This research paper analyses market performance based on environmental, social, and governance (ESG) factors. The report explores the effectiveness of two specific strategies, the ESG Tilt and ESG Momentum, in enhancing ESG ratings while outperforming the global benchmark index between February 2007 and March 2015.

The research aims to analyse whether the inclusion of ESG factors in investment processes leads to weaker, risk-adjusted returns by using MSCI’s ESG data. The first strategy tested in the report, the ESG Tilt, involves overweighting higher-rated ESG stocks in a portfolio using a global setting. The second strategy, the ESG Momentum, focuses on overweighing companies that improved their ESG rating over the last year, as opposed to those with higher ESG ratings.

According to the results of the study, both the ESG Tilt and ESG Momentum strategies outperformed the global benchmark between February 2007 and March 2015 while improving the ESG profile of portfolios. Additionally, the report suggests that some of the outperformance could be attributed to ESG factors rather than style factors.

The results of the ESG Tilt strategy demonstrate that the model portfolio earned a significant part of its outperformance from stable and persistent active factor exposures. However, the portfolio also experienced significant risk arising from specific sources, with the correlation between the portfolio’s active return and the stock-specific contribution being 0.93. The ESG Momentum strategy had a stronger focus on short-term factors, as the market is expected to react to changes in rating more quickly.

The main takeaways for investors are that it is possible to create systematic strategies that both improve ESG ratings and outperform global benchmarks while including a systematic approach to ESG in an investment process. Additionally, the study recommends investors consider an ESG Tilt or ESG Momentum strategy as a means to improve the ESG profile of their portfolio on a systematic basis while minimising some active risk.

The report indicates that incorporating ESG factors into investment processes does not always lead to weaker returns, and such factors can be an essential driver of a portfolio’s return as evidenced by strong outperformance of ESG-oriented portfolios relative to the global benchmark.