiri

Supervisor: Gunilla Myreteg

IS GREEN THE NEW BLACK? – An empirical study on the correlation of ESG performance and profitability on Nordic mutual funds

Abstract

This research examines whether Corporate Social Responsibility (CSR) initiatives impact fund financial performance of 46 Nordic mutual funds during the past five years (2016-2020). Previous studies have focused on which of the two alternatives generates a rewarding financial result. To complement previous research, this study focuses on the development of CSR - whether the gap formed between CSR initiatives and fund financial performance is moving closer towards each other based on the increased focus of ESG factors during the recent years. Two categories, strong and weak ESG performance, are juxtapositioned to find out at what stage the development is. Furthermore, analysis on which of the three categories: environmental, social or governance individually, is the driving factor of the development of CSR initiatives.

Based on the matched pair methodology and hypothesis testing, funds with CSR initiatives have reached the point, in which they perform equally well to their peers without such motives. The underlying drivers behind the development are examined.

Keywords: CSR, sustainable funds, fund financial performance, Nordic market

Acknowledgments

I would like to express my sincere gratitude for my supervisor Gunilla Myreteg for her valuable guidance, perspectives and constructive feedback during the entire process.

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Table of Contents 1. Introduction ...... 4 1.1. Background ...... 4 1.2. Problematization ...... 5 1.3. Research Question...... 6 1.4. Purpose and Knowledge Contribution...... 6 1.5. Delimitation...... 7 1.6. Structure ...... 7 2. Theoretical Framework...... 8 2.1. Introduction to ESG performance...... 8 2.2. Forces behind CSR practice ...... 9 2.3. Purpose of CSR - support ...... 9 2.4. Purpose of CSR - critique ...... 10 2.5. ESG in funds ...... 10 2.6. ESG and financial performance ...... 11 2.7. Modern Portfolio Theory ...... 13 2.8. Diversification ...... 13 2.9. Risk ...... 14 2.10. Efficient Market Hypothesis ...... 14 2.11. Jensen’s alpha...... 15 2.12. Summary...... 15 3. Research Design...... 17 3.1. Introduction ...... 17 3.2. Research Method ...... 17 3.3. Matched-pair ...... 17 3.4. Mutual fund performance...... 18 3.5. Capital Asset Pricing Model ...... 20 3.6. Jensen’s alpha...... 21 3.7. Sharpe ratio ...... 21 3.8. Treynor ratio...... 22 3.9. Hypothesis formulation ...... 23 3.10. Hypothesis testing ...... 24 3.11. Scientific perspective ...... 26 3.12. Reliability and Validity ...... 27 3.13. Source critical consideration ...... 27 3.14. Research ethical reflection ...... 28

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4. Data ...... 29 4.1. Data description ...... 28 4.2. Sustainalytics ...... 30 4.3. Benchmark ...... 32 4.4. Risk free rate ...... 32 4.5. Limitation...... 33 5. Empirical results ...... 34 5.1. Empirical statistics ...... 34 5.2. Hypothesis testing ...... 37 5.3. Environmental, Social, Governance ...... 39 6. Discussion ...... 42 6.1. Findings ...... 42 6.2. Critical reflection ...... 48 7. Conclusion ...... 49 7.1. Conclusions ...... 49 7.2. Limitations ...... 49 7.3. Future Research ...... 50 8. References ...... 52

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1. Introduction

The introductory section presents the background and motivation for conducting empirical research on the development of corporate social responsibility initiatives in relation to its corporate financial performance, followed by introducing the research question. Finally, the section will end with a compressed presentation on the upcoming sections.

1.1. Background

Global warming has been raised as one of the most significant causes of species extinctions in this century. According to Intergovernmental Panel on Climate Change (IPCC), a rise of 1.5°C on average could lead to the extinction of crucial ecosystems, poverty and 140 million climate migrants by 2050.

In January 2016, United Nations, and its’ 193 countries, introduced the 2030 Agenda with 17 Sustainable Development Goals (SDGs), which have been implemented since then. Through these mutual goals, countries are committed to developing the world toward a sustainable and equal future by, e.g. eliminating poverty and hunger, ensuring human rights and gender equality, whilst ensuring protection to our ecosystems and their resources.

Shareholders and boards of firms have an increasing understanding of the importance of SDGs and hence put pressure on their companies to introduce Corporate Social Responsibility initiatives (Peloza and Shang, 2011). Since the mid-nineteenth century, Corporate Social Responsibility (CSR) has become an increasingly important point on the company agenda (Philips et al., 2019). From previously focusing mainly on stakeholder intentions, companies have now self-imposed, incorporated tailored social and environmental actions to their day-to-day operations and updated their business model (Cheng et al., 2014). In addition, companies set their own KPIs, which often are linked to Sustainable Development Goals.

Since the introduction of SDGs, the previously vague topic has become somewhat concrete as companies have clear mutual goals to strive for and contribute to their best possible way. Targets have become a booster for more companies to consider and introduce CSR initiatives. CSR initiatives are a form of responsible investing, which aims to contribute to the future growth of companies and corporate advantage towards a sustainable future (Peloza and Shang, 2011). Like any investment, it takes time before the consequences of CSR initiatives are visible.

The financial sector wants to motivate clients to take SDGs seriously; hence numerous attractive solutions from corporate sustainability-linked loans and bonds with reduced interest rates and ESG funds have been introduced. As a result, solely the low-carbon industry is assumed to reach economic benefits totalling $25 trillion by 2030 (The New Climate Economy).

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1.2. Problematization

The debate on whether corporate social responsibility initiatives are to the benefit of shareholders still remains a current topic (Abeysekera and Fernanddo, 2018). Previous studies have shown varying results.

As CSR initiatives are considered an investment (Peloza and Shang, 2011), it takes time before the consequences, including financial performance, become visible. The baseline for this study is that once CSR initiatives are introduced in companies, a gap between the company’s CSR initiatives and its’ financial performance is created. Hence, at some point, the gap between the two categories unites and the categories perform equally well. After which, the firms with CSR initiatives are expected to perform better than those without. Fund financial performance in this study is measured through the development of the fund Net Asset Values.

A major challenge, however, is that a firm’s CSR initiatives are dependent on the industry it operates in and its conditions, including sector-specific norms, ways of practice as well as overall trends impact (Dabic et al., 2016; Isaksson et al., 2014). Thus, some firms even may not be able to introduce initiatives at this stage due to their nature, not based on lack of interest.

Similarly, United Nations, with its’ Sustainable Development Goals framework, aims to create a stable tomorrow, in which environmental, social and governmental issues are taken into consideration in economic decision-making. Once ESG factors are considered in economic decision-making, sustainable growth is created (Principles of Responsible Investment, 2018).

In order to study the relationship and the level of CSR in relation to financial performance, this study is to be based on a selection of mutual funds. Mutual funds are selected instead of equities in order to obtain a wider spread and combination of industries together within the funds rather than focusing on the variation of the selection of industries due to the natural drivers for varying level of CSR initiatives (Wang et al., 2016). The level of CSR is measured in this study by using Sustainalytics ESG ratings on the selection of mutual funds.

This empirical research is keen to study the current state of the gap between CSR engagement and financial performance, whether a trend of the development is identifiable. This is done by juxtapositioning the financial performance of funds with strong ESG rating in relation to those with weak ESG performance. This study defines that CSR initiatives can be measured through ESG performance, given that each company has its own individual initiatives and agenda that suits it, whilst ESG rating supports to measure and compare the initiatives making them also accountable. It is acknowledged that academia has historically used CSR and ESG performance with slightly altering

5 definitions, however these are used interchangeably in this study. CSR initiatives and ESG performance is measured by using the individual environmental, social and governance ratings of a company as well as including the summed rating including all three categories (Sustainalytics, 2021), to find out whether a specific category is an underlying factor for driving the development of the ESG and financial performance.

Firms are facing pressure from multiple directions; shareholders, investors and board expect to generate higher revenues, whilst CSR has become a top priority on the corporate agenda (Alfred Berg, 2019). Introducing CSR initiatives could potentially lead to competitive advantage, given that new innovative ways of operating, offering or launching a new product are introduced.

1.3. Research Question

As CSR initiatives have been increasing during the past years, the intention of this research is to gain insight into the Nordic mutual fund market and analyze the current stage of the gap between CSR initiatives and financial performance consequences. The study is based on a selection of Danish, Finnish, Norwegian and Swedish mutual funds. Fund financial performance is collected between FY 2016-2020, totalling five years. A reason for selecting the timeframe of 5 years is based on that UN Sustainable Development Goals were implemented in 2016. CSR initiatives are measured based on Sustainalytics ratings, and the selection of funds consists of those with strong ESG rating as well as weak ESG rating. Fund ESG ratings are based on its portfolio companies. The fund ratings are adjusted regularly based on the latest information communicated by the firms (Sustainalytics, 2021). Fund ESG ratings utilized in this study are as per March 2021 and the latest up to date ratings.

Based on the previous reasoning, the research question for this study is:

How are Corporate Social Responsibility initiatives reflected on fund financial performance in the Nordic mutual fund market?

1.4. Purpose and Knowledge Contribution

Previous studies have shown varying results on whether sustainable or “unsustainable” funds perform better. Multiple studies imply that sustainable funds have been underperforming in different countries and regions (including Hamilton et al., 1993; Mallin et al., 1995; Statman et al., 2000; Kreander et al., 2005). Previous studies have, however, been framed around which of the two alternatives is the viable one when considering maximizing profit. These studies have not, nevertheless, answered academically or practically whether any change within the results found as time goes by, whether the differences between the two categories are becoming smaller or larger, for instance. Due to the lack of researches within the field, this study has as its primary purpose to answer

6 the call on how the gap between CSR initiatives and fund financial performance is developing. This study will not provide any recommendation but rather contribute to understanding how and why CSR initiatives are potentially impacting the development. Also, studies on ESG performance and financial performance on the Nordic mutual fund market and its underlying drivers have not been conducted before, to my understanding. Moreover, by looking at the four ESG factors, I aim to contribute to an additional level of analysis and understanding of the drivers behind it.

1.5. Delimitation

This study analyzes how the gap between CSR initiatives and financial performance have developed in the context of a selection of Nordic mutual funds. Four factors of ESG including, Environmental, Social, Governance and Overall, are used to analyze the impact of driving the development of gap. We use data from FY 2016-2020 with the criteria that funds have an inception date at the latest in January 2016 and have ESG ratings from Sustainalytics. The funds are registered in one of the four Nordic countries, and their portfolio consists similarly of Nordic equities. The study is limited to Nordic markets, given that the area is leading within sustainability questions (ESG Investing, 2021), but additionally have similar regulation and mutual determination to preserve nature (Alfred Berg, 2019).

1.6. Structure

The study consists of three primary sections compromising of seven chapters. The first section focuses on forming the frame of this study, including structuring the hypothesis, presenting existing literature and theoretical framework and method of this study.

The second section has a focus on data and introduces the data selection and collection process. A selection with a total of 46 funds is used as a part of this study.

The final section of this study focuses on demonstrating the study's empirical results on the gap between CSR initiatives and fund financial performance. It followed by a discussion, and a final conclusion is being made.

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2. Theoretical Framework

This section will present the theoretical frameworks behind CSR Initiatives/ESG Performance by well- known academics within their field, followed by a literature review consisting of relevant previous studies. Lastly, a summary of the theories is introduced, used as the baseline for conducting the study.

2.1. Introduction to ESG performance

Corporate Social Responsibility (CSR) is a concept in which a company self-imposed incorporates social and environmental actions into their day-to-day operations and business models (Cheng et al., 2014). Marrewijk and Werre (2003) pointed out that companies vary within operations and environment leads to varying CSR engagements and hence argue that there are multiple levels of CSR. The engagement level of CSR is often correlated to the institutional arrangements a firm has. Hence, to successfully implement CSR in a firm's operations, it is crucial to have well-defined and clear objectives internally and externally. Objectives could include, e.g. market trends alike intentions of a firm's employees or the firm itself. It is crucial to have the company ambition, intention and responsibility in line with the overall company strategy (Marrewijk and Werre, 2003). Furthermore, Marrewijk and Werre (2003) add that transparency in line with a firm's ambition on its sustainability intentions and decisions is essential.

ESG performance measures a company's overall performance, including environmental, social and governance aspects, which can affect the company's operation (PRI, 2018). Principles of Responsible Investment, consisting of international institutional investors, founded these principles to contribute to sustainable economic growth whilst promoting United Nations Sustainability Development Goals.

This study defines that CSR initiatives can be measured through ESG performance, given that each company has its own individual initiatives and agenda that suits it, whilst ESG support to measure and compare the initiatives making them also accountable. It is acknowledged that academia has historically used CSR and ESG performance with slightly altering definitions, however these are used interchangeably in this study.

The connection between sustainability and corporate financial performance is an area that has increased interest within researchers from academia and asset managers managing their funds. According to Alshehhi et al. (2018), discrepancies within the variables and methodologies in the existing studies are the key driver for varying views on the correlation between sustainability and financial performance. However, 78% of a selection consisting of 132 papers identify a positive relationship between corporate sustainability and its financial performance (Alshehhi et al., 2018).

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While studies with a focus on the correlation on the Nordic markets remains scarce, the Nordic markets are considered to be leading within corporate social responsibility. It increases the curiosity whether Nordic Markets are in line with the findings of Ashehhi et al.

2.2. Forces behind CSR practice

Firms are more likely to succeed in being socially responsible if clear regulations, internally and externally, are introduced (Campbell, 2006). Those could include governmental and industrial restrictions, standards like pressure from external stakeholders. Campbell (2006) adds that firms have a higher probability of implementing CSR if the firm is engaged in related associations and close dialogue with key stakeholders and has increased pressure on these topics on firm leaders. Campbell extended his study research in 2007 to identify the underlying factors leading to increased CSR. His findings suggest that a key driver for acting socially responsible is robust financial performance. Campbell (2007) adds that the strength of the societal economy impacts a firm’s engagement in CSR questions. Hence, this implies that the Nordic markets, in which this study focuses, which all have strong societal economies, should similarly positively affect the CSR practices the firms in the countries have. According to Campbell (2007), moderate levels of competitiveness have the strongest driver to succeed in implementing CSR within a firm, compared to low or high levels.

Firms have close relationships with their banks and the financial markets through the services they provide – from advisory to cash management and debt financing through term loans, revolving credit facilities and bonds. During the past years, CSR incentives have been incorporated in bank offerings through sustainability-linked or green debt financing to support firms to strive for sustainable solutions (Danske Bank, 2021). Chiesa and Barua (2018) highlight the importance of firms meeting increased pressure for such offerings connected to firm-specific sustainability targets, as investors and societies have shown significant interest in such products.

2.3. Purpose of CSR – Support

There are multiple views on corporate social responsibility and sustainability that either complete or compete with each other. According to resource-based views, CSR is considered an intangible strategic asset that could enable sustainable firms a competitive advantage over their peers (Qiao and Wu, 2019). Such advantage could consist of improved financial performance, as a consequence of increased positive reputation. Similarly, it could enable to boost talent acquisition. On the financing side, strong ESG performance or targets could lead to better terms (Qiao and Wu, 2019), for example, sustainability-linked loans or bonds.

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Similarly, Porter and Kramer (2011) established a concept of creating shared value, where a company’s profit and ethical perspective should not exclude one another given they both impact the society. According to Godfrey et al. (2009) and Deng et al. (2013), stakeholder-based view, companies with keen relationships with their stakeholder, has better support in its day-to-day operations, which is linked to improved financial performance. Godfrey et al. (2009) also bring up that in situations where a company with strong CSR initiatives unexpectedly is in the light of negative news, the company is more likely to be faced with milder negative reactions, given that the CSR activities serve as goodwill. According to Qiao and Wu (2019), companies with ESG performance have a better reputation according to their stakeholders, also known as institutional theory. Finally, the signalling hypothesis of CSR proposes that CSR performance signal its financial prospects (Lys et al., 2015). Therefore, given these views, we can say that CSR expenditures support company performance and should lead to positive revenue

2.4. Purpose of CSR – Critique

Friedman (1970) is one of the best-known critiques within the field of socially responsible investing. He argued that the primary purpose and responsibility of a company is to create value for its shareholders, rather than splurging the shareholders' money on "social responsibilities" (Friedman, 1970). Hence, the focus should instead be on allocating resources efficiently, boost and create wealth in the society, whilst ensuring to serve their own interest. Barnett and Salomon (2006) pointed out that the screening processes to identify which funds are ESG friendly require a significant amount of resources, which is reflected in management fees. Similar to Friedman's view, the shareholder expense view regards CSR activities at the end of the day as costs financed by the shareholders, which would create a competitive disadvantage (Deng et al., 2013). According to these critiques, CSR engagement and ESG performance lead to decreased performance, inefficiently allocated resources, which would be reflected with decreased Net Asset Value.

2.5. ESG in Funds

Corporate social responsibility initiatives and engagement can be measured through, e.g. ESG factors. In this study, emphasis is laid on the independent environmental, social and governance factors to determine whether one outweighs the other in relation to financial performance. ESG measures are based on Refinitiv ESG scores.

American investors explain that the main reasons for considering potential investments are primarily due to pressure from clients and financial performance (PRI, 2018). Asset managers and shareholders motivate that by conducting ESG analysis, better investment decisions are made and better

10 performance obtained (PRI, 2018). According to Principles of Responsible Investment (2018), the underlying motive is that ESG matters can provide supplementary investment value.

2.6. ESG and Financial Performance

One of the first studies within the field of sustainable funds analyzed the performance of 32 mutual funds with socially responsible emphasis split into two categories – founded before or after 1985 (Hamilton et al., 1993). These funds were analyzed against a selection of 320 conventional funds, which were similarly divided into two groups with the same inception date requirement. The two categories were compared with another with Jensen’s alpha and with the NYSE Composite Index. The study concluded that there was no profit generated between the categories, and hence no expectations on financial benefits should be linked to socially responsible funds.

Mallin, Saadouni and Briston (1995) studied ethical and non-ethical funds in the United Kingdom between 1986 and 1993, combined 29 pairs in which fund age and size-matched one another whilst focus on social responsibility varies and are considered as the founders of “matched-pair approach”. They focused on analyzing each pair rather than focusing on categories as a whole. Their results indicated that the UK funds, regardless of their approach, underperformed during the period. However, those with corporate social responsibility focus tend to perform better than those without. Finally, Mallin et al. (1995) propose that the increased interest in sustainability question had captured awareness and interest in the crucial questions, which had led to increased sustainable options.

Gregory et al. (1997) further developed Mallin et al.’s (1995) study on the matched-pair approach, in which two additional categories, “investment area” and “fund type”, were introduced. The driver behind this was to ensure increased tailoring between pairs. Between a time frame of 1986 to 1994, a total of 18 funds were analyzed against the FTASA Index. No significance was found despite extending the study around CAPM, which considers the level of return on capitalization stocks into consideration. Gregory et al. (1997) propose that after considering CAPM within the study, no significance was found. Finally, Gregory et al. (1997) add that fund size may be misleading criteria, given that it does not impact fund financial performance.

A study conducted by Werhane and Freeman (1999) stated that an asset manager should aim to ensure the shareholder value, in this case, net asset value, continues to develop and to strive for maximizing its profits. According to them, introducing a corporate social responsibility perspective with profit maximization does not go hand-in-hand. Werhane and Freeman concluded that funds with a sustainability focus should not be seen as an attractive alternative as they do not create potential returns (1999).

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Statman (2000) similarly conducted a study based on the matched-pair approach, in which it pairs 62 non-ethical funds with 31 ethical funds. The study is conducted between 1990-1998 and indexed against two indices, including Domini Social Index and S&P 500. Statman (2000) found out that S&P underperformed against Domini Social Index. Unfortunately, once the returns were risk-adjusted S&P 500 instead performed better than the socially responsible index.

Another study within this field of research was conducted by Kreander, Gray, Power and Sinclair (2005), which focused on the financial performance of ethical funds between 1995-2001 in Sweden, the United Kingdom, Germany and the Netherlands. Similar to previous studies, Kreander et al. (2005) utilized the matched pair methodology and the study comprised of 60 socially responsible mutual funds. The study takes into consideration market timing to see whether any change in asset class would impact the forecast. The result, however, found no impact of market timing and nor selecting socially responsible funds have an impact on financial performance.

Renneboog et al. (2008) analyzed the performance of ethical funds between 1991 and 2003 with a dataset consisting of nearly all funds within this segment worldwide. CAPM and Carhart four-factor model was used to analyze a total of 440 ethical mutual funds and a benchmark of 16 036 non-ethical funds. Fund returns against risk loadings were analyzed and lead to results indicating that funds with an ethical approach in several European countries, UK, Asia-Pacific and the US underperform in relation to their local benchmarks. Renneboog et al. (2008) add that investors focusing on ethical investments are not capable of finding funds that outperform.

On the same front, Friede, Bush and Bassen (2015) studied the relationship between corporate social responsibility and corporate financial performance. Based on their data, summarized from over 2200 studies, they propose that significant correlation is found in 90% of studies, and hence, all rational investors should be introduced to increase ESG focus.

In Sahut and Pasquini-Descomps (2015) study, the relationship between companies’ ESG rating, financial and market performance in Switzerland, UK and the US were analyzed. They assumed companies with strong ESG rating to similarly performing strongly financially due to lower residual risk. However, the results showed neutral to partially negative relationships in the UK, whilst not in Switzerland and the US. Sahut and Pasquini-Descomp (2015) found that the correlation was impacted by the year and industry the business operated in and concluded that this could motivate why investors cannot identify the varying levels of residual risk by the variation of ESG rating.

Finally, Amel-Zadeh and Serafeim (2017) instead focused on how institutional investors utilize ESG information. The participants of this study represented investors equivalent to 43% of global

12 institutional assets under management. Amel-Zadeh and Serafeim (2017) study found out that 82% of these investors say they consider ESG factors when looking at investment opportunities. Out of all participants in this study, 52% of institutional investors (63% of those 82% of investors) motivated that ESG factors are crucial in investment performance, and hence consider those. In addition to investment performance, a mutual motivation was client demand, after which product strategy and ethical considerations. The study was able to demonstrate that worldwide the interest in ESG questions is strongly due to financial performance motivations at the end of the day, rather than genuine ethical considerations. However, the interest in ethical motives is significantly higher in Europe than in the US. Based on the institutional investors attending this study, expect to significantly increase in the near future.

One of the most recent studies, conducted by Alshehhi et al. (2018), states that discrepancies within the variables and methodologies seem to be the main reason for the correlation between sustainability and financial performance to show varying conclusions. However, 78% of a selection consisting of 132 papers identify a positive relationship between corporate sustainability and its financial performance (Alshehhi et al., 2018). While studies focusing on the correlation on the Nordic market remains scarce, the Nordic markets are considered to be leading within corporate social responsibility.

2.7. Modern Portfolio Theory

Through Modern Portfolio Theory, Markowitz (1952) presented that a diversified portfolio is most likely to generate the best return, which is aligned with the shareholder’s interest in maximizing the return of their holdings. Furthermore, Markowitz (1952) added that the choice of risk an investor makes is based individually on each security and fund, instead of having a mutual view on all exposure. Hence, an investor may take a higher risk on a specific fund. Given that an investor takes a higher risk, the expected return should also be correlated.

Based on Markowitz’s Modern Portfolio Theory, the selected funds for this study considered to have weak ESG performance could be considered efficient. This is because having strong ESG performance as a criterion will be delimiting the selection. As a consequence, the fund portfolio of an asset manager will be less diversified, and as Markowitz (1952) describes, less efficient.

2.8. Diversification

Modern Portfolio Theory (Markowitz, 1952) foundation lays on diversification. A fund is considered diversified when diversified either by varying industries or products as equities and bonds. When a portfolio is diversified, it leads to the risk being divided on all securities rather than one specific, and

13 this leads to the total level of risk being reduced (Markowitz, 1952). In addition, Markowitz highlighted that the expected return is maximized when the risk is properly diversified. In other words, this means that the selected securities in the fund are not to correlate with one another in any way (Markowitz, 1952).

2.9. Risk

According to Modern Portfolio Theory, the risk is defined by Markowitz (1952) as the standard deviation of expected return. Markowitz added that whilst risk should be undesirable, expected return, on the contrary, should be desirable (1952). It is not possible to bullet-proof mitigate risk, but instead, by diversifying properly, the risk can be minimized. According to Markowitz (1952), investors tend to be risk-averse.

Markowitz (1952) pointed out that it is impossible for risk to have no risk in a portfolio through diversification. This is because systematic risks simply cannot be mitigated. An example of systematic risk is interest rates, which are not controlled by human but rather markets. Furthermore, systematic risk does not exclude anyone but rather is identical for all parties within the same market (Investopedia, 2020).

In addition to systematic risk, unsystematic risk occurs. Unsystematic risk is unique to specific security and can be mitigated by selecting another security or industry (Investopedia, 2020).

2.10. Efficient Market Hypothesis

The efficient Market Hypothesis, established by Fama (1970), is based on the ideology of market prices being correlated with the available public information. In other words, this means that everyone is provided with the same information, and theoretically, no arbitrage opportunities should be possible. This means that the security price adjusts directly to its new market price if new information influencing the price is revealed. A market functioning efficiently and immediately adjusting to new prices makes it unsuccessful to outperform the market. According to Efficient Market Theory, in case someone succeeds to outperform the market, it is primarily caused by luck at a sudden occasion rather than outstanding skills.

The Efficient Market Hypothesis consists into three levels of engagement: weak, semi-strong and robust (Fama, 1970). The motive of these categories is to indicate the engagement of the market efficiency. According to Fama (1970), the weak form of Efficient Market Theory is impacted directly by public information, and prices are mainly reflected by historical returns and prices. Instead, the semi-strong form focuses on the historical prices alongside the public information and the new publicly shared information, which shifts the prices to the new ones. The final type, the substantial

14 form, consists of a semi-strong form of EMH and includes private information, which is only available for those on the insider list of the firm, and the impact of that on the equity/ fund price (Fama, 1970).

Despite Fama (1970) established Efficient Market Theory, one should not generalize that the markets function fully efficiently. Some people have insider access compared to others, and hence the market is not efficient. Similarly, Grossman and Stiglitz (1980) stated that prices are not equivalent to all public information. If one would put effort to further analyze to understand the business model and details, it could enable that person to outperform the market.

2.11. Jensen’s alpha

The history behind Jensen’s alpha is based on when Jensen conducted a study (1967) where he would observe 115 mutual funds to find out whether fund returns and market returns had any correlation. Jensen (1967) based his study on Capital Asset Pricing Model (CAPM), where alpha was utilized to even the estimated and actual regression. Thus, when alpha is not zero, it may lead to increased return or vice versa.

In case alpha is negative, it indicates that the risk does not beat the index in terms of excess return. Jensen analyzed returns during 1945-1964 whilst using statistical tools to analyze the regressions. Based on his study, Jensen (1967) found that, on average most funds underperforming the market. Those that outperformed were rather with irregular success, whilst there is limited testimony on forecasting security prices (Jensen, 1967). Worth mentioning that diversification was excluded in this study.

2.12. Summary

Based on the selection of previous literature varying between 1993 and 2018, as presented below in the summary Table A, most of the study seems not to have been able to prove a positive correlation between sustainability-linked initiatives and fund financial performance. Only recent studies have found a positive correlation—worth pinpointing that these studies do not concentrate on the Nordic region but rather on other market segments. Existing studies motivate to further investigate the gap between CSR initiatives and fund financial performance and the underlying drivers behind it. Similarly, conducting a study focusing solely on the Nordic fund market would complement the existing literature library.

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푇푎푏푙푒 퐴 − 푆푢푚푚푎푟푦 표푓 퐿푖푡푒푟푎푡푢푟푒 푟푒푣푖푒푤:

Authors Publication Region Timeframe Collection Measures Indices ESG + year of funds Financial Performance Correlation Hamilton,Joe and 1993 United 1982-1990 32 CAPM NYSE Index No and Statman States Mallin,Saadouni 1995 United 1986-1993 29 CAPM, FT All Share No and Briston Kingdom Treynor, Index Sharpe Gregory,Matatko 1997 United 1986-1994 18 Two- FT All Share No and Luther Kingdom factor Index, Hoare model Goett Index Statman 2000 United 1990-1998 31 CAPM S&P 500 No States Kreander,Gray, 2005 Belgium, 1990-2002 40 CAPM MSCI World No Power and Sinclair Germany, Index Netherlands, Scandinavia, Switzerland, United Kingdom Renneboog, Horst 2008 Total of 19 1991-2003 440 CAPM, Worldscope No and Zhang countries Carhart Equity Index (value- weighted) Sahut and 2015 Switzerland, 2007-2011 200 Five- Swiss Yes Pasquini- United factor Performance Descomps Kingdom, linear Index, FT All- United market Share Index States model, Fama- French Alshehhi, 2018 Total of 33 1984-2017 132 Sharpe Dow Jones Yes Nobanee and countries existing ratio, Sustainability Khare papers Stock Index return, ROI and 71 other

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3. Research Design

The following section will formulate the hypotheses of this study, which contribute to an area within CSR initiatives and mutual fund performance that has not been previously researched. The research method is presented as well as introducing the measures for analyzing mutual fund performance.

3.1. Introduction

As formulated in chapter 1, the research question for this study is How are Corporate Social Responsibility initiatives reflected on fund financial performance in the Nordic mutual fund market?

The previously presented literature review and theoretical framework will support to conduct the study on studying the relationship between CSR initiatives and fund financial performance alongside the following methods section.

3.2. Research method

In order to examine and answer the research question of this study, the following sections will present the methodology and theories that were used as a base for this study, alongside the literature review presented earlier. Matched-pair method has been selected to be utilized to analyze funds with strong ESG performance alike weak ESG performance, which is presented below in chapter 3.3. Thereafter, the theories applied to calculate the risk-adjusted returns on the selected funds are introduced. That is followed by a presentation of the hypothesis formulation and hypothesis testing is presented lastly, alongside the perspectives on the reliability and validity of this study.

3.3. Matched-pair

Matched pair methodology created by Mallin et al. (1995) is a rather commonly used method in which funds are split into two categories to analyze their performance. The categories are divided between funds with ESG emphasis and those without and pairs matched based on i.a. fund size and/or inception date.

Multiple studies (including Gregory et al., 1997; Kreander et al., 2005; Renneboog et al., 2008) have stated that fund size is not a driver impacting the performance of funds with strong ESG ratings. Therefore, given that fund size has been claimed not to impact financial performance, it is not to be considered in selecting pairs.

Most recently, Leite and Cortex (2014) have extended the matched pair method by including region. That factor is suitable for studies analyzing multiple varying regions. However, this study consists of solely funds domicile in the Nordic region, investing in Nordic equities. Hence, the entire selection of funds has fulfilled those criteria and is not further divided into countries. The main criteria for selecting

17 and dividing into pairs within the categories are the age of the fund (inception date) and Sustainalytics rating. The difference between the inception years of a pair is not to exceed ten years as this study considers funds with an age difference of over ten years to be in different stages of development. In addition, the categories are to split between a selection of funds with strong ESG rating and weak ESG rating. A pair consists of a fund with strong ESG rating and fund with weak ESG rating, that have as similar characteristics as possible. A total of 23 pairs are included in this study.

Given that this study has its focus on the correlation between CSR initiatives and fund financial development, forming pairs of groups with similar characteristics, should lead to trustworthy results, and thus the matched pair methodology is considered the most suitable method for this study.

In the following table B, the matched pairs are presented.

푇푎푏푙푒 퐵 − 푀푎푡푐ℎ푒푑 푝푎푖푟

3.4. Mutual fund performance

Fund total net assets and ESG rating were used to create pairs for this study. The performance of the each selected fund is calculated based on their Net Asset Values (NAV). Net Asset Value is the price an investor is willing to sell or buy their fund on the market (Bodie et al., 2014). Hence, NAV is essential to calculate the return of the selected funds.

As the first step, Return on Investments (ROI) is calculated by using the monthly Net Asset Values between January 2015 and December 2020. Return R, standard deviation σ and covariance

퐶표푣(푅푝, 푅푚) are introduced first monthly and then formulated to annual.

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Net Asset Value is used to calculate the return of the funds. The rate of return on investments R is defined following in equation I.

푁퐴푉푡 − 푁퐴푉푡−1 푅푡 = ( ) 푁퐴푉푡−1

퐸푞푢푎푡푖표푛 퐼 − 푅푎푡푒 표푓 푟푒푡푢푟푛 표푛 푖푛푣푒푠푡푚푒푛푡

NAVt is defined as Net Asset Value at time t, in which t stands for months (Brooks, 2014). The monthly returns are then converted to average annual returns, as in equation II.

1 푅푎푛푛푢푎푙 = (1 + 푅푡표푡)푛 − 1

퐸푞푢푎푡푖표푛 퐼퐼 − 퐴푛푛푢푎푙 푟푒푡푢푟푛 표푛 푖푛푣푒푠푡푚푒푛푡

Rtot is defined as total return on investment whilst n is defined as the number of years of the selected period (source).

Standard deviation is used to calculate IV. First the monthly standard deviation σ is calculated as presented in equation III,

푛 1 σ = √ ∑(푅 − 푅̅)2 푚표푛푡ℎ푙푦 푛 − 1 푡 푡=1

퐸푞푢푎푡푖표푛 퐼퐼퐼 − 푀표푛푡ℎ푙푦 푠푡푎푛푑푎푟푑 푑푒푣푖푎푡푖표푛 where 푅̅ is defined as monthly return on investment (Newbold, Carlson, Thorne, 2013). The annual σ is then compounded followingly in equation IV,

√12σ푚표푛푡ℎ푙푦

퐸푞푢푎푡푖표푛 퐼푉 − 퐴푛푛푢푎푙 푠푡푎푛푑푎푟푑 푑푒푣푖푎푡푖표푛

Covariance 퐶표푣(푅푝, 푅푚) in calculated followingly in equation V (Newbold et al., 2013).

푛 ∑푡=1(푅푝,푡 − 푅̅푝)(푅푚,푡 − 푅̅푚) 퐶표푣(푅 ,푅 ) = 푝 푚 푛 − 1

퐸푞푢푎푡푖표푛 푉 − 퐶표푣푎푟푖푎푛푐푒

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3.5. Capital Asset Pricing Model

Capital Asset Pricing Model (CAPM) is a tool established by Sharpe (1964) to describe the relationship between the return of an asset and its’ risk. CAPM may be used to analyze the potential compensation whilst taking into consideration its’ systematic and nonsystematic risk, as introduced in chapter 2.4. In CAPM, the risk is impacted by the market the specific asset is in and used as an assisting tool in pricing the asset to match the expected returns and cost of capital in relation to the risk.

퐸(푅푝) = 푅푓 + 훽푝(퐸(푅푚) − 푅푓)

퐸푞푢푎푡푖표푛 푉퐼 − 퐶푎푝푖푡푎푙 퐴푠푠푒푡 푃푟푖푐푖푛푔 푀표푑푒푙

The Capital Asset Pricing Model is presented above in equation VI, where 퐸(푅푝) is expected return,

푅푓 risk-free rate, β market risk and 퐸(푅푚) expected market return.

Risk-free rate (푅푓) indicates a rate of return an investor would gain by being risk-averse. According to Sharpe (1964), a suitable measure for a risk-free asset is a government bond.

Market risk (훽푝), describes what the impact of including a specific asset in a portfolio would be in a scenario where the portfolio is otherwise aligned with the market. Beta is also known as the measure of systematic risk. The market is considered as β =1, and thus in scenarios where β < 1, is less risky than the market and will reduce the risk of the portfolio. In a scenario where β >1, the asset is considered risker than the market it is in and similarly will increase the risk of the portfolio. Market risk may be calculated followingly, as in equation VII.

퐶표푣(푅푝, 푅푚) β푝 = 푉푎푟(푅푚)

퐸푞푢푎푡푖표푛 푉퐼퐼 − 퐵푒푡푎

The expected market return (퐸(푅푚)) indicates the return of a specific asset selected to evaluate its economic gains.

Market risk premium ((퐸(푅푚) − 푅푓) is the difference between expected market return and the risk- free rate (e.g. government bond) and indicates what an investor could gain instead of being risk-averse and selecting a risk-free option.

Sharpe (1964) created the CAPM by assuming that investors tend to be risk-averse and select the least risky alternative with the lowest variance and mean. The intention of CAPM is to support investors to

20 evaluate whether the asset of interest is decently priced when taking into consideration its risk and the cost in relation to its expected return.

Worth noting that this study does not use CAPM as a measurement for analyzing financial performance. It was thoroughly presented in order to understand the fundamentals behind calculating Jensen’s Alpha in chapter 3.6. CAPM also supports to calculate Beta and thus was considered crucial to be introduced at this stage.

3.6. Jensen’s alpha

Jensen (1967) established Jensen’s Alpha, a commonly used tool to analyze the performance of a portfolio whilst including the risk taken for that specific investment. In this study the annual Jensen’s alpha will be utilized by using the following formula as expressed in equation VIII,

훼푎푛푛푢푎푙 = 푅𝑖 − (푅푓 + 훽(퐸[푅푚] − 푅푓)

퐸푞푢푎푡푖표푛 푉퐼퐼퐼 − 퐽푒푛푠푒푛′푠 퐴푙푝ℎ푎 − 푎푛푛푢푎푙 in which 훼 is Jensen’s alpha, 푅𝑖 actual return, 푅푓 risk-free rate, 훽 market risk, 퐸[푅푚] expected market return.

Jensen’s alpha is interpreted followingly:

In case 훼 > 0, the return on that particular investment is greater than expected according to CAPM. Hence, the actual return and performance is better than the referred benchmark.

If 훼 = 0, the actual and expected return are aligned when calculated by CAPM.

In case 훼 < 0, the return of the particular investment underperforms when referred to its benchmark, when calculated using CAPM.

Given that Jensen’s alpha measures the risk taken, it can be used as a tool in this study to analyze the correlation of the performance of the selected funds and their levels of risk. Hence, it supports this study on whether funds with strong or weak ESG performance perform better.

3.7. Sharpe Ratio

Sharpe (1966) established Sharpe Ratio, a commonly used tool to analyze the risk-adjusted performance of the selected investment, presented below in equation IX.

푅푝 − 푅푓 푆ℎ푎푟푝푒 푟푎푡푖표 = 휎푝

퐸푞푢푎푡푖표푛 퐼푋 − 푆ℎ푎푟푝푒 푅푎푡푖표

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퐸푥푐푒푠푠 푅푒푡푢푟푛 = 푅푝 − 푅푓

퐸푞푢푎푡푖표푛 푋 − 퐸푥푐푒푠푠 푟푒푡푢푟푛

Sharpe ratio consists of excess return, as defined in Equation X, and 휎푝 = volatility of the selected investment/portfolio.

In case Sharpe ratio > 0, the return of the selected investment is larger than risk taken. In such case, the investment can be considered a “good investment”.

If Sharpe ratio = 0, the risk-adjusted return is balance with the return and in other words no risk is taken if the selected investment is selected.

In case Sharpe Ratio < 0, the risk adjusted-return of the selected investment is smaller than the risk taken. In such case, the investment can be considered a “bad investment”.

Worth mentioning that the returns may be infinitive in either way – however, a very negative return would be an extreme situation given that the volatility (a.k.a. denominator) cannot be negative; it would require a negative excess return. It would mean that the investment would perform worse than the risk-free solution as government bonds. Such a scenario occurs very seldom.

Similarly, cases where 휎푝 = 0, occur very seldom, as that would automatically make the excess return risk free. However, Sharpe ratio may be very close to zero.

Given that Sharpe ratio measures the performance with the adjusted level risk, it can be used as a tool in this study to analyze the correlation of the performance of each selected fund. Hence, it supports this study on whether funds with strong or weak ESG performance perform better in terms of return.

3.8. Treynor ratio

Treynor introduced in 1965 Treynor ratio, a commonly used measure to analyze the risk-adjusted performance of the selected investment, in comparison to the market risk (β). Market risk is a type of systematic risk.

푅푝 − 푅푓 푇푟푒푦푛표푟 푅푎푡푖표 = β푝

퐸푞푢푎푡푖표푛 푋퐼 − 푇푟푒푦푛표푟 푟푎푡푖표

Treynor ratio consists of excess return, as defined above in Equation XI, and β푝 = market risk of the selected asset/portfolio.

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In case Treynor ratio > 0, the return of the selected investment is larger than the market risk.

If Treynor ratio = 0, the risk-adjusted return is balance with the market return and in other words no risk is taken if the selected investment is selected.

In case Treynor Ratio < 0, the risk adjusted-return of the selected investment is smaller than the market risk.

Given that the Treynor ratio measures the performance with the adjusted level risk, it can be used as a tool in this study to analyze the correlation of the performance of each selected fund. Hence, it supports this study on whether funds with strong or weak ESG performance perform better in terms of return.

Treynor ratio differs from Sharpe ratio by having the excess return compared to the market risk rather than the volatility of the selected asset. However, both, indicate the correlation with the risk taken by investing in the selected asset from varying perspectives, enabling this study to similarly look at risk vs return from different perspective.

3.9. Hypothesis formulation

The previously presented literature review and theoretical framework have inspired me to study the gap between CSR initiatives and fund financial performance. Therefore, the following hypothesis are formulated followingly in order to answer the research question How are Corporate Social Responsibility initiatives reflected on fund financial performance in the Nordic mutual fund market?:

Hypothesis 0: CSR initiatives impact Nordic mutual funds with no significant difference

Hypothesis 1: CSR initiatives impact Nordic mutual funds with a significance

Based on existing theories, such as Markowitz’ Modern Portfolio Theory, funds with an ESG profile should not perform well in comparison to those without such niche. One of the commonly argued reasons is that funds with ESG focus cannot diversify to the same extent as those without such limitations.

During recent years, the awareness and focus on CSR initiatives and ESG factors in corporate operations have increased (Cheng et al., 2014). According to the baseline of this study, in which CSR initiatives are considered as investments, requiring resources and leading to a gap before its financial consequences are visible.

In case H0 fails to reject, it would indicate that the two types of funds perform equally well, where CSR initiatives’ (“the investment”) financial performance is just as successful as those without CSR

23 initiatives and the gap is closed. Conversely, in case H0 is rejected, H1 is significant indicating that a gap between CSR initiatives and financial performance exists, either under or over performing in regards to those without CSR initiatives.

3.10. Hypothesis Testing

In order to estimate whether Nordic funds with strong or weak ESG profile perform better, the previously introduced tools will be used to conduct the study. However, making conclusions directly is insufficient. In order to ensure the validity of the study and to answer the Hypothesis presented in Chapter 3.9., a hypothesis test is conducted.

The hypothesis test selected for this research paper consists of a t-test, which is to be conducted on Jensen’s alpha, Sharpe ratio and Treynor ratio. The t-test will allow us to reject or fail to reject our research question - How are Corporate Social Responsibility initiatives reflected on fund financial performance in the Nordic mutual fund market?

One-tailed and two-tailed t-tests will be conducted in this study. According to Newbold, Carlson and Throne (2013), one-tailed t-tests enable to determine whether one of the two is greater than another. This study would indicate that funds with either strong or weak ESG performance would have better returns than others.

As introduced in Chapter 3.3. in table B , category I consists of funds with strong ESG performance and category II of funds with weak ESG performance. The following equations XII, XIII, XIV will present the one-tailed t-testing for Jensen’s alpha, Sharpe ratio and Treynor ratio:

퐻푦푝표푡ℎ푒푠푖푠 푡푒푠푡:퐽푒푛푠푒푛′ 푠 퐴푙푝ℎ푎

퐻0: 훼퐼 = 훼퐼퐼

퐻1: 훼퐼 > 훼퐼퐼

퐸푞푢푎푡푖표푛 푋퐼퐼 − 푂푛푒 − 푡푎푖푙푒푑 푡 − 푡푒푠푡 − 퐽푒푛푠푒푛′푠 푎푙푝ℎ푎

퐻푦푝표푡ℎ푒푠푖푠 푡푒푠푡:푆ℎ푎푟푝푒 푟푎푡푖표

퐻0: 훼퐼 = 훼퐼퐼

퐻1: 훼퐼 > 훼퐼퐼

퐸푞푢푎푡푖표푛 푋퐼퐼퐼 − 푂푛푒 − 푡푎푖푙푒푑 푡 − 푡푒푠푡 − 푆ℎ푎푟푝푒 푟푎푡푖표

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퐻푦푝표푡ℎ푒푠푖푠 푡푒푠푡: 푇푟푒푦푛표푟 푟푎푡푖표

퐻0: 훼퐼 = 훼퐼퐼

퐻1: 훼퐼 > 훼퐼퐼

퐸푞푢푎푡푖표푛 푋퐼푉 − 푂푛푒 − 푡푎푖푙푒푑 푡 − 푡푒푠푡 − 푇푟푒푦푛표푟 푟푎푡푖표

In two-tailed t-test both tails of the distribution curve are analyzed to reject or fail to reject the hypothesis. It will indicate whether there either are no differences or whether either of the two categories perform better than the other (Newbold, Carlson and Throne, 2013). The following equations XV, XVI, XVII will present the one-tailed t-testing for Jensen’s alpha, Sharpe ratio and Treynor ratio:

퐻푦푝표푡ℎ푒푠푖푠 푡푒푠푡:퐽푒푛푠푒푛′ 푠 퐴푙푝ℎ푎

퐻0: 훼퐼 = 훼퐼퐼

퐻1: 훼퐼 ≠ 훼퐼퐼

퐸푞푢푎푡푖표푛 푋푉 − 푇푤표 − 푡푎푖푙푒푑 푡 − 푡푒푠푡 − 퐽푒푛푠푒푛′ 푠 푎푙푝ℎ푎

퐻푦푝표푡ℎ푒푠푖푠 푡푒푠푡:푆ℎ푎푟푝푒 푟푎푡푖표

퐻0: 훼퐼 = 훼퐼퐼

퐻1: 훼퐼 ≠ 훼퐼퐼

퐸푞푢푎푡푖표푛 푋푉퐼 − 푇푤표 − 푡푎푖푙푒푑 푡 − 푡푒푠푡 − 푆ℎ푎푟푝푒 푟푎푡푖표

퐻푦푝표푡ℎ푒푠푖푠 푡푒푠푡: 푇푟푒푦푛표푟 푟푎푡푖표

퐻0: 훼퐼 = 훼퐼퐼

퐻1: 훼퐼 ≠ 훼퐼퐼

퐸푞푢푎푡푖표푛 푋푉퐼퐼 − 푇푤표 − 푡푎푖푙푒푑 푡 − 푡푒푠푡 − 푇푟푒푦푛표푟 푟푎푡푖표

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The significance level selected for this study is 5%, assuming all assets to have equal variances on both one-tailed and two-tailed t-tests.

As the study intends to find out whether either of the categories outperforms, we are interested in conducting both t-tests rather than focusing on whether the categories are similar. Hence, the H0: ESG performance does not impact the performance of a fund is according to Newbold, Carlson and Throne (2013) to be rejected when,

푅푒푗푒푐푡 퐻0 푤ℎ푒푛

푡 − 푠푡푎푡푖푠푡푖푐 > 푡 − 푐푟푖푡푖푐푎푙

푝 − 푣푎푙푢푒 < 훼

Worth taking into consideration is that in cases where the t-test is not strong enough may lead to failing to reject the null hypothesis, which may be misleading the results (Newbold, Carlson and Throne, 2013).

3.11. Scientific perspective

This study is conducted through a quantitative approach to analyze the profitability of Danish, Finnish, Swedish and Norwegian funds with varying levels of CSR initiatives. A deductive methodology is used to conduct the study. The structure is built by introducing the theory and forming the hypothesis. Followed by collecting the data fulfilling the criteria and analyzing the findings of the selected data. Lastly, the study is concluded with a confirmation or rejection of the hypothesis and the theory is been revised (Bryman, 2012).

The study follows the ontology of objectivism, in which the data utilized to conduct the study is based on external data, facts and theories. Given the selected ontology of the study, similar studies within the same topic should lead to similar results (Bryman, 2012). Therefore, the conclusions made in this study are based on the selected data, fulfilling the specific criteria, whilst not impacted by existing, published theories and conclusions – also known as positivistic epistemology.

Secondary data is utilized in this study to analyze the performance of funds. The data is collected from Refinitiv and Sustainalytics. Secondary data is suitable for conducting studies with market data. According to Bryman (2012), by using secondary data, errors are limited whilst making it time-efficient. The flip side, however is the lack of control of the data set.

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One should keep in mind that a quantitative study consisting of hard data is solely reliable on the numeric data and excludes all supporting qualitative information. Hence, reasoning behind possible fluctuations or impacts, including emphatic and social aspects of the funds and asset managers thoughts are excluded.

3.12. Reliability and Validity The conducted study is based on historical NAV values collected from Refinitiv. The data collected used to conduct the analysis is public information available for everyone. Net Asset Values reflects the market and remain the same for everyone, both historically and at a particular moment. Hence, NAV is considered reliable (Bryman, 2012). Refinitiv is an international platform that is well-known and considered a transparent and trustworthy source, providing all its users with realistic and identical data.

Given that all users of Refinitiv are provided with identical data, it should lead to identical results when excluding the risk of potential errors in the formulas used. The selection of funds is neutral and are picked based on their fit to the research criteria, with no personal preferences or information. The ambition of this study is not to give buy/sell recommendations but rather analyze the development of CSR, and there are no biased views in the selection of funds. The selected sources consisting of historical data, academic articles, supporting literature and frameworks are all considered reliable and highly relevant, ensuring the study is valid.

3.13. Source critical consideration

In order to conduct the study on whether ESG performance and fund profitability have a correlation, varying sources are used. Primary source data, including potential one-to-one interviews with the asset managers of the funds, are excluded in this quantitative study, which could have led to in the worst case to skewed results. Instead, the historical data of the 46 selected funds are collected from Refinitiv. The theoretical framework supporting the data consists of numerous academic articles, which all are published in well-known general academic journals. Other notable frameworks used in this study, including The Principles of Responsible Investments, are approved and supported by United Nations. Academic articles and public historical data are combined with literature with well-known academic authors within their field of study. Hence the author highly believes the sources for conducting this research are highly trustworthy, making the results of this study reliable.

3.14. Research Ethical Reflection

Given that this study is based on secondary market data, academic articles and existing theories, excluding any collection of primary data or connection with any asset manager or professional within

27 the field of sustainability or asset management, this study excludes any unethical interference. This research is not affiliated or funded by any partner, which could have any opportunity for conflict of interest (Bryman and Bell, 2013).

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4. Data

The following section introduces the process of retrieving the data of Nordic mutual funds for this study, which will be utilized to analyze the data and answer the research question presented in the previous chapter 3.

4.1. Data Description

In order to apply the appropriate models to measure the gap between CSR initiatives and financial performance measures, relevant data is required. Therefore, this part supports identifying the selection process of the data utilized in this study. The following section will describe the approaches behind the categorization of CSR initiatives, risk-free rate, and benchmark. Finally, risks related to the selected dataset are to be discussed.

The interest in this study underlies in the Nordic market; hence a prerequisite is that the mutual funds are domiciled in one of the Nordic countries, i.e., Denmark, Finland, Norway or Sweden and investing in Nordic equities. The study is limited to Nordic markets, given that the area is leading within sustainability questions (ESG Investing, 2021), but additionally have similar regulation and mutual determination to preserve nature (Alfred Berg, 2019).Thus asset managers working for Nordic funds have a deeper understanding in conducting business within the area and ethical standards. Ethical standards of funds could differ between Nordic region and other regions, and thus have been chosen to be excluded. By excluding non-Nordic funds, the ethical standard is more likely to be aligned between the funds.

The observation period of this study is between January 2016 and December 2020, totalling five years, and hence are expected to have an inception date of latest on 1 January 2016. The reason for selecting the timeframe of 5 years is based on that UN Sustainable Development Goals were implemented in 2016. This study is aware that companies may have had CSR initiatives prior to 2016, however having mutual targets that are easier to benchmark on all companies/funds is a reason for analyzing the development since establishing the United Nations SDG’s. It may have also encouraged companies to introduce CSR initiatives on the company agenda since 2016, and thus increasing the reliability of this study. Another prerequisite for this study is to solely include funds that have not been closed during the period.

In line with earlier studies (Renneboog et al., 2008), the fund financial performance of this study is measured through end-of-month Net Asset Values (NAV), which is commonly determined as the price/share of mutual funds. The five-year period enables 60 monthly observations per fund, which is considered to contribute to acceptable results of fund performance and statistical validity (Sitanshu

29 et al., 2013). Worth noting that the importance of sustainability-related questions has increased drastically during the past five years, and becoming a prioritized point on the corporate agenda, supports the choice of recent five years as the most relevant timeframe.

The data retrieving process inheres of three steps; the initial step in selecting Nordic funds that fulfil the criteria below is selected on Morningstar. The following step is to retrieve the ESG ratings of these funds from Sustainalytics. Finally, fund financial data of the selected funds are retrieved from Refinitiv.

Criteria: - Region: Nordic, i.e. Danish, Finnish, Norwegian and Swedish - Portfolio: Nordic equities - Fund Total Net Assets: Exceeding EUR 10m - Inception date: latest 1 January 2016 - Sustainalytics ESG rating - Ignore: fund management fees - Exclude: dividends - Exclude: funds closed during 2016-2020 After considering the collection of criteria, this study consists of a selection of 46 Nordic mutual funds. The selection contributes to a total of 23 pairs. This provides a data set of 2 760 observations on the Nordic mutual fund market.

4.2. Sustainalytics

This study assumes that Corporate Social Responsibility initiatives are reflected on corporate ESG ratings. Hence, those funds with an ESG rating towards the higher end are assumed to have CSR initiatives in place. ESG ratings utilized in this study are conducted by Sustainalytics, which is an independent provider of ESG ratings and research. Sustainalytics provides combined ESG rating, as well as individual ratings environmental, social and governance rates for companies and funds. In order to conduct this empirical study, the latest ESG ratings, combined and individual E, S, G ratings from March 2021 will be used to measure the CSR initiatives against fund financial performance.

Sustainalytics is a globally well-known firm providing independent ESG ratings on firms, as well as research and analysis within ESG and corporate governance. Sustainalytics is a commonly used rating within the finance industry, from banks to asset managers and pension funds, who use the Sustainalytics’ products to conduct their analysis and make investment decisions (Sustainalytics, 2021). Sustainalytics is today a part of the Morningstar group. The Sustainalytics’ ESG Risk Rating consists of a quantitative score as well as a risk category. The ratings are solely based on public

30 information. The quantitative score indicates the ESG risks that are not under control or managed. The rating is between 0-50 and divided into five categories – negligible, low, medium, high and severe (Sustainalytics, 2021). The smaller the rating, the better the firm performs in that category, i.e. zero indicates no risk.

Given that the Sustainalytics ratings are assessed on firms, the funds selected for this study with Sustainalytics ratings are a combination of the individual portfolio company ratings. Sustainalytics takes into account in its assessment both the current, existing ESG risks and how they are controlled and worked on, as well as analyzing ESG risks that are not worked on (Sustainalytics, 2021).

The ESG Risk rating is based on three main themes that consist of Corporate Governance, material ESG issues and idiosyncratic ESG issues (Sustainalytics, 2021). The first category, Corporate Governance is important as lack of it creates an increased risk for corporate material risks. Corporate Governance risks do not preclude anyone; hence it is relevant for all industries. Sustainalytics (2021) states that corporate governance plays a large role in the overall unmanaged risk score. Unmanaged corporate governance risk may account for an equivalent of about 20% of the overall score.

The second category, material ESG issues, compromises mainly topics within Human Capital, from diversity to recruitment and engagement, as well as labour relations, according to Sustainalytics (2021). Another common topic within the category is related to health and safety within the position, which enables all employees the highest safety to conduct their work (Sustainalytics, 2021).

Lastly, the idiosyncratic issues are independent company-specific issues that may occur and are not directly related to the industry. Those issues and risks do not look at any specific industry but rather may happen to any company unexpectedly (Sustainalytics, 2021).

Sustainalytics ESG Risk rating is a rather multidimensional risk assessment, and in addition to analyzing each category separately, it also makes an assessment on the exposure of the risk as well as how it was mitigated or unmanaged (2021). Within exposure, Sustainalytics also takes into account the company sensitivity on ESG risks too, which could be related to anything, i.e. CO2 emissions. Apart from solely assessing risk exposures, Sustainalytics rating also weighs the company management’s actions and initiatives to address the ESG risks it faces in its day to day operations (Sustainalytics, 2021).

Additionally, Sustainalytics provides risk assessment focusing entirely on environmental, social and governance factors. Sustainalytics analyzes risks and divides its shares into different categories. Hence a corporate risk may have an impact on all three categories at different levels (Sustainalytics, 2021).

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As presented above, Sustainalytics rating takes into account the ESG risks from multiple perspectives, from risk identification, to how it is handled within the organization and how it can be changed for the better. Furthermore, a rating considering the potential for progress is valuable as some industries can transform more smoothly than others. This study consists of Nordic mutual funds, each having its portfolio of firms, hence varying between industries. Using a rating that considers the ESG risks from multiple perspectives contributes to a reliable assessment within the analysis of the development of the CSR initiatives and their reflection on the financial performance of those mutual funds.

The Sustainalytics ESG Risk Rating has been selected for this study, as it not only is a highly appreciated extensive ESG research house, but also are one of the few research houses that provide individual scores for E, S and G categories alongside the ESG rating, which is crucial for this study where the interest is to find out which of the categories is the driving factor contributing to the CSR development.

4.3. Benchmark

This study intends to find out the most attractive alternative funds with strong or weak ESG performance, the alternatives are weighed against a market index. OMX Nordic 40 is selected as the benchmark for this study. Given that the study focuses on funds registered on all four Nordic countries – Denmark, Finland, Norway and Sweden, OMX Nordic 40 is the most relevant choice for the index. The OMX Nordic 40 index is based on the 40 most actively traded stocks on the four Nordic exchanges and was introduced on 28 December 2001. The collection of selected shares for the index are revised twice a year (Nasdaq, 2021). The observation of 5 years provides a data set of 60 monthly observations on the OMX Nordic 40 Index.

The OMX Nordic 40 Index was selected as the benchmark index, given that the selection of funds for this study consists of varying industries, alike the OMX Nordic 40 index. The other Nordic funds are mainly either country or industry focused, making the OMX Nordic 40 the most suitable one for this study. It is acknowledged that the benchmarking of 40 most actively traded stocks and their performance may have an impact on the results as company sizes may alter within the selection of funds.

4.4. Risk free rate

Risk and return may go hand in hand. In order to consider risk, a risk-free level is required to compare. A suitable option as the choice for risk-free rate is government bonds, as zero-coupon treasury securities are generally considered risk-free (Bodie, Kane and Marcus, 2014). Furthermore, countries with strong financial stability are expected to never fail to pay back and thus are seen as the ground for risk-free investments (Bodie et al., 2014).

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As this study focuses on Nordic markets – Denmark, Finland, Norway and Sweden, the 10-year government bonds for each country will be used as the base for expected returns, as in Sharpe and Treynor ratio. The origin of each fund is matched with the correct government bond.

During the past decade, an increasing amount of studies have introduced interbank offered rates as an alternative option for t-bills and government bonds as risk-free rates (Renneborg et al., 2008).

4.5. Limitation

In order to ensure equal treatment and analysis of the selection of Nordic mutual funds, this study excludes funds with dividend payouts. Funds have personalized dividend payout strategies; hence, some reinvest the generated profit, while others payout dividends to their shareholders. Therefore, to ensure aligned analysis on all funds, this study excludes funds with dividend payouts.

Additionally, this study ignores whether the funds are actively or passively managed; hence fund management fees are similarly excluded. Fund management fees are paid by the investors investing in the funds, which does not impact fund performance for the asset manager, but rather may impact returns of an individual investor as management fees diminish the profit. Given that this study does not focus on the return of individual investors, management fees are irrelevant for this study and thus are excluded.

It is also acknowledged that the selection of criteria determined for this study as brought up earlier in the chapter, including timeframe of 2016-2020, using Sustainalytics ESG rating and focusing solely funds domiciled in the Nordics investing in Nordic equities, may have an impact on the results and the results are not to be generalized within the field of CSR initiatives and financial performance of Nordic mutual funds.

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5. Empirical Results

The following section presents the results from the empirical analysis. The intention of this study is to discover whether Corporate Social Responsibility initiatives and the development of ESG rating impacts fund financial performance. By implementing the Matched pair methodology, two groups based on their ESG ratings were formed and benchmarked on the Nordic OMX40 index. The second part of the section presents the results from hypothesis testing. Lastly, the factor driving ESG development is explored and presented.

5.1. Empirical Statistics

The first section presents an overview of the empirical results of the measures introduced in chapter 4, consisting of Jensen’s alpha, Sharpe ratio and Treynor ratio. Jensen’s alpha measures excess returns. Sharpe ratio defines excess returns in relation to risk, whilst the Treynor ratio measures the return in relation to its systematic risk.

Hence, results presented in table C indicate the relation between risk and return and are annualized. All results are presented as decimals.

푇푎푏푙푒 퐶 − 푀푎푡푐ℎ푒푑 푝푎푖푟 푒푚푝푖푟푖푐푎푙 푟푒푠푢푙푡푠

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Table D presents the average annual returns of the two categories in relation to the benchmark. The benchmark of this study, Nordic OMX index on average had annual returns of 0.071. Both categories despite their ESG rating, outperform the Nordic OMX40 index. The selected Nordic mutual funds with strong ESG rating on average had an annual return of 0.097, whilst funds with weak ESG rating generated 0.114

푇푎푏푙푒 퐷 − 푅푒푠푢푙푡푠 표푣푒푟푎푙푙 푝푒푟푓표푟푚푎푛푐푒 Overall performance Mean Standard Deviation Category I 0,097 0,874 Category II 0,114 0,873 Benchmark 0,071 0,744

푇푎푏푙푒 퐸 − 푅푒푠푢푙푡푠 퐽푒푛푠푒푛′ 푠 푎푙푝ℎ푎 Jensen's alpha Mean Standard Deviation Category I 0,090 0,038 Category II 0,106 0,030

Jensen’s alpha was used to analyze whether the selected Nordic mutual funds over-or underperform in relation to the theoretically expected returns. Theoretically, expected returns are based on the Capital Asset Pricing Model (CAPM). As presented in Table E, the selected Nordic mutual funds with strong ESG rating on average had an annual return of 0.090, whilst funds with weak ESG rating generated 0.106. Out of 23 pairs, funds with strong ESG performance performed better in nine cases, whilst funds with weak ESG performed better in ten cases. The remaining four had varying results. Given that the distribution was equal, however, the results are insignificant.

푇푎푏푙푒 퐹 − 푅푒푠푢푙푡푠 푆ℎ푎푟푝푒 푟푎푡푖표 Sharpe ratio Mean Standard Deviation Category I 0,112 0,039 Category II 0,126 0,037

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푇푎푏푙푒 퐺 − 푅푒푠푢푙푡푠 푇푟푒푦푛표푟′푠 푟푎푡푖표

Treynor's ratio Mean Standard Deviation Category I 0,145 0,211 Category II 0,089 0,026

Nordic mutual fund returns in relation to their risk are measured through the Sharpe ratio. As presented in table F, the average Sharpe ratio for funds with strong ESG performance is at 0.112, whilst 0.126 for funds with weak ESG performance. Out of 23 pairs, in 13 cases, funds with weak ESG performance outperform. This result also is not significant. On the contrary, the Treynor ratio, measuring fund return in relation to systematic risk, shows that funds with strong ESG performance have an average of 0.145 whilst funds with weak ESG rating have an average of 0.089, as presented in table G. In 12 cases, funds with strong ESG performance outperform those with weak performance. This means that risk-adjusted performances in comparison to market risk are stronger for funds with strong ESG performance. This, however, is considered significant.

푇푎푏푙푒 퐻 − 푅푒푠푢푙푡푠 퐵푒푡푎

Beta Mean Category I 0,961 Category II 1,242

All betas for the selection of funds are significant. For example, the strong ESG category has 13 funds of 23 with beta exceeding 1, which indicates that the mutual funds are more volatile than the market. On the other hand, only one fund with a weak ESG rating had a beta of less than 1, which means the fund is less volatile than the market. The difference between the betas of the portfolios consisting of funds with strong ESG and weak ESG rating indicates that funds with strong ESG rating, 21 out of 23 times, are more likely to be sensitive to market fluctuations than those with a strong weak ESG rating. However, when looking at the average betas for the categories, category I consisting of funds with strong ESG performance, on average, performs less volatile than the market, as shown in Table H.

This finding varies with the efficient market theory (Fama, 1970). The group consisting of funds with strong ESG performance also had higher volatility than its peers, with higher standard deviation and a wider return spread.

The empirical results have not proven statistically that Nordic mutual funds with strong ESG performance and weak ESG performance have varying performances. At this stage, it is seen that

36 funds with strong and weak ESG performance perform with equal success. However, no conclusion on the development of ESG performance in relation to the financial performance or whether the tipping point has been reached can be evaluated at this stage. The findings at this stage are in line with multiple previous studies where funds with strong ESG performance do not over perform funds with weak ESG performance (e.g. Hamilton et al., 1993; Kreander et al., 2005; Renneboog et al., 2008).

The results at this stage are also in line with the modern portfolio theory, in which ESG screening limitates investment alternatives, which leads to having to exclude attractive alternatives and smaller opportunity to assemble a fully diversified portfolio. As a consequence, it may lead to not being the most attractive alternative.

The findings at this stage also imply that funds with strong ESG performance are more likely to be sensitive to market fluctuations, which is controversial to previous studies (Mallin et al., 1995; Gregory et al., 1997; Kreander et al., 2005).

In order to further study at what stage the development of CSR initiatives are and whether the financial consequences are becoming visible, hypothesis testing will be conducted. Hypothesis testing will support to analyze at what stage the Nordic mutual funds are, whether the CSR initiatives have any impact on the financial performance or not.

5.2. Hypothesis Testing

In 5.1. the empirical statistical testing results were presented, which were not able to indicate a clear outperformer. Therefore, in order to make any accurate conclusions, a hypothesis test was conducted to prove scientifically whether the hypothesis of this study holds.

The null hypothesis of this study - CSR initiatives impact Nordic mutual funds with no significant difference, is to be tested through t-tests. If the null hypothesis would fail to reject, it would indicate that the funds with CSR initiatives perform equally well as those without such agenda. The results of implementing such initiatives are becoming visible and at that stage are even. In case the null hypothesis is rejected, it indicates that a difference between the two categories exists. In such a case, the CSR development is at a stage where the financial effects are not visible yet or on the other hand, the tipping point has been exceeded, indicating that the positive financial performance consequences are visible. One-tailed and two-tailed hypothesis tests were conducted on Jensen’s alpha, Sharpe ratio and Treynor’s ratio based on returns during January 2016-December 2020.

Results of the one-tailed t-test are presented below in table I, with a significance level (α) of 0.05.

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푇푎푏푙푒 퐼 − 푅푒푠푢푙푡푠 표푛푒 푡푎푖푙푒푑 푡 − 푡푒푠푡 One tailed t-test Jensen's alpha Sharpe Ratio Treynor's Ratio

t Stat -1,434 -1,124 1,242

P(T<=t) one-tail 0,083 0,137 0,114

t Critical one-tail 1,717 1,717 1,717

Similarly, results of the two-tailed t-test are presented below in table J, with a significance level (α) of 0.05.

푇푎푏푙푒 퐽 − 푅푒푠푢푙푡푠 푡푤표 푡푎푖푙푒푑 푡 − 푡푒푠푡 Two tailed t-test Jensen's alpha Sharpe Ratio Treynor's Ratio

t Stat -1,434 -1,124 1,242 P(T<=t) two-tail 0,166 0,273 0,227

t Critical two-tail 2,074 2,074 2,074

To reject null hypothesis 퐻0, following criteria is required to be fulfilled:

푅푒푗푒푐푡 퐻0 푤ℎ푒푛 푡 − 푠푡푎푡푖푠푡푖푐 > 푡 − 푐푟푖푡푖푐푎푙

푝 − 푣푎푙푢푒 < 푎푙푝ℎ푎

As seen above, the t-statistics for Jensen’s alpha (-1,434), Sharpe ratio (-1,124) and Treynor’s ratio (1,242) do not exceed the one-tailed t Critical value of 1,717 or two tailed t Critical value of 2,074.

Thus, 퐻0 fails to be rejected on both one and two-tailed t-tests. The significance level, 푎푙푝ℎ푎 is set as 0.05 in this study. The p-value for one tailed Jensen’s alpha (0.083) and Sharpe ratio (0.137) as well as one-tailed Treynor’s ratio (0.114) are all larger than 푎푙푝ℎ푎, implying to fail to reject. Hence, at this stage, one-tailed t-test fails to reject on both requirements.

The p values for two-tailed Jensen’s alpha (0,166), Sharpe ratio (0,273) and Treynor’s ratio (0,227) are similarly all larger than the 푎푙푝ℎ푎, which in other words does not either fulfill the predetermined criteria. Therefore, the two-tailed t-test also fails to reject the null hypothesis.

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As both one and two-tailed t-tests fail to reject the null hypothesis, the study scientifically supports that 퐻0 - CSR initiatives impact Nordic mutual funds with no significant difference holds. Hence, the currently the CSR development and its financial performance consequences are performing equally well. The results of investing in CSR initiatives and implementing those in the company day-to-day operations has been by end of 2020 enabled to perform results for performing equally well, or even possibly closing the gap between those with and without CSR initiatives. In order to further analyze the development of the CSR initiatives that has enabled to drive the development between the two categories and its main drivers, chapter 5.3. has conducted an analysis on the impact of each ESG category.

5.3. Environmental, Social, Governance

Hypothesis testing earlier in the chapter validated that the stage in which funds with CSR initiatives perform as well as those without, on the Nordic mutual fund market has been reached. The Sustainalytics ESG rating, introduced in chapter 3.2. was used in the hypothesis testing. The second part of the data analysis consisted of testing which of the ESG categories Environmental, Social and Governance is the underlying driver behind the development of CSR initiatives. The independent E, S, G ratings for each mutual fund is presented below in table K. 푇푎푏푙푒 퐾 − 퐼푛푑푒푝푒푛푑푒푛푡 퐸,푆, 퐺 푟푎푡푖푛푔푠 푓표푟 푠푒푙푒푐푡푒푑 푚푢푡푢푎푙 푓푢푛푑푠

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The Sustainalytics clustered ESG ratings were used on all 46 funds of this study, and ANOVA single factor testing conducted. In contrast to the first part of the study, the two groups are not juxtapositioned, but rather each E, S, G category consists of both group I and group II scores. By doing so, the analysis will focus on which of the three categories is the underlying driver for CSR development. In addition, sub hypotheses for solely studying the ESG ratings were formed.

Sub Hypothesis 0: E, S, G categories mutually contribute to the CSR development with no particular driver

Sub Hypothesis 1: E, S or G is the driver contributing to CSR development

If the null sub hypothesis fails to reject, it would indicate that environmental, social, or governance categories do not independently drive the development. If the null sub hypothesis is rejected, it would indicate that one of the categories is driving the development primarily forward.

푅푒푗푒푐푡 푆퐻0 푤ℎ푒푛 퐹 − 푣푎푙푢푒 > 퐹 − 푐푟푖푡푖푐푎푙

푝 − 푣푎푙푢푒 < 푎푙푝ℎ푎

The results of the ANOVA testing on the individual E,S,G categories are presented in table L.

푇푎푏푙푒 퐿 − 푅푒푠푢푙푡푠 표푓 퐹 − 푡푒푠푡푖푛푔

SUMMARY Groups Count Sum Average Variance E 46 210,210 4,570 1,892 S 46 334,910 7,281 2,454 G 46 286,370 6,225 1,745

ANOVA Source of Variation SS df MS F P-value F crit Between Groups 171,787 2,000 85,893 42,307 0,000 3,063

Within Groups 274,082 135,000 2,030

Total 445,869 137

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In order to verify whether the ANOVA testing holds, the p-value and f-values are analyzed. The p-value of the data set is 5.44E^-15, which is smaller than the p-critical of α=0,05, meaning that the relationship is significant. The second step is to analyze the f values. F value for the dataset is 42.3, which is larger than the F-critical of 4.8 and, similarly, validates that the results are significant. As both the p-values and f-values were significant, it indicates that the categories do not influence evenly but rather at varying levels. However, as both requirements are fulfilled, the null hypothesis is rejected and further studied whether the environmental, social, or governance factor is the primary driver for the development.

According to the Sustainalytics rating (2021), the factor with the lowest rating between 0-10 is considered the leading variable. Hence, as seen in table L, the lowest value is obtained by the environmental category with an average of 4.57. This indicates that the CSR initiatives in relation to their financial performance are primarily driven by environmental factors and initiatives. Following the environmental category, governance is the second category driving the ESG development, with a rating of 6.22. Finally, the last category is Social, with a rating of 7.28.

To my knowledge, previous research has not covered the impacts of each ESG category individually when regarding fund financial performance. Hence this finding is new to the field of academia.

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6. Discussion

This section will further analyze and highlight the findings discovered and introduced in the previous section. The discussion section will be linked to previous findings and a discussion on the driving factors for ESG development. The section will also consist of personal reflection on the results. Lastly, the critical reflection of this study is discussed.

6.1. Findings

The reason to conduct this empirical research was to further analyze the relationship and the level of CSR in relation to financial performance. Previous studies have focused on which alternative is the most feasible alternative regarding financial performance and most often concluded that the non-ESG focused was the one. This study had that as its baseline, a gap between the performance of the two fund types was created once CSR initiatives were made. Based on a selection of Nordic mutual funds, their ESG performance rating and financial performance during 2016-2020, the point in which funds with strong ESG rating perform equally well to those without was reached.

Such results based on the data set utilized in this study, indicates that the two fund types, despite their ESG performance, performs equally well regarding financial performance. This, however, does not mean that the funds with strong ESG performance perform better when considering the financial performance at this stage. This finding is in line with Werhane and Freeman (1999), who concluded that sustainable funds do not perform the highest potential return. Looking at the empirical results of the returns of this study, it agrees with Kreander et al. (2005) finding that funds with weak ESG performance have higher returns. However, then hypothesis testing results found significance between the two categories, which is controversial to Kreander et al.'s (2005) finding that ESG performance does not have a positive association with fund financial performance. Without the development of CSR initiatives in the operations, such advancement would not have been reached at this stage. Worth keeping in mind is that this study is conducted on selecting funds domiciled in one of the four Nordic countries and similarly investing solely in Nordic equities. The Nordic region is unique with four small countries with a very similar culture, importance of preserving nature and ways of conducting business. Previous studies with a focus on this topic with a focus on the Nordic markets are scarce, and those presented in this study are mainly from other countries and regions, i.a. The United Kingdom and United States (e.g. Kreander et al., 2005) or the Asia-Pacific region (Renneboog et al., 2008), hence the results are not directly comparable.

This study considered CSR initiatives as investments made by the firms, according to Peloza and Shang's (2011) view. Once these initiatives are adequately integrated into the company operations,

42 the companies with new initiatives operate according to the updated processes. This could lead to reaching a competitive advantage, which would also be reflected in the corporate and fund financial performance. This view on competitiveness is also shared by Campbell (2007), who suggested that moderate levels of competitiveness have the strongest driver to succeed in implementing CSR within a firm. Given that the funds with CSR initiatives are based on the time period of 2016-2020, performing equally well as those without such initiatives, possibilities for the new ways of conducting business could be the decisive factor driving further the development of the funds with CSR initiatives, to become the most attractive alternative in the future.

The findings that funds with strong ESG performance were 21 out of 23 cases more likely to be sensitive for market fluctuations is contradictory to what, e.g. Mallin et al. (1995), Gregory et al. (1997), and Kreander et al. (2005) concluded. A reason for this could be that the Nordic equity market is relatively small and limited with alternatives compared to the larger stock exchanges. Funds investing in publically exchanged companies with a strong ESG focus are limited and hence the possibility to compromise an adequately diversified portfolio (Markowitz, 1952). According to Markowitz (1952) Modern Portfolio theory, the most diversified portfolios are more likely to generate the best return.

According to the efficient market theory, a rational investor tends to select the alternative, generating the highest return. The market prices react instantly to events, so it is somewhat impossible to outperform the market (Fama, 1970). Given that the field of analyzing CSR initiatives and understanding the varying levels of ESG ratings is rather complex, whilst the CSR rating providers offer their services and analysis at a relatively high price, one can question whether the market functions efficiently. The company-specific ESG analysis provides equal information to everyone. However, one can question whether everyone has access to ESG analysis providers as Sustainalytics.

Similarly, Grossman and Stiglitz (1980) stated that prices are not equivalent to all public information. In case one would put effort to further analyze to understand the business model and details, it could enable that person to outperform the market. Such an example would also include asset managers who are looking to understand the new CSR initiatives companies have and are to implement in their operations.

The timeframe of the study focuses on the years 2016-2020, a time period which least said was remarkable years consist of growing economies in the Nordic markets, historically low-interest rates. Funds managed by portfolio managers make their investment decisions based on their modelling and discounting the future cash flows, and analyzing the potential growth based on historical values. Up until early 2020, companies seemed to be performing well, with the combination of low-interest rates,

43 including negative interest rates, which decreased the total costs. This consequence could lead to a biased view of analysis, where companies were performing better than they were. Similarly, as the selected funds of this study invest in companies, the funds could also have performed better than they did. Therefore, the risk-adjusted formulas used in this study, including CAPM, uses interest rates as part of the analysis. On the other hand, low-interest rates are also reflected in the cost of debt, which is then seen on the weighted average cost of capital (WACC).

Unexpected situations, such as the Covid-19 pandemic outbreak in March 2020, which unexpectedly had a drastic effect on the financial markets worldwide, once it was declared as a pandemic, which led to a significant market drop overnight, totalling -23.7% on the European STOXX 600 index, which includes all four Nordic markets (Statista, 2021). This naturally impacted a significant drop in the share prices and, consequently, to the funds. However, an unexpected vast recovery took place, and by the March of 2021, STOXX 600 index had obtained the same levels as before the pandemic (Reuters, 2021).

The Covid-19 reaction on the market was a reminder for everyone that the past years of economic growth may have an overnight turn and lead to unexpected consequences. This is also the main reason for selecting the period of 2016-2020 for this study. The results on CSR initiatives in relation to the fund financial performance could have led to a skewed result. To support previous research with the development of CSR initiatives and ESG performance, it was considered appropriate to include 2020 in the study.

The day Central Banks consider that sufficient economic stability has been obtained after the financial crisis and the covid-19 pandemic, interest rates increase. Increased interest rates will lead to increased debt and the weighted average cost of capital, which will impact as a domino effect first the companies with debt, followed by the funds investing in them. This reaction will mimic that returns are decreasing as an increased amount of money is allocated on costs of debt. Depending on company capital structures and financing structures of firms, the consequence of an increased interest rate could lead to companies' economic stability change significantly. Funds, including those Nordic funds selected for this study, could also be affected by increased costs and weakened performance. Given that funds charge managing fees, the open question remains whether funds, in general, could be still seen as an interesting investment alternative after increased interest rates.

The empirical results of this study indicate that a stage has been reached where funds with CSR initiatives perform equally well after their investments. For someone keen to make an investment in which both alternatives perform equally well, they have to weigh the opportunities and the level of importance of ethical questions on sustainability to themselves. For someone, the thought of buying

44 funds with strong ESG performance could create a belief that one is contributing to society. An individual may feel that their contribution towards a better tomorrow through their day-to-day choices is not powerful enough to impact. Considering the firms within a fund portfolio, and investing in such a fund, would result in a sustainable impact on a larger level. Deciding to invest in sustainable funds also enables someone with an interest in the area with little knowledge to allow an investment manager with overall industry understanding to contribute to the society whilst generating revenue on the invested money. At the end of the day, the basic individual need and interest are to make a profit.

On the other hand, investors buying sustainable funds are buying trust from the managers, companies and society. Without an unsustainable lifestyle, investing in sustainable funds could be a way for greenwashing on an individual level. As noted earlier, this study does not take into consideration annual management fees of funds. It is important to understand that some funds may compensate their high knowledge and competence in sustainability analysis with increased management fees. Higher management fees eat a part of the profit generated by the fund, and as years pass by, it could be a significant chunk of the return that the fund managers have obtained. The management fees or the varying levels of sustainability focus should not frighten a novice investor. There is a wide range of funds available for investors to select, of which each fund has its focus and ambitions, and there is something suitable for everyone.

The conversation around sustainable investing through funds is only the beginning; it remains a current topic, with increasing focus after the first waves of the covid-19 pandemic. The pandemic has enabled everyone to reflect on our previous routines, contributions and ways of working at all levels and matters. As the general mindset is changing, people start thinking in new ways and realize that they are not to be any longer irrational investor by investing in sustainable funds. It may challenge existing theories, such as the efficient market theory, where an investor always aims to select the alternative with the highest return (Fama, 1970).

Based on the findings of this study, that the change in CSR initiatives is starting to reflect in the financial performance, a suggestion is that the definition of return is also to be updated in the future. From previously focusing on the monetary aspect, shifting towards considering highest return as a sum from multiple aspects, e.g. change in monetary returns + change in sustainability-related matters.

Going forward, the social pressure on implementing sustainability focus could increase to such an extent that all portfolio managers would solely invest in firms with a high level of CSR initiatives. As new sustainable innovations are being created, external pressure from shareholders, governments and supranational are increasing the expectation towards such movements. If such actions would not

45 be made, those investing in the companies through funds could decide to transfer their money to other funds focusing on CSR initiatives. This would lead to eventually funds not considering the sustainability aspect important, to be left without capital and, in the worst case, required to close the fund if no drastic change is to be made. Significantly, the people raised in the Nordic countries understand the importance of nature and its power, whilst how crucial it is to preserve it.

Given that the topic of this study CSR initiatives and its correlation to fund financial performance on the Nordic market is a rather new field of study, few academic papers have been published. In order to support the existing theoretical framework and academic papers, the following part of the section focuses on discussing the topic from a practical perspective supported by findings of various financial organizations. As the field and offerings are increasing, financial and consultancy organizations are aiming to contribute to the change by striving their customers to select more responsible alternatives. Thus, they are constantly providing updated findings, in order to increase understanding and interest of organizations and individuals, which also are considered relevant for this study. To draw conclusions based on the findings of this study, together with existing theoretical and practical findings, it is supported to increase relevance of the results.

The data analysis conducted on the ESG ratings indicated that environmental rating is the most prominent one driving the CSR initiatives, followed by governance and social. The Nordic countries and market are rather developed and considered the best in class when compared to other countries and regions (ESG Investing, 2021). According to Sustainalytics (2021), working on optimizing ESG risks contributes to a sustainable society and economy, reflected in the company enterprise value. Based on a study conducted by Nordea (2020), the companies that introduce corporate social responsibility initiatives in their business models are mainly larger firms. This could be because larger firms have the resources to form the new market where smaller firms can, later on, join to the extent that suits their resources.

People of the Nordic region are grown-up whilst building a strong relationship to the surrounding nature, which Alfred Berg (2019) points out to be the underlying factor for environmental and sustainable development. The importance of nature for Nordic people and the importance of preserving it for future generations could explain why the results of this study indicated that environmental development is the driver of CSR initiatives and development. Similarly, the Nordic countries have a high level and potential for innovation (Alfred Berg, 2019), which is a significant driver for creating new revolutionizing solutions and products that are sustainable or environmentally friendly and contribute to a sustainable tomorrow.

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The Nordic countries have free of charge, high-quality education and social security to their inhabitants (ESG Investing, 2021), which lies an outstanding prerequisite for good morale and further on in life. Given that the governance and social categories performed very close to one another in this study, it could be impacted by the Nordic human capital as it impacts both categories (Sustainalytics, 2021). Equal education, opportunities and social security are a basis for life in the Nordic countries and a most likely factor for driving better human capital and corporate decision-making. Alfred Berg (2019) points out that communication within the Nordic region is clear. Hence it is communicated that sustainability-related factors are to be considered seriously. The Nordic region is unique with its strong cooperation within the four countries. One of the mutual areas of collaboration has been to together contribute to sustainable development as an individual country and together as a region since the UN Stockholm conference in 1972 (ESG Investing, 2021).

According to McKinsey & Co. study (2021), firms that have implemented corporate social responsibility initiatives tend to have employees that are content with their employer, as, in addition to their commitment at work, the company in return aims to contribute to a better future than solely focusing on profit. McKinsey & Co. report (2021) adds that CSR's importance impacts employee productivity. Increased productivity can enable future growth, which can lead to a positive vicious cycle when employees feel that they can contribute and be passionate and feel that they can stand behind the firm's values. This can then lead to better social performance and social contributions and can all the time continue to develop similarly.

Despite financial and consultancy organizations have provided interesting insights based on relevant data to support the discussion of this study, it is acknowledged that the points mainly presented by the organizations have a positive perspective. By presenting interesting findings with a positive perspective, financial and consultancy organizations may succeed to tune the counterparty’s views on the topic to similarly be positive and understand the importance of CSR initiatives. It can be criticized whether it is acceptable that those organizations solely focus on the benefits of supporting CSR initiatives, however on the other side of the spectrum, for the past decades e.g. global warming has been a topic worrying people and it is understood that it cannot be denied or any action aiming to prevent such should not be considered negative.

This study, a combination of the empirical results together with the discussion above, does not state that an ESG focus on its own should be the reason for financial success. Rather a sustainability focus at this stage enables a firm to consider new innovative solutions, develop existing operations and routines. In case firms succeed in launching new solutions and routines it proves that the firm can

47 adapt, which should as a consequence be reflected on the financial performance as positive development.

6.2. Critical Reflection

This study intended to determine whether ESG profile and financial performance have a correlation, i.e. which alternative generates the highest return. In order to make conclusions statistically, hypothesis testing was conducted. As this study focused on normally distributed returns, another viable alternative to test normal distribution could have been the Shapiro-Wilk test. However, that test was excluded from the study due to the limitation of resources.

As seen in table C in chapter 5.1., the results between the two categories had solely minor differences at a significance rate of 0.05. Therefore, tracking error could have been a suitable addition to this study, as it would have described how the selected funds of this study against the OMX Nordic 40 index benchmark develop throughout 2016-2020.

The study is based on a set of funds on which the portfolio managers have made their investment decisions. Therefore, this study did not consider the composition of equities on companies and their industries of the mutual funds. Given that industries vary with their CSR development and their opportunities to do so, this may affect the study and its results.

The dataset to conduct this empirical study is based on all funds that fulfilled the selections criteria for this study, totalling 46 funds and 23 pairs. Compared to previous studies, the selected sample size could be argued to be somewhat limited, given that some previous studies had a significantly larger selection of funds, such as Friede, Busch and Bassen (2015) study consisted of 2200 funds. The Nordic fund market is naturally smaller than, e.g. entire European market. On the other hand, Kreander, Gray, Power and Sinclair (2005) selected 60 funds from four different markets. Given that the Nordic countries are relatively small markets, using a dataset consisting of 46 funds that fulfil the entire criteria may be considered eligible for this study. As the sustainability theme continues to rise, it will continue to be reflected in the alternatives available. Furthermore, this study required funds to be established at the latest on January 1st, 2016, meaning that these funds have been the trendsetters of this new important segment. On the flip side, it can be assumed that smaller samples should show more clearly if any significant differences occur.

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7. Conclusion and Future Research

The final section will summarize the findings of this study on the development of CSR initiatives in relation to the fund financial performance and discuss the limitations of this research. Finally, suggestions for future research are presented.

7.1. Conclusions The study aimed to verify whether Corporate Social Responsibility initiatives and their consequences influence financial performance. With an expectation of a gap being created between CSR initiatives and fund financial performance, the study aimed to answer the research question: How are Corporate Social Responsibility initiatives reflected on fund financial performance in the Nordic mutual fund market?

Based on a selection of Nordic mutual funds, with strong and weak ESG performances, their financial data was collected from January 2016 to December 2020 and analyzed. Based on annual and risk- adjusted returns, with matched-pair methodology, the category consisting of strong ESG rated funds was beneficial in 9 out of 23 cases, whilst the category consisting of funds with weak ESG performance was more beneficial in 10 out of 23 cases. However, these had little to no significance.

Followed by hypothesis testing, the null hypothesis - CSR initiatives impact Nordic mutual funds with no significant difference failed to reject. This implies that the stage where funds with CSR initiatives perform equally well regarding financial performance compared to those with CSR initiatives. However, those with CSR initiatives have updated sustainable operations, which could lead to continuing to generate positive financial performance going forward, making it an attractive and better-performing alternative.

This study also further explored which of the ESG categories, environmental, social, and governance, is the underlying driver for the development within CSR initiatives. Based on the selected dataset of 46 Nordic mutual funds, this study concludes that the main driver influencing the financial performance through CSR initiatives are environmental initiatives. 7.2. Limitations

To conduct this study and answer the determined research question, a selection of criteria was set to frame the study. Hence, limitations were made. The analysis is based on 2016-2020, which limited the number of funds to choose from. Numerous funds were excluded, as their criterion did not fulfil the requirements.

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Sustainalytics sustainability rating was to determine whether selected funds had a high or low ESG profile. Naturally, there are numerous external sustainability-rating providers, which may have varying assessments on sustainability factors. However, due to the lack of resources, this study has solely used one sustainability-rating provider. Hence results may be biased by Sustainalytics’ view of judgement.

Funds typically have annual management fees, and transaction costs may occur when buying or selling one share. These factors, alongside dividend payout, are not included in this study. Worth mentioning that annual management fees affect the fund's costs and are reflected in the total return. By including management fees in this study could have impacted the conclusion of this study. Dividend payouts were simply excluded from this study to maintain consistency. Were dividend payouts to be considered, unreliability would have increased as not all funds pay dividend payouts in general. Transactions costs were not included as the motive was to analyze the development of funds throughout the years, instead investing and divesting and the costs related to that.

Finally, whilst extracting data from the Refinitiv database, this study is not to exclude the risk of errors in relation to data collection, which could have led to misleading results.

7.3. Future Research

This study concluded that the selection of Nordic mutual funds with CSR initiatives had reached a point in which they perform equally well as those without CSR initiatives. Four suggestions to consider for future research:

Given that the two categories performed equally well, a proposal for further research would be to deep dive in other factors impacting the result, such as macroeconomic factors and market behaviour. To further analyze, whether a tipping point at this stage, based on the 2016-2020 financial performance, has actually been obtained.

After a matter of years, conduct the same study again with the Nordic mutual funds to see whether the funds with CSR initiatives have shifted to performing better in comparison to those without CSR initiatives.

Another suggestion for further research would be to expand from solely analyzing Nordic funds to expanding to European funds too and see in what stage are they with their CSR initiatives in relation to the fund financial performance and whether the tipping point has been reached or not.

Furthermore, a suggestion of combining quantitative and qualitative methods, where financial development of funds investing in companies with CSR initiatives are analyzed, whilst also interviewing portfolio managers who, based on their own analysis, make investment decisions. The

50 hybrid methodology could contribute to understanding other underlying factors than solely looking at the Sustainalytics or equivalent rating.

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