By Prof. Kristjan Jespersen and Alexzander Ellekilde
In recent years, sustainable investing has shifted from a niche interest to mainstream practice, driven by climate-conscious investors and institutions eager to align their financial goals with ethical values. ESG (Environmental, Social, and Governance) exchange-traded funds (ETFs) have emerged as a favored solution promising both sustainability and market-level returns. Yet are ESG ETFs truly distinct in their impact and performance?
And still further other questions linger behind the ESG label on these investment vehicles: Are investors really doing good without giving up returns? And perhaps even more essential, are these ESG ETFs structurally different from their conventional counterparts? What exactly are investors getting when investing in these assets?
Our recent analysis addresses this very question by examining 28 passively managed European ESG ETFs over an 11-year period, comparing their financial performance and sector allocations against the MSCI All Country World Index (MSCI ACWI). Our findings indicate that ESG ETFs slightly underperformed the MSCI ACWI in terms of returns, but the performance gap was minimal, suggesting investors aren’t significantly sacrificing financial gains for ethical alignment.
The Main Findings
1. Modest Underperformance
The ESG ETF portfolio underperformed the MSCI ACWI slightly in terms of both raw and risk-adjusted returns. However, the difference was minor and should not deter the average investor from seeking exposure to these.
2. Lower Volatility
ESG ETFs were generally less volatile than the benchmark. This supports the idea that sustainable investing may offer a smoother ride compared to conventional investments.
3. No Alpha
Across all factor model specifications, there was no statistically significant alpha. In plain terms, the ESG ETFs did not beat the market and performed in accordance with expectations.
4. High Correlation
Return correlation between ESG ETFs and the benchmark was consistently high. The sector allocations of the ESG portfolio closely mirrored that of the MSCI ACWI, which indicates that the ESG ETFs are not heavily skewed by ESG screening. Thus, no sector allocation bias was detected.
Implications and Insights
So, what insight should investors take away from this? Most importantly: sustainable investing through ESG ETFs does not necessitate a financial sacrifice. These products are financially viable and relatively low risk. They are not delivering outperformance, but they are not lacking significantly behind either – a reassuring message for those looking to align investments with ethical values.
However, perhaps the most important insight was the question that was raised by the close alignment between ESG ETFs and the benchmark: how much substance is behind the ESG label? While the ETFs used in this study carry an ESG label, the analysis showed that in many instances their actual composition and return behavior nearly mirror the conventional index. If they behave just like conventional funds, is the ESG label doing anything other than making investors feel better while paying a premium and checking an ESG box to meet fund labeling requirements?
The strong return correlation and the lack of a major sector allocation deviation suggests that many ESG ETFs are, for all practical purposes, simply traditional passive market funds. This may reflect a desire by fund providers to minimize tracking error and to protect profitability once the fund reaches a certain size, yet these actions run the risk of diluting the ESG narrative.
While these products offer accessible exposure to sustainable investing, those looking for deep ESG integration might be disappointed. The majority of European ESG ETFs that were investigated seem built more for appeal than impact.
Looking Ahead
Figure 1 – Key areas of concern for the future of ESG ETFs.
The study confirms that ESG ETFs can deliver competitive financial performance without requiring investors to sacrifice returns. This is a promising signal for the viability of sustainable investing, yet it also reveals something more complex.
If ESG ETFs behave almost identically to a conventional index that applies no ESG screenings, what differentiates them beyond the label? As ESG ETFs grow in size, they appear to become increasingly more benchmark aligned. This raises an important and underexplored question: Do ESG ETFs start out more distinct and gradually lose that distinction as they scale?
If true, it points to a tension in passive sustainable investing. A tension between ESG integrity and the incentive to attract capital and minimize tracking error that may slowly erode the ESG characteristics that justified the products in the first place. In that case, ESG becomes more of a compliance badge or marketing feature than a genuinely meaningful investment filter.
Understanding this dynamic and the potential institutional pressures behind it is essential to assessing the real impact of ESG ETFs, especially from a sustainability point of view. It could inform future regulation, ESG rating methodological standards, and how investors evaluate potential investment products.
In conclusion, ESG ETFs offer investors a practical route to responsible investing without meaningful financial sacrifice. Yet, ensuring these ETFs deliver substantive ESG impacts –beyond superficial labeling – requires ongoing vigilance, clearer standards, and active stakeholder engagement. Ultimately, their true value will be determined not only by market performance but by measurable contributions to sustainability goals.
About the Authors
Prof. Kristjan Jespersen is an Associate Professor in Sustainable Innovation and Entrepreneurship at the Copenhagen Business School (CBS). Kristjan is an Associate Professor at the Copenhagen Business School (CBS). As a primary area of focus, he studies the growing development and management of Ecosystem Services in developing countries. Within the field, Kristjan focuses his attention on the institutional legitimacy of such initiatives and the overall compensation tools used to ensure compliance. He has a background in International Relations and Economics.
Alexzander Ellekilde recently completed an MSc in Applied Economics and Finance at Copenhagen Business School. His academic interest spans investment analysis, financial markets, and sustainable finance topics. This August, he will be joining Shark Solutions as a Business Analyst, continuing to explore the intersection of business strategy and financial performance in a sustainability-focused business environment.