The Alpha of Outcasts: Financial Insights from Excluded Companies

Abstract

Research from Hoepner and Schopohl (2018) finds that excluding companies from investment portfolios does not significantly impact the performance of major funds, such as the Norwegian Government Pension Fund and the Swedish AP fund. Our study takes a complementary approach, building upon their research. In this thesis, we focus on the exclusion of firms’ financial impact on the excluded firms themselves. We investigate whether companies excluded from portfolios due to Environmental, Social, and Governance (ESG) concerns offer abnormal returns. The study analyzes 382 excluded companies from developed markets between 2016 and 2023. We construct portfolios to compare their performance against a best-in-class ESG benchmark. The results indicate that excluded companies consistently outperform the comparable ESG portfolio, exhibiting higher cumulative and risk adjusted returns with lower downside risk. Additionally, we investigate the most and least excluded companies in our excluded companies portfolios. The results reveal that the least frequently excluded companies yield significantly higher returns. Finally, as we study the impact of time, we find that the returns of excluded companies do not jointly vary significantly across sub-periods. However, we apply the perspective of economic significance and argue that the portfolios experience variations in returns. We discuss how relevant macroeconomic events might influence these variations.