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16 October 2020 Financial Analysts Journal Volume 77, Issue 1

Toward ESG Alpha: Analyzing ESG Exposures through a Factor Lens

  1. Ananth Madhavan, PhD
  2. Aleksander Sobczyk
  3. Andrew Ang, PhD

Rather than trying to assess the likely success of idiosyncratic ESG stock selection, observing factor weightings in ESG funds could provide better insight into future performance.

Using data on 1,312 active US equity mutual funds with $3.9 trillion in assets under management, we analyzed the link between funds’ bottom-up, holdings-based environmental, social, and governance (ESG) scores and funds’ active returns, style factor loadings, and alphas. We found that funds with high ESG scores have profiles of factor loadings that are different from those of low-scoring ESG funds. In particular, funds with high environmental scores tend to have high quality and momentum factor loadings. In partitioning the ESG scores into components that are related to factors and idiosyncratic components, we found strong positive relationships between fund alphas and factor ESG scores.
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