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How has integrating ESG considerations into the investment process affected performance?

This remains a perennial question. Some studies suggest that companies with robust ESG practices displayed a lower cost of capital, lower volatility, and fewer instances of bribery, corruption and fraud over certain time periods. Conversely, studies have shown that companies with lower ESG scores had a higher cost of capital, higher volatility due to controversies and other incidences such as spills, labor strikes and fraud, and accounting and other governance irregularities.1

It may come as no surprise then that numerous academic and investor studies in recent years have found historically lower risk and even outperformance over the medium to long term for portfolios that integrated key ESG factors alongside rigorous financial analysis.

In an MSCI study, researchers focused on understanding how ESG characteristics have led to financially significant effects. The study examined how ESG information embedded within stocks is transmitted to the equity market. Borrowing from central banks, we created three “transmission channels” within a standard discounted cash flow (DCF) model. We call these the cash-flow channel, the idiosyncratic risk channel and the valuation channel

Our research showed that ESG had an effect on valuation and performance of many of the companies in the study.

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Three Major Channels from ESG to Financial Value

Companies with higher ESG ratings were associated with:


Cash-flow channel: High ESG-rated companies were more competitive and generated abnormal returns, often leading to higher profitability and dividend payments, especially when compared to low ESG-rated companies.

Gross profitability of ESG quintiles

Gross profitability of ESG quintiles

01 = worst ESG quintile and 05 = best ESG quintile


Idiosyncratic risk channel: High ESG-rated companies experienced a lower frequency of idiosyncratic risk incidents such as major drawdowns. Conversely, companies with low ESG ratings were more likely to experience major incidents.

Large drawdown frequency of top vs. bottom ESG quintile

Large drawdown frequency of top vs. bottom ESG quintile


Valuation channel: High ESG-rated companies have shown lower systematic risk exposure, evidenced by less volatile earnings and less systematic volatility. Compared to low ESG-rated companies, they also experienced lower betas and lower costs of capital.

Systematic volatility of ESG quintiles

Systematic volatility of ESG quintiles

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ESG and Performance Related Cards

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1Sources: Chava, 2011; 20+ studies, both academic and industry; Lansilahti, 2012; Credit Suisse; Deutsche Bank; MSCI ESG Research, et al.; Huang, 2010; Bhagat and Bolton, 2008; Cremers et al., 2005; Deutsche Bank, 2012; ISS, 2011; et al.