Wealth Strategies
Indexing Giant Fires Cautionary Note At ESG Cheerleaders

The indexing organisation sounds a sceptical note about some of the claims - at least for now - made about environmental, social and governance-driven investment.
Choosing to invest in companies over how they treat the
environment, society and governance (ESG) might smooth portfolio
returns, but the jury is out on whether these factors make
clients better off in the long term, according to Morgan Stanley
Capital International, the indexing organisation more usually
known as MSCI.
MSCI’s 14-page report, Weighing The Evidence: ESG And Equity
Returns, released last month, has some good news for ESG
evangelists at a time when this approach to investing has gone
from being a fringe enthusiasm to a ubiquitous theme. But the
report also throws cold water over the idea that ESG can be
conclusively proven as a driver of positive returns for the
long-term.
The organisation’s comments are significant because many fund
managers use its indices to compare their funds against others.
When a fund is benchmarked against an MSCI index it is often a
crucial step in drawing in money. When MSCI recently moved to
allow mainland China equities to be held in its flagship Emerging
Markets index, for example, this was seen as a big boost for the
Chinese market.
As this publication has already noted, ESG investment and ideas
of sustainability and impact are constant talking points in
wealth management. Advocates also contend that ESG does not mean
that investors need to sacrifice returns to “do good”. Shunning
fossil fuels, investing in renewables, combatting child poverty
and exposing crooked firms is good, hard-nosed business, ESG
advocates say.
The MSCI report refers to more than 2,000 research articles from
financial services professionals and academics and, referring to
one such paper by G Friede, T Busch and A Bassen (2015), it noted
that few reports prove that ESG impedes investment. However,
there is also little consensus that ESG boosts risk-adjusted
returns.
“Consolidating findings from various academic and industry
researchers, we observe there is significant evidence that the
application of MSCI ESG ratings may have helped reduce systemic
and stock-specific tail risks in investment portfolios,” the MSCI
report said.
“The More difficult question is whether ESG ratings, in general,
have been linked to a risk premium like those of traditional
financial factors such as quality, value or momentum. ESG ratings
have a much shorter history than traditional factors, meaning the
statistical confidence level is fairly low compared to that of
common factors,” it continued.
The report concluded that there is some evidence that changes in
ESG characteristics of firms can drive portfolio performance, but
more time is needed to be sure about this. The organisation
argues that too much data regarding ESG does not illuminate
debates on performance.
(This publication continues to track debate about ESG investment
ideas and wealth managers’ approaches to this issue. To see an
editorial analysis about the topic and to set the scene,
click here.)