Investment Strategies

Indexing Giant Fires Cautionary Note At ESG Cheerleaders

Tom Burroughes Group Editor May 13, 2019


The indexing group says there isn't yet solid evidence that ESG approaches to investment are distinct and new drivers of positive returns - although they can make portfolios less volatile.

Choosing to invest in companies over how they treat the environment, society and governance (ESG) might smooth portfolio returns, but the jury is out on whether these factors make clients better off in the long term, according to Morgan Stanley Capital International, the indexing organization more usually known as MSCI.

MSCI’s 14-page report, Weighing The Evidence: ESG And Equity Returns, released last month, has some good news for ESG evangelists at a time when this approach to investing has gone from being a fringe enthusiasm to a ubiquitous theme. But the report also throws cold water over the idea that ESG can be conclusively proven as a driver of positive returns for the long term.

The organization’s comments are significant because many fund managers use its indices to compare their funds against others. When a fund is benchmarked against an MSCI index it is often a crucial step in drawing in money. When MSCI recently moved to allow mainland China equities to be held in its flagship Emerging Markets index, for example, this was seen as a big boost for the Chinese market.  

As this publication has already noted, ESG investment and ideas of sustainability and impact are constant talking points in wealth management. Advocates also contend that ESG does not mean that investors need to sacrifice returns to “do good”. Shunning fossil fuels, investing in renewables, reducing child poverty and exposing crooked firms is good, hard-nosed business, ESG advocates say.

The MSCI report refers to more than 2,000 research articles from financial services professionals and academics and, referring to one such paper by G Friede, T Busch and A Bassen (2015), it noted that few reports prove that ESG impedes investment. However, there is also little consensus that ESG boosts risk-adjusted returns.

“Consolidating findings from various academic and industry researchers, we observe there is significant evidence that the application of MSCI ESG ratings may have helped reduce systemic and stock-specific tail risks in investment portfolios,” the MSCI report said. 

“The More difficult question is whether ESG ratings, in general, have been linked to a risk premium like those of traditional financial factors such as quality, value or momentum. ESG ratings have a much shorter history than traditional factors, meaning the statistical confidence level is fairly low compared to that of common factors,” it continued. 

The report concluded that there is some evidence that changes in ESG characteristics of firms can drive portfolio performance, but more time is needed to be sure about this. The organization argues that too much data regarding ESG does not illuminate debates on performance.

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