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Toward ESG Alpha: Analyzing ESG Exposures through a Factor Lens
Financial Analysts Journal
Authored by: Ananth Madhavan, Aleksander Sobczyk, Andrew Ang
Summary notes courtesy of Hillsdale:
The authours used Morningstar mutual fund data (for 1300 actively managed funds) and MSCI ESG scores for 5 years ending in 2019, together with factor loadings from MSCI factor indexes (value, momentum, quality, low vol, large cap, small cap). The authours found that funds with the highest ESG scores also had higher momentum and quality exposures. Funds with higher environmental scores had higher momentum exposures in particular. Their Fama-French decomposition showed funds with higher ESG scores had lower market beta, lower vol, larger size and negative exposure to value.
The authors do note several caveats with their analysis: they used only one source for ESG scores (MSCI) and their analysis was done over a short period (5 years). They also did not consider sector exposures.
The most important conclusion comes from comparing fund active returns vs ESG scores. The authours found that ESG metrics by themselves do not provide excess returns but appear to do so from the momentum, quality etc. factors that come along with them.
“...the link between high ESG ratings and high returns is only through the ESG components that are correlated with factor components. Other ESG components unrelated to factors carry insignificant excess return premiums that are economically small.”