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Integrating ESG Ratings into Value, Growth, and Momentum Portfolios

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Summary

This study examines whether investors can incorporate environmental, social, and governance information into value, growth, and momentum equity strategies without materially harming financial results. It builds multidimensional style scores, uses past returns for momentum, and adjusts ESG ratings for company size and industry, with additional regional adjustment for European governance scores. Portfolios are formed by combining rankings and rebalanced annually using lagged data to reduce look-ahead risk. The analysis covers US and European stocks from 2002 through 2015, with portfolio returns evaluated into 2016.

The reported evidence suggests ESG integration can improve portfolio sustainability scores while generally reducing risk; risk-adjusted return effects vary by strategy and region. The study also finds that ESG components do not behave uniformly: governance may be more relevant to value portfolios, while environmental and social measures can matter more to growth portfolios. Results are historical and depend on the ESG ratings, sample, portfolio design, and adjustment choices. The authors also identify industry-specific materiality as useful and note that materiality may change over time, which their fixed relationships do not capture.

Key ideas

  • The study combines style or momentum rankings with ESG rankings to form equity portfolios.
  • It adjusts ESG scores for company size and industry to reduce the influence of those characteristics.
  • The historical US and European results suggest ESG integration can raise sustainability scores without a clear general performance penalty.
  • Risk reduction and risk-adjusted return effects vary by strategy and region.
  • Environmental, social, and governance components can have different relationships with value and growth portfolios.
  • Industry-specific ESG materiality may improve integration, but its changing nature remains a limitation.

Tags

EquitiesFactor investingMomentumPortfolio constructionRisk management

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