ESG outperformance requires a human touch

Academic research suggests responsible-investing factors act as a booster, not a generator, of alpha

ESG outperformance requires a human touch

According to devotees of ESG integration, considering ESG factors in investment decisions leads to outperformance. But new research suggests that they may only be half-right about that.

In a newly published paper, Kyle Welch of George Washington University and Aaron Yoon of Northwestern University concluded that ESG factors don’t lead to outperformance unless they’re combined with high employee satisfaction.

In a phone interview with Institutional Investor, Yoon said his research has not produced any evidence that ESG measures improve returns on their own. However, he’s found that high employee satisfaction alone improves annual shareholder returns by roughly 3%.

“We know that employee satisfaction is related to firm value and enhancing stock returns,” Yoon told the publication. “Before doing this work, we didn’t know what the role of ESG is in shaping that relationship.”

In the new study, Yoon and Welch built equal- and value-weighted portfolios of companies based on ESG ratings data from MSCI and employee ratings information from Glassdoor, which they said is more protected against fraudulent and self-promoting reviews. Using a “double sort” function, they were able to create portfolios based on both ESG scores and employee satisfaction ratings.

Compared to portfolios of companies with low ESG ratings, those that score high on both ESG and employee satisfaction outperform by 5.61% on an equal-weighted basis, and 5.83% on a value-weighted basis.

In addition, portfolios made up of companies with both high ESG ratings and high employee satisfaction outperformed those with low ESG but high employee satisfaction by 2.75% on an equal-weighted basis. Portfolios of high scorers in both ESG and satisfaction also outperformed those with high ESG performance and low employee satisfaction by 5.64%.

“For ESG to work, employee satisfaction seems like a necessary condition,” Yoon said.


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