Stockholm (NordSIP) – According to a new research paper by Scientific Beta, adjusting for ESG strategies’ risk shrinks their excess risk-adjusted return (alpha) to zero. Indeed, the research finds that sector biases and exposures to equity style factors are able to capture the returns of ESG strategies. The analysis also suggests that returns are inflated when investor attention to ESG rises.
The study is authored by Giovanni Bruno, Mikheil Esakia and Felix Goltz and examines equity strategies that exploit information in ESG ratings, and contradicts several papers that suggest that ESG strategies are able to outperform the market.
The study uses ESG ratings data from MSCI from January 2007 to June 2020 to design strategies that focus on all as well as on each of the ESG components. To measure the level of returns of ESG strategies that does not come from exposure to standard factors, the authors use a standard time series multi factor regression model with seven factors: the market, value, size, momentum, low volatility, high profitability , and low investment factors. The intercept estimated by the statistical analysis corresponds to the ability of ESG strategies to enable investors to improve their risk-adjusted returns.
Their conclusion is that the main driver of positive performance is the quality factor, because ESG strategies are biased towards high profitability and low investment the authors argue. “We conclude that claims of positive alpha in popular industry publications are not valid because the analysis underlying these claims is flawed. Omitting necessary risk adjustments and selecting a recent period with upward attention shifts enables the documenting of outperformance where in reality there is none,” the authors argue in the paper.
“Claims of positive alpha in popular industry publications are not valid because the analysis underlying these claims is flawed. Omitting necessary risk adjustments and selecting a recent period with upward attention shifts enables outperformance to be documented where in reality there is none,” says Dr Noël Amenc, CEO of Scientific Beta. “Investors should ask how ESG strategies can help them to achieve objectives other than alpha, such as aligning investments with their values and norms, making a positive social impact, and reducing climate or litigation risk. These results also question the way in which ESG providers, and the investment industry more generally, promote ESG. By relying on biased research results, which as such have no value, the promoters of alpha in ESG investing are taking the great risk of disappointing investors on this supposed outperformance and diverting them in time from an investment theme that is important for sustainable economic development,” Amenc adds.
Established by the EDHEC-Risk Institute, Scientific Beta aims to be the first provider of a smart factor and ESG/climate index platform to help investors understand and invest in advanced factor and ESG/climate equity strategies.