Sustainable factor investing: Where doing well meets doing good

John Fan    John Hua Fan, Lachlan Michalski
30 May 2019
Categories: Industry/Sector Analysis, Fundamental Analysis, Investment Management, ESG, Equity Investments, Corporate Finance

Country or region: Australia

Summary:
Analysis of the impact of ESG integration on systematic factors in Australian equities shows that simultaneously exploiting ESG scores with quality, momentum and size characteristics outperforms standard factor strategies.

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Reference URL: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3361445


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Abstract

‚ÄčThis 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.



Date of original publication:

04/19/2019


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