Understanding Sector-Specific Sustainability Risks in Australia’s Equity Market
Key findings
- Australian companies that best managed their financially material sustainability risks and opportunities saw an equity-market performance boost from the ESG factor.
- Our analysis at both the sector and thematic levels highlighted the sector-specific nature of sustainability risks and opportunities in Australian equities since 2020.
- The results of our study emphasize “one size does not fit all” when it comes to incorporating sustainability data into an investment process.
We have found that companies with higher MSCI ESG Ratings scores outperformed those with lower scores over the long term in the global equity universe. But does this trend hold true in Australian equity markets?
The impact of corporate responsibility on Australian equities
To explore this question, we looked at the MSCI Australia Listed 300 Index, which tracks the largest 300 securities on the Australian Securities Exchange. We ranked companies within the index based on a specific indicator (MSCI ESG Ratings score or pillar score), dividing them into equal-weighted quintiles to analyze differences in performance across the groups. Our goal was to identify whether companies with higher values of the indicator exhibited distinct market trends compared to those with lower values.
Using the MSCI Global Equity Factor Model, we decomposed the active return of the top-quintile companies into different factors, including the ESG factor, to understand how each contributed to the overall active return of the model portfolio. Our performance attribution of the top-quintile portfolio used the bottom-quintile companies as the benchmark portfolio.[1]
Equity style factors, including ESG, contributed positively across portfolios
The ESG factor contributed positively to returns for the group of companies with the highest overall MSCI ESG Ratings as well as for companies scoring highest on each of the individual pillars. This outcome was driven by both a positive exposure to the respective score (ESG factor or pillar scores) and the factor's strong performance.
While the overall active returns for top-quintile companies were negative for both the MSCI ESG Ratings score and environmental pillar, this was driven by industry exposure and specific factors. In contrast, equity style factors (including the ESG factor) contributed positively to all four ESG scores.
Contribution breakdown across the ESG factor and pillars
Data from March 31, 2017, to Dec. 31, 2024. Quintiles are created every month based on adjusted scores in the MSCI Australia Listed 300 Index. Scores are first standardized by the Global Industry Classification Standard (GICS®) sector and then size adjusted. GICS is the global industry classification standard jointly developed by MSCI and S&P Global Market Intelligence. The chart shows active performance attribution of top quintiles versus bottom quintiles using the MSCI Global Equity Factor model. Source: MSCI ESG Research
To better understand these divergent results, we dug further into the relationship between specific sustainability risks and equity-market performance. Moving beyond the headline pillar scores, we analyzed the performance of different sustainability themes within different sectors. We used halves instead of quintiles for this analysis to ensure more reliable results, since quintiles at the sector level had fewer constituents in each group, which could have led to results being influenced by idiosyncratic factors.
We analyzed all relevant theme scores for the top two sectors in the MSCI Australia Listed 300 Index: financials and materials. The index consisted of 58 companies in the materials sector and 39 companies in the financials sector, on average, across the analysis period (July 2019 to December 2024). The remaining sectors had too few companies, on average, to generate reliable results (fewer than 35 companies).
Sustainability risks manifest differently across sectors
Data from July 31, 2019, to Dec. 31, 2024, for all scores except the stakeholder-opposition theme score, for which the longest available history is from Nov. 30, 2020, to Dec. 31, 2024. Halves are created every month based on size-adjusted scores in the top two sectors (by sector weight) of the MSCI Australia Listed 300 Index. We calculate the next month's performance (in USD) of the halves. The heatmap shows the annualized difference between the top and bottom halves' performance for each relevant theme per sector. The environmental-opportunities theme was not analyzed because, on average, only 9% of companies in the materials sector were weighted and had available data. Source: MSCI ESG Research
Environmental, social and governance risks and opportunities played out differently across sectors. Our analysis of theme scores by sector revealed mixed patterns. For example, materials companies with high scores in all relevant environmental, social and governance themes outperformed their peers — except for the natural-capital theme. Companies in the financials sector showed mixed results: those with high scores in some social themes — human capital and social opportunities — outperformed their lower-scored peers, whereas those with high scores in all relevant environmental and governance themes underperformed their peers.[2] These findings are consistent with the divergent performance observed in the first chart.
Integrating sustainability considerations can drive investment value
Performance attribution for top-quintile companies based on the MSCI ESG Ratings score and individual environmental, social and governance pillar scores against the bottom-quintile companies indicated that ESG integration added value in the Australian equity market.
Our analysis further highlighted the sector-specific nature of sustainability risks and opportunities in this market — at least for two sectors, materials and financials, which were analyzed in detail. By going beyond ESG scores and analyzing the underlying themes at the sector and market levels, investors can gain additional insights into the historic drivers of risk and returns. A deeper understanding of these drivers can help them in refining their sustainable-investing approach by focusing on the most relevant sustainability risks and opportunities.
1 Since the MSCI Australia Listed 300 Index consists of companies from Australia, France, New Zealand, South Africa, U.K. and the U.S., we cannot use the Australia Equity Factor model.2 This underperformance in governance themes should be interpreted with caution. The financials sector in Australia is highly regulated and companies in this sector generally demonstrate high governance standards with less dispersion between top- and bottom-quintile companies. In such cases, underperformance of top-quintile companies could be driven by idiosyncratic or other style factors rather than the governance factors.
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