The Role of Environmental, Social and Governance Rating Providers for Alpha Generation – A Comparative Study
21st March 2023
Author: Christian Buhagiar
This research aims to examine the function of Environmental, Social and Governance (ESG) rating providers in asset management and investigate if ESG integration leads to enhanced portfolio performance. The research will assess various ESG scoring methods provided by independent agencies to determine if any of them offer superior financial results compared to the overall market. This will be done by constructing ESG-focused portfolios using different scoring methods from the industry and comparing their risk and return versus a standard market benchmark. A key issue for asset managers is the varying conclusions from independent rating agency data as there is yet to be an agreed industry standard for the rating methods employed.
The introduction of the dissertation provides a brief overview of the ESG topic, the meaning of an ESG score and identifies the research aim, questions, and objectives. The literature review focuses on how the ESG topic evolved in relation to the standards and regulations over the years and explains the different ESG rating methods adopted by four well-known research agencies. These include Morgan Stanley Capital International Inc. (MSCI), Morningstar Inc. Sustainalytics (MS Sustainalytics), S&P Global Ratings (S&P Global) and Refinitiv. It also delves into different research papers written on the subject by various academics, rating agencies and investment managers and the difference between their conclusions in relation to risk and return driven by ESG criteria. Finally, the research compares a portfolio consisting of United States (U.S.) equities having a high ESG score from the different rating providers against each other, and against the market benchmark. In this case the U.S. equity market as represented by the Standards & Poors 500 Index (S&P 500) is used. This research concludes that integrating high ESG scores in equity portfolio management generates higher returns and at times, also lower risk over the long and medium term.