Investing in companies that are improving their environmental, social, and governance (ESG) activities could improve the likelihood of outperformance, research from MSCI has shown.
Using its own ESG ratings for equities, the index provider applied an “ESG momentum” tilt to stocks in the MSCI World index, which involved overweighting companies that had improved their score in the preceding 12 months.
Over a period of seven years, the ESG momentum model portfolio outperformed the MSCI World index by 2.2 percentage points a year, authors Zoltán Nagy, Altaf Kassam, and Linda-Eling Lee reported.
The authors also tested an ESG screen for the MSCI World index with companies with the highest current scores given more weight. This method was also shown to add alpha—1.06% a year above the index.
“These results… show that it is possible to employ systematic strategies that both improve ESG ratings and outperform a global benchmark,” the authors wrote.
MSCI’s research also showed that, towards the end of the seven-year period tested, mid-cap stocks began to have more of an influence on outperformance. Nagy, Kassam, and Lee said this showed that smaller companies were taking ESG criteria more seriously as demand from investors increased.
“These results show that a strategic tilt towards higher ESG-related assets led to a persistent bias in favor of lower idiosyncratic volatility and mid-cap stocks and to a tilt away from value stocks,” the authors wrote.
The full report is available from MSCI’s website.
Related: When ESG Means Alpha