Is ESG a systematic risk factor for US equity mutual funds?

On the outperformance of responsible investing (RI) which incorporates environmental, social, and governance (ESG) into investment decisions, the empirical evidence to date is inconsistent from the viewpoint of ex-post performance. This paper tries to explain the nature of return differential between RI and conventional investing within the well-known risk-return paradigm. From the viewpoint of ex-ante equity risk premium, the five factor model of Fama and French [2015. "A Five-factor Asset Pricing Model." Journal of Financial Economics 116: 1-22] combined with a ESG-related factor applies to returns on 1,425 US open-end equity funds for the period from April 2009 to December 2016. Empirical findings include that US open-end equity funds tend to hedge the ESG-related systematic risk, and that the exposure to ESG-related systematic risk is significantly priced in the market. The result implies that RI provides the downside protection against ESG-related systematic risk which is not reduced even through extensive diversification.