Is ESG just warming up?


The base-line expectations of investors around ESG issues have become more prevalent and stricter.

Whether ESG factors are truly ‘alpha’ factors equivalent to their Value, Momentum, Quality and Low Volatility counterparts remains a contentious issue within the investment community. In this article from GSFM’s investment partner Man Group, it examines the rise of interest in ESG and whether ESG factors can provide superior investment returns.

The discussion about responsible investment (‘RI’) has evolved from a low murmur to a rising crescendo in recent years. The UN-supported Principles for Responsible Investment (UNPRI) has experienced another year of growth in its signatory base; a greater than 20% rise in signatory numbers in 2018/19, the greatest increase in the signatory base since 2010/11[1].

There is also growing diversity in the UNPRI’s signatory base, encompassing greater variety in location, size and type of investor – new areas of asset owner growth in 2018/19 include increasing numbers of corporate pension funds, insurance providers, public treasuries and central banks. Figure one illustrates the geographic diversity of signatories.



In conjunction with the increase in signatories, the base-line expectations of investors around environmental, social and governance (‘ESG’) issues have become more prevalent and stricter: either through exclusion lists by which stocks are removed from the investment universe for failure to meet certain ESG standards, or factor integration where ESG factors are included alongside financial factors to inform investment decisions.

Responsible investment: from theory to practice

Responsible investing originates in the belief that certain non-purely financial factors can both influence the performance of portfolios and align investors with broader societal objectives. Using the PRI’s framework as a common standard across the industry, responsible investing is thus defined as “an approach to investing that aims to incorporate ESG factors into investment decisions, to better manage risk and generate sustainable, long-term returns.”,[2].
This definition, intentionally quite broad, is then qualified by encouraging investors to consider certain ESG topics or issues, and incorporate them into investment and risk processes according to six voluntary and aspirational principles (figures two and three).



From an investment standpoint, the broad concept of responsible investment therefore appears to be translated in practice into: (i) an assessment on how certain actions (e.g. land use, fracking, employee relations, corruption), or the consequences of certain implied actions (e.g. climate change, water) might affect the risk/return characteristics of portfolios via the assets owned (cf. PRI Principle 1); and (ii) an imperative to influence the actions deriving from those assets (cf. PRI Principles 2 and 3) – as illustrated schematically in figure four.



Are ESG factors ‘alpha factors’?

In 2019, the performance of ESG factors delivered returns worthy of attention and provides a useful data point for ESG champions to use in discussion with sceptics.

ESG sceptics point to the lack of history, messy raw data and inconsistency across vendors. As the narrative goes, both Value and Momentum are easily explained by investors’ behavioural biases, and thus worthy to be classified as anomalies or alpha factors. The sceptics would also say that the empirical evidence for ESG factors is too limited. And, of course, there is no neat academic finance theory paper to point to.

Meanwhile, ESG champions point to an evolving world where responsibility and sustainability take front and centre. They (and we) believe that consumers and investors will increasingly want to be associated with companies that consider their environmental impact, treat their employees well and have in place strong governance structures.

Champions believe this will, in turn, lead to meaningful impact on the company’s businesses through increased revenues/profits and better stock prices.

While the team at Man Group is a strong believer in the latter thesis, they do not expect this debate to be resolved anytime soon. That said, regardless of your point of view, the recent performance of ESG factors, both from a breadth and depth perspective, has been encouraging. In 2019, ESG factors have certainly delivered beyond many investor’s expectations.

ESG factor performance in 2019

In 2019, the MSCI Standard indices underperformed their MSCI ESG Leaders counterpart (figure 4). This was consistent across multiple regions. The MSCI ESG Leaders indices are constructed using MSCI’s proprietary stock-level ESG factors and have sector weights that target the underlying parent index and hence provides a relatively sector-neutral view of ESG.



In the energy sector for example, both the MSCI World and MSCI World ESG Leaders indices are approximately 4-5% weight in the index. As such, the outperformance of ESG cannot simply be attributed to the fact that the energy sector underperformed or that it was simply a temporary low-carbon effect that will reverse when oil prices bounce.

A more nuanced view of the performance of ESG factors is through the lens of Man Numeric’s proprietary ESG model, which is based on 15 fundamental pillars. The team uses multiple data sources to construct its ESG model. In addition, the team ensures that the ESG model is sector neutral and is neutral to common factors (e.g. Size, Value, Momentum, Beta, etc).

Man’s research found that non-neutral common factor exposures are typically observed in raw ESG data. By cleansing the data of these factor exposures, we ensure that the ESG factor investor is not simply buying ‘some other factor’, and the performance observed is not simply a proxy for Value, Size or another common factor.

Figure five shows the positive returns to a series of ESG-related factors, compiled using Man Numeric’s proprietary alpha signals across our global investment universe. Early sceptics of ESG factors wondered if Governance (long utilised by quants in their investment processes) may be the lone productive ESG factor. Contrary to the case, the 2019 ESG factor returns paint a different picture.



Environmental factors performed the best, with low carbon intensity companies being rewarded strongly. In the Social dimension, investors rewarded social consciousness amongst others, while shareholder transparency was the best-performing Governance factor. All in all, 14 out of the 15 Man Numeric ESG pillars were positive for the year, which is a remarkable statistic in itself and reflective of ESG more generally performing positively over the period.

Finally, it is also important to note that each of Man Numeric’s 15 ESG pillars are independent definitions of different ESG concepts, each with low correlation relative to one another (figure six). Clearly, Man Numeric’s ESG pillars are not simply slight variations of the same concepts, but orthogonal factors all expressing independent views of the strength of ‘ESG’ of a company. Statistically, the low score correlation adds to the unusualness of their concurrent outperformance.




Case study: Going carbon negative with IKEA

Did you know that you would need to drive 63 miles to produce the same emissions as eating one kilogram of beef?

Changing the foods we eat can have a massive impact on our carbon footprint. This is the main reason furniture retailer Ikea – ironically famous for its meatballs – has started selling plant-based foods along with its meaty versions as it seeks to slash its emissions, according to the company’s Chief Sustainability Officer Pia Heidenmark Cook.

“A plant-based hot dog has seven times less footprint than a meat one,” Heidenmark Cook said in a podcast hosted by Jason Mitchell, Co-Head of Responsible Investment at Man Group. “The future is plant-based protein with potentially meat as a treat.”

Food is just one way in which the retailer is trying to “meet the needs of people in life in new ways going forward,” according to Heidenmark Cook. It is also focusing on home energy (via home solar and heat pumps), how we consumer as a family (via the circular model) and transport (via electric vehicles and alternative fuels).

It’s fundamental that a company exists to serve people, to be relevant and to provide what people need, but “not at any cost,” she said in the podcast. “We also need to reflect on questions like:

  • is it realistic that everything should be delivered in two hours just because it is convenient?
  • If the footprint is 10 times higher, then can we inform people that there are alternatives?
  • We need companies to step out and inform customers that they have a choice.

It’s not about eating a plant-based hot dog once. It takes 10,000 hours to create a habit – how do we make it stick?”



There are a number of possible explanations for the outperformance of ESG factors in 2019. ESG champions point to alpha, while ESG sceptics may argue otherwise. Yet another possible explanation may be that some of the outperformance is simply related to flows into ESG strategies.

Man Group continues to monitor the performance of its ESG factors and strategies. In addition, it has started to monitor the valuation of ESG factors for potential crowding. That said, Man believes it’s still in the early innings of flows into ESG strategies.

To conclude, the debate about ESG factors will not be resolved by one year’s worth of data. Nevertheless, the performance of Man Groups factors in 2019 provides a useful data point for ESG champions to use in discussion with sceptics.


[1] UNPRI, Annual Report 2019
The information included in this article is provided for informational purposes only. The information contained in this article reflects, as of the date of publication, the current opinion of Man Group plc and is subject to change without notice. Sources for the material contained in this article are deemed reliable but cannot be guaranteed. We do not represent that this information is accurate and complete, and it should not be relied upon as such. Any opinions expressed in this material reflect our judgment at this date, are subject to change and should not be relied upon as the basis of your investment decisions. All reasonable care has been taken in producing the information set out in this article however subsequent changes in circumstances may occur at any time and may impact on the accuracy of the information. Neither Man Group plc, GSFM Pty Ltd, their related bodies nor associates gives any warranty nor makes any representation nor accepts responsibility for the accuracy or completeness of the information contained in this article.

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