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Jun 25, 2015

Companies with recent ESG rating gains may outperform benchmarks

Stocks with fast ESG improvement outperform benchmark by 2.2 percent a year, MSCI report shows

Investing in companies that are gaining momentum in a drive to improve their record in ESG factors may be key to outperforming the market, according to research by index provider MSCI.

For the research, MSCI adopted an ‘ESG momentum’ strategy by overweighting stocks that had improved their ESG ratings (according to MSCI’s own calculations) in the preceding 12 months. The firm also adopted an ‘ESG tilt’ strategy that overweights companies that have already established high ESG ratings.

The performance obtained from the two strategies was then compared with the MSCI World Index. The ESG momentum strategy offered an annualized return of 2.2 percent over the benchmark while the ESG tilt strategy had an annualized return of 1.1 percent.

‘We find both of these strategies outperformed the global benchmark over the last eight years, while also improving the ESG profile of the portfolios,’ the report authors write. ‘Furthermore, a significant part of their outperformance was not explained by style factors and thus may have been attributable to ESG factors. The momentum strategy performed consistently well through the sample period, while the tilt strategy saw roughly two thirds of its outperformance come in the last two years of the eight-year sample period.’

The ESG momentum strategy, which the researchers say is more ‘short term in nature’, was designed on the assumption that future performance of a stock can be linked to the change in ESG ratings. Under the theory, the company’s rating increase shows it is now better able to deal with ESG risks and the stock price may not have been adjusted accordingly.

The ESG tilt strategy assumes future performance can be directly linked to a company’s current ESG ratings. Under this theory, companies with high ESG ratings are better able to avoid ESG-related problems such as labor disputes and environmental fines and can more readily adopt related opportunities such as clean technologies.