White paper from index provider questions ‘biased’ evidence of outperformance, highlights risk of disappointing investors
Many proponents of ESG investment believe that it can be a source of outperformance, creating the opportunity for investors to do well as they help companies do good. But according to recent research from a well-known index provider, the evidence on that is not so clear-cut.
In a white paper titled ‘Honey, I Shrunk the ESG Alpha’: Risk-Adjusting ESG Portfolio Returns, the firm hit back against the broadly shared view across the asset management industry that ESG delivers long-term outperformance, reported ETF Stream.
According to the paper, the view is questionable because of its reliance on strong returns observed across sustainable strategies since the Global Financial Crisis.
Dr. Noël Amenc, CEO of Scientific Beta – which also constructs ESG indices – dismissed claims of positive alpha made in popular industry publications, alleging that the analyses underlying them are flawed.
Calling the results of such research “biased,” he said those who promote the idea of ESG investing alpha “are taking the great risk of disappointing investors and diverting them in time from an investment theme that is important for sustainable economic development.”
Looking at the performance of 24 ESG strategies over the period from 2008 and 2020, the authors from Scientific Beta confirmed that most outperformed by up to 3% a year.
But drilling into the drivers of returns, they found that ESG strategies were heavily exposed to companies that scored well on the quality factor. As an example, they found that the return attributable to quality in one US ESG strategy amounted to 1.7%, exceeding the strategy’s annualized 1.3% returns.
“The results show that the quality factors (high profitability and low investment) make pronounced positive return contributions to most types of ESG strategies,” the report said.
Significant sector biases, notably toward technology stocks, have also boosted ESG strategies’ ability to produce returns since the GFC, the authors said. When applying standard risk adjustments, they found that the ESG strategies showed no outperformance, suggesting that ESG ratings add no value beyond what’s contained in sector classifications and factor attributes.
Another possible source of artifact returns, the authors said, is the surge in ESG interest since the GFC. The U.S. ESG strategy, for example, was found to deliver 5% performance during periods of high attention for ESG, compared to 1.3% performance in times when attention was low.
“Investors who look for value-added through outperformance [in ESG] are looking in the wrong place,” the authors said.