MSCI Research Shows Diversified ESG Investing Delivers High Returns
(3BL Media/Justmeans) – A growing number of institutional investors now seek to avoid financial risks associated with environmental, social, and governance (ESG) factors. Their goal is to achieve portfolio diversification to mitigate risk as well as engage with corporate managements as active investors or owners.
MSCI has published a piece of research looking at how investors can maintain a diversified portfolio while taking into consideration ESG factors. Using the MSCI ACWI ESG Universal Index as an illustration, MSCI found that it is possible to strike a balance between maintaining a large, diversified roster of companies with strong ESG characteristics while excluding only those with high headline risk.
The MSCI ACWI ESG Universal Index aims to tilt toward stocks with strong ESG characteristics. This index is also designed to exclude only a small group of highly objectionable stocks. This approach allows for maintaining diversification within the index while enabling institutional investors to engage with poor ESG performers.
The MSCI ACWI ESG Universal Index outperformed its parent index by 39 basis points (bps) annually over the five years ended June 2017. The performance can be broken into two parts:
1. Allocation effect: Measures the contribution at the group level from excluding highly objectionable (“red-flag") stocks, and increasing the weights of remaining stocks.
2. Selection effect: Measures the effect of overweighting stocks with strong ESG scores or underweighting stocks with weak ESG scores.
The allocation effect added 36 bps on an annualized basis, and the selection effect 38 bps. Notably, 100 percent of the allocation effect came from excluding the small group of red-flag stocks. This result shows that red-flag stocks underperformed and that the remaining stocks as a group performed in line with the total ACWI universe.
On the other hand, the selection effect was attributable almost entirely to reweighting the “other" stocks based on their ESG scores or changes in their ESG scores.