Climate Investing

7Green Alpha

7.1. Introduction

In this chapter, we explore one specific approach of ESG integration in investment management. In particular, we introduce ESG – with a focus on environmental data – as stock-selection signals, alongside conventional value, momentum and profitability factors. We start from the MSCI ESG database, including the headline ESG score, three pillars (environmental, social and governance), and more importantly, nearly 300 key attributes that measure every aspect of a company’s sustainability. We conduct an in-depth study of ESG rating’s characteristics from a factor lens. Furthermore, we introduce a suite of novel stock-selection factors based on ESG data – from carbon emissions, clean technology, supply chain labor management, to corruptions and instability. Unlike conventional stock-selection factors whose performance has retreated considerably in recent years, sustainability metrics not only deliver highly uncorrelated excess returns, but also enjoy strong alpha since 2017. Therefore, “doing well by doing good” is certainly achievable.

7.2. Research methodology

First, we would like to lay out the foundations of this research. Given the unique features of ESG data, we need to carefully adjust country, sector and other style factors, before we can study the predictive power of sustainability factors.

7.2.1 Region classification

For the purpose of this chapter, we divide the global equity space into four geographic regions – US, Developed Europe (including ...