24 Jun 2019

The impact of ESG momentum on valuations


Mobilising the world’s wealth for positive social and environmental goals is an increasingly popular idea, from boardroom, to coffee shop, to newspaper column.

Sustainable investing has gained attention since the global financial crisis of 2008-2009 demonstrated to millions of people the power of capital markets. Nowadays, it’s a broad church, attracting institutions analysing new risk factors – such as corporate governance and board diversity – as well as individuals simply looking to make a positive change with their money. 

For all its potential benefits, one question still often comes up when sustainable investing is discussed, particularly among professionals charged with delivering optimal risk-adjusted return:

“Does sustainable investing help or hurt performance?”

New research from indexing giant MSCI looked into this question and came up with some interesting results.

The ESG question: correlation or causation?

In its research paper How markets price ESG,1 MSCI tried to establish whether changes in a company’s environmental, social and governance (ESG) profile drive changes in its share price.

An ESG profile includes factors such as a company’s corporate governance, ownership structure, tax transparency, carbon footprint and gender diversity – “all [the] characteristics that investors may look at when doing a financial analysis of a company”.

Why ask this question? MSCI researchers found over 2,000 studies on ESG, and a lively debate in academic and professional circles about its potential financial benefits. But they did not find any consensus on the answer.

Therefore, they decided to examine the underlying economic questions. If they could not find a link, any correlation between ESG scores and share-price movement might just be a coincidence.

The researchers recognised immediately that many factors influence share-price movement. Companies with high ESG scores would often have strong balance sheets, loyal employees and less exposure to risk. It could be these factors, not ESG scores, that accounted for any outperformance.

So, the researchers built a model, looking at year-on-year changes in a company’s ESG profile (which they called ‘ESG momentum’), which also controlled for other factors that might affect the results.

Read the full results or check out the first conclusion below.

ESG momentum seemed to predict share-price growth

One of MSCI’s conclusions from this research is seen in the chart below. It shows the historic performance of top-quintile companies as measured by ESG momentum relative to bottom-quintile companies, across developed and emerging markets.

What we can see is that companies with positive ESG momentum outperformed companies with negative ESG momentum, going back nearly a decade.

Performance of top versus bottom ESG momentum quintile portfolios2

Performance of top versus bottom ESG momentum quintile portfolios

1Study may be found online at: https://www.msci.com/www/research-paper/how-markets-price-esg-have/01159646451.

2Source: MSCI, “How Markets Price ESG”, Nov 2018, Giese, Nagy. Data covers two hypothetical long-short indexed portfolios. Developed market performance represents going long for the equal-weighted upper quintile of MSCI World Index, while the bottom equal-weighted quintile goes short. DM data is from June 2009 to February 2018. The emerging-market hypothetical portfolio applies the same methodology to the MSCI Emerging Markets Index, from June 2013 to February 2018, as older data was unavailable. Past results are not a reliable indicator of future results.

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