Reference URL: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3361445
This paper investigates the impact of ESG integration on systematic factors in Australia. Whilst negative screening leads to inferior factor performance, simultaneously exploiting ESG scores with quality, momentum and size characteristics outperforms standard factor strategies. The outperformance is more pronounced during adverse market conditions such as periods of recession, high inflation, credit risk and market volatility. Furthermore, integrating E, S or G ratings individually into factors only leads to improved risk-adjusted performance in quality and momentum strategies. Finally, we find that forcing portfolio diversification across sectors leads to inferior factor performance. Since ESG integration increases portfolio tilts to higher scoring industries, managers should clearly communicate the opportunity costs arising from mandated sector diversification. Overall, our findings suggest that sustainable factor investing not only allows asset-owners to include their ethical preferences while offering strong potential for wealth generation, but also provides asset managers with the opportunity to mitigate risk, whilst improving societal welfare.
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