Stock funds weighted toward companies with positive environmental, social, and governance (ESG) scores outperformed global markets over the past five years, according to analysis from sustainability data provider ESG Book.

The research of model portfolios, including an average of sixty to eighty-five stocks by ESG Book, revealed that performance varied significantly by individual ESG component. For example, companies with higher governance scores outperformed those with higher social scores.

To avoid distortion, the analysis excluded companies with low market capitalisations and daily transaction volumes.

With trillions of dollars coming into ESG-focused funds, investors are increasingly interested in whether and to what extent ESG performance impacts returns.

A similarly constructed portfolio of companies in Asia-Pacific (APAC) was close behind, beating its benchmark by an average of 1.02% annually, while North American and global portfolios marginally outperformed, with excess returns of 0.17% and 0.13%, respectively.

The ESG Book debuted in December 2021 with support from HSBC, Deutsche Bank, and Swiss Re to make business sustainability data more visible and comparative.

This year, a decline in tech stocks and a surge in their energy rivals have taxed sustainable investors, causing many ESG equity funds to underperform. However, the ESG Book study adds to the growing body of evidence that ESG may still produce outperformance over extended periods.

“Over a long-term horizon, regardless of region, there are benefits and better risk-return profiles,” said Todd Bridges, head of ESG research and sustainable investing at ESG Book.

At the same time, ESG Book uncovered wide performance disparities when model portfolios were built around individual environmental, social and governance components.

For instance, portfolios weighted toward companies with good corporate governance indicators outperformed their benchmarks in all four areas evaluated by ESG Book, with an average yearly outperformance of 2.17 per cent in Europe.

"It’s a very uniform signal that markets understand the importance of governance and have been seeing it as a value creator," said Bridges.

In contrast, a preference for firms with high social scores resulted in underperformance in North American and global portfolios, but outperformance in Asia-Pacific and European portfolios.

"The markets are confused as to what it is, how to measure it and how to determine performance implications," Bridges added.

Daniel Klier, chief executive officer of ESG Book, remarked that there is a growing understanding regarding the importance of environmental factors as businesses seek to quantify and reduce climate-related risks.

Companies that ESG Book rated highly on environmental measures contributed to outperformance in all portfolios except the global portfolio, which lagged its benchmark by an average of 0.82 per cent per year due to its exposure to emerging economies.

This variability in performance shows why singular ESG ratings that blend all three elements into one score can be "meaningless" to investors, according to Klier.

"Unless you unpack a single score into the drivers, you will never get to the bottom of what’s driving performance," he said.

Source: Minutehack

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