Sustainability and Climate in Focus: Momentum and Magnificent Seven Tipped the Balance
Key findings
- Performance of the MSCI ACWI ESG and MSCI ACWI Climate Indexes for the five months ending May 2024 was a mixed bag.
- The indexes with positive exposures to the momentum factor, information-technology sector and Magnificent Seven enjoyed positive performance.
- Methodology and sustainability and climate metrics impact index composition and influence index performance. We use this lens to examine the returns of the MSCI ESG and Climate Indexes for the 12 months ending May 2024.
In the first five months of 2024, performance of the MSCI ACWI ESG Indexes and MSCI ACWI Climate Indexes was mixed, while the MSCI ACWI Socially Responsible Investing (SRI) and MSCI ACWI Climate Paris Aligned Indexes underperformed by -4.5% and -1.4%, respectively. To better understand these differences, we look at how the indexes' exposures to factors, sectors and specific stocks have influenced their performance.
Performance of the MSCI ACWI ESG and MSCI ACWI Climate Indexes through May 2024
Year-to-date and trailing gross returns in USD as of May 31, 2024.
The MSCI ESG and Climate Indexes' methodologies neither overweight factors or sectors nor impose neutrality. In combination with sustainability and climate metrics, however, they may favor one or more factor or sector over the others to influence stock selection and, thus, performance.
Factor, sector and stock exposures boosted performance through May
Our analysis showed that the MSCI ACWI ESG and Climate Indexes' exposures to the value and momentum factors helped explain their differences in performance.
On average, from June 2023 through May 2024, the MSCI ACWI ESG Leaders and MSCI ACWI Climate Change Indexes' momentum exposures aided their performance, whereas their value exposures detracted from performance.[1] By comparison, the MSCI ACWI SRI and MSCI ACWI Climate Paris Aligned Indexes' exposures to both factors negatively influenced their returns.
Value and momentum exposures helped explain active performance differences
Data period from May 31, 2023, to May 31, 2024. Returns and risk calculated with monthly data, using the MSCI Global Equity Factor Model for Long-Term Investors.
For the 12 months ending May 2024, the market did not appear to favor either value or growth. Momentum's performance was strong, however, with the MSCI ACWI Momentum Index exceeding the MSCI ACWI Index by 17% (41% vs. 24%).
Over the same period, communications services and information technology (IT) were the highest-performing sectors,[2] as measured by the cumulative returns of the MSCI ACWI Communication Services and Information Technology Sector Indexes, returning 34% and 31%, respectively. Their performance was buoyed by members of the Magnificent Seven.
Exposure to IT and communication services yielded positive returns
Data from May 31, 2023, to May 31, 2024. Cumulative gross returns are in USD.
As of May 31, 2024, the Magnificent Seven represented 18.7% of the MSCI ACWI Index and, by sector, represented 4.1% of communication services, 3.0% of consumer discretionary and 11.7% of IT. Although this group shares several characteristics, it is quite diverse in terms of key sustainability and climate metrics.
Index inclusion varied with Magnificent Seven stocks' sustainability and climate metrics
Data as of May 31, 2024. An "x" in the far-right column indicates that the company had a target or targets approved by the Science Based Targets initiative (SBTi) or has been assessed to have a credible track record based on the MSCI Climate Action Indexes methodology.
Stock selection's role in indexes' performance
We recently analyzed the financial performance of MSCI ESG Ratings over the long term — 11 years across both developed and emerging markets and 17 years in developed markets only.[2] We found that after controlling for dimensions of risk, such as region, size and factor exposures, companies with higher ratings outperformed those with lower ratings and had better earnings fundamentals. MSCI ESG Ratings provide an assessment of a company's management of its financially relevant sustainability-related risks and opportunities and are assigned relative to industry peers. The ratings range from AAA to CCC, with AAA being highest.
The methodologies of the MSCI ACWI ESG Leaders and MSCI ACWI SRI Indexes target 50% and 25% coverage, respectively, of each of the 11 GICS sectors by float-adjusted market capitalization. The former limits inclusion to stocks with an MSCI ESG Rating of BB or higher, and the latter to A or higher. Index eligibility also depends on metrics such as MSCI ESG Controversies, which provide an opinion of a company's involvement in sustainability-related controversies and incidents.
For the 12 months ending May 31, 2024, the active return of the MSCI ACWI ESG Leaders Index was driven mainly by sector allocations, whereas stock selection within the sectors played a larger role in the MSCI ACWI SRI Index's active return. Both indexes use a "best in class" approach, but their differences in aggregate sector coverage and MSCI ESG Ratings eligibility resulted in a return difference of approximately 7%.
The MSCI Climate Indexes use a variety of climate metrics, including the percentage of revenues generated from six clean-tech themes: alternative energy, energy efficiency, sustainable water, green building, pollution prevention and sustainable agriculture. Although their methodologies do not stipulate explicit targets for the percentage of green revenues, some of these indexes, such as the MSCI Climate Paris Aligned Indexes, target four times green-to-fossil-fuels-based revenues relative to the parent index. The MSCI Climate Action Indexes use multiple scoring criteria, including whether a company has had its targets to reduce carbon emissions approved by the Science Based Targets initiative or whether it has demonstrated historical reductions in its carbon emissions.
Sustainability and climate metrics varied across the MSCI ACWI ESG and MSCI ACWI Climate Indexes
Data as of May 31, 2024. MSCI ESG Ratings range from AAA to CCC (AAA highest), and MSCI ESG scores range from 0 to 10 (10 highest).
The role of methodology and metrics in index performance
For the five months ending May 2024, the MSCI ACWI ESG and MSCI ACWI Climate Indexes that had positive exposures to the momentum factor and IT sector outperformed their parent, the MSCI ACWI Index. The IT sector benefited, as it did over the last 12 months, from the strong performance of Magnificent Seven stocks Nvidia, Apple and Microsoft. The variation in the Magnificent Seven stocks' sustainability and climate metrics affected their eligibility for inclusion — and, thus, their degree of influence on performance — across the universe of the MSCI ESG and Climate Indexes.
An index's methodology, and how it uses sustainability and climate metrics, determine an index's composition and, consequently, influence its return over various time horizons. An understanding of how methodology and metrics combine to impact index composition can provide insights into the performance disparities of the MSCI ESG and Climate Indexes, not only for the most recent period, but over other horizons.
1 Factor exposures were calculated using MSCI IndexMetrics®.2 Sectors are defined using the Global Industry Classification Standard (GICS®). GICS is the industry-classification standard jointly developed by MSCI and S&P Global Market Intelligence.3 Global equities were proxied by the MSCI ACWI Index and developed equities by the MSCI World Index.
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