AQR quant paper using MSCI ESG scores and Barra factor model. “Stocks with worst ESG exposures have total and stock-specific volatility that is up to 10-15% higher, and betas up to 3% higher, than stocks with the best ESG exposures. This finding is strong overall, robust to a wide variety of controls, and clear globally as well as in individual regions (US, World ex US, or in emerging markets). We also find that ESG scores may help forecast future changes to risk estimates from a traditional risk model. Controlling for the contemporaneous risk model estimates, we show that poor ESG exposures predict increased future statistical risks. While the effect is modest in magnitude, it is consistent with ESG exposures conveying some information about risk that is not captured by traditional statistical risk models.”
“..we find that deterioration of ESG score from the 75th to the 25th percentile is associated with about a 1% increase in risk. While this increase might seem small, it may simply reflect the fact that ESG captures risks that are long-run in nature and may not materialize in short to medium term. For example, a firm with poor governance may be more likely to experience a scandal, earnings misstatement, etc., but that does not mean that such an event will necessarily happen over the next few years and consequently be captured in a statistical risk model. Moreover, we are using a state of the art risk model that already reflects much of the information about a given stock’s risk, whether such risk is driven by ESG or any other type of exposure. Thus, it is by no means obvious that ESG information could help improve on this risk model’s forecast, even if it is by a modest amount. Overall, we conclude that investors might be able to utilize ESG information to glean additional insights about the riskiness of their investments…”
Me: (1) The “modest effect” on the future risk estimate might be considered by some to be small enough to dismiss. (2) The use of Barra and MSCI ESG gives an amount of standardisation and ability to replicate the work but is not “consensus ESG”. (3) The constant flow of ESG quant papers is notable. Most recent are neutral to modertately positive. (4) Short run data will be a problem for histroic validification but the forward looking situation tends to chime and never exactly rhyme.
Source from AQR: http://bitly.com/2GwShXT
More thoughts on ESG ratings: https://www.thendobetter.com/investing/2018/9/21/why-esg-ratings-will-never-agree-and-some-of-the-problems-of-ratings