Combining ESG Scores and Momentum with Knapsack Optimization

Summary

This document describes a monthly, long-only strategy that combines stock momentum with environmental, social, and governance scores. It frames portfolio selection as a knapsack problem: one characteristic acts as the portfolio constraint and the other as the value to maximize. The highlighted version favors stocks with both high ESG scores and strong momentum, using ranked momentum and reversed ESG scores to define the optimization, with a weight cap based on the highest ESG stocks. A simulated annealing method finds the stock combination, and the selected portfolio is equally weighted.

The article reports that these optimized portfolios slightly reduce profits relative to pure momentum while improving risk-adjusted performance; the high-ESG portfolio that maximizes momentum is described as the most consistent. It attributes the risk improvement to lower volatility and drawdowns among higher-ESG stocks, citing regression analysis. The account is based on a source paper and a large-US-stock universe with a specified ESG data provider. It offers no detailed performance series or implementation costs, and says the approach can reduce drawdowns but is not a complete bear-market hedge.

Key ideas

• The strategy uses a knapsack formulation to combine ESG scores and price momentum in stock selection.
• The highlighted portfolio maximizes ranked momentum subject to a constraint favoring high ESG scores.
• A simulated annealing approach is used to solve the stock selection problem.
• The portfolio is long-only, equally weighted, and rebalanced monthly.
• The article attributes improved risk characteristics to ESG scores and reports stronger risk-adjusted results than classical momentum.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.