Author Details

Meggin Thwing Eastman

Meggin Thwing Eastman

Research Editorial Director

Guido Giese

Guido Giese

Managing Director, MSCI Research

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Looking inside ESG indexes

  • ESG investments often intertwine values-based and financial considerations.
  • Values-based ESG screens are a portfolio constraint that have historically led to more concentrated portfolios with slightly higher levels of risk.
  • Integrating ESG screens with ESG considerations showed risk reduction during our study period.

Some investors want their investments to reflect their values or beliefs, such as avoiding reputational risk or complying with client mandates by avoiding companies involved in major scandals or business activities such as tobacco or weapons. But we have observed institutional investors increasingly are motivated by financial concerns — both in mitigating risk at systemic and systematic levels and reducing risk and seeking opportunities at the stock-specific level — in integrating environmental, social and governance (ESG) information into their portfolios.1 What has been the trade-off between values and certain financial objectives in ESG approaches?

Intuitively, screens that exclude certain securities constitute a portfolio constraint because they effectively reduce the opportunity set for investing.2 At best, financial results similar to those from investing in the full market have been expected.3 In contrast, integration of financially relevant ESG information into the portfolio construction process — as a method to improve overall ESG quality — may have helped reduce tail risk and improve certain metrics during our study period (from May 2007 to November 2017).4

Integrating ESG into benchmarks is one way investors can address their ESG-related investment objectives. How have ESG indexes with varying levels of values and ESG considerations performed? We look at the five-and-a-half year live track record of MSCI ESG Indexes5 to illuminate the differences. All of these indexes are based on standard market-capitalization indexes.

  • Limited exclusions plus ESG weight tilt. The MSCI ACWI ESG Universal Index applies limited exclusions (red-flag controversies and controversial weapons) and tilts weights toward companies with higher and improving ESG quality. It uses a straightforward mechanism to determine stock weights.
  • Limited exclusions plus maximized ESG quality. The MSCI ACWI ESG Focus Index applies basic exclusions6 and then uses an optimizer to maximize the ESG quality under strict tracking error and sector deviation constraints.
  • Greater exclusions plus best-in-class stock selection. The MSCI ACWI ESG Leaders Index and MSCI ACWI SRI Indexes apply more extensive exclusions and then perform a best-in-class selection of the highest MSCI ESG-rated companies (the best 50% and 25%, respectively). These indexes are narrower than the others with a broad set of exclusions and high criteria for ESG quality.

The exhibit below summarizes the ESG profile of these integrated indexes compared to the MSCI ACWI Index. The ESG profiles are illustrated along two dimensions: the number of exclusions (which we use as a measure for the incorporation of values-based considerations) and ESG quality (measured as index-level ESG scores based on MSCI ESG Ratings).


ESG quality of constituents vs. number of exclusions (MSCI ACWI Index)

ESG quality of constituents vs. number of exclusions (MSCI ACWI Index)

As of Dec. 31, 2018, MSCI ACWI Index re-balancing. Bubble sizes represent market coverage after exclusions but before MSCI ESG Ratings were applied. 


Each of these ESG indexes follows a two-step methodology: The first step applies exclusions to the underlying index (“values”), while the second step integrates MSCI ESG Ratings into the index. Thus, we can break out the separate investment impacts of the two. We analyzed the risk and return implications of applying the index-specific exclusionary screens only (step 1) and then the risk-return characteristics of the combined methodology (step 1 + step 2) from May 31, 2013 through Dec. 31, 2018.


How integrating ESG with exclusions affected risk and return

How integrating ESG with exclusions affected risk and return


Looking at exclusions alone for these four indexes (before ESG considerations are applied), the risk of each approach exceeded that of the MSCI ACWI Index during the study period, generally in line with the extent of exclusions except for ESG Focus exclusions, which showed the same level of risk as the benchmark after step 1.

In contrast, integrating financially focused ESG considerations (in the form of the MSCI ESG Ratings) had a positive impact on both risk-and-return characteristics of all four indexes. Integration led to improved risk-adjusted returns, with slightly higher returns and lower levels of risk than the MSCI ACWI Index during our study period.

Overall, we found that integrating ESG considerations outweighed the effects of the exclusions on our four indexes.



1 Giese, G., Lee, L..-E., Melas, D., Nagy, Z., and Nishikawa, L. 2019. “Foundations of ESG Investing: How ESG Affects Equity Valuation, Risk and Performance.” Journal of Portfolio Management, July 2019.

2 Asness, C. “Virtue Is Its Own Reward: Or, One Man’s Ceiling Is Another Man’s Floor.” AQR, May 18, 2017.

3 Values-based exclusion may have resulted in outperformance in some situations. For example, alternative energy companies have outperformed coal-based utilities in recent years (from Dec. 31, 2008, to Dec. 31, 2018], so the exclusion of the latter has helped investors during that period. However, these typically have been unsystematic one-off effects.

4 Giese, G., Lee, L..-E., Melas, D., Nagy, Z., and Nishikawa, L. 2019. “Foundations of ESG Investing: How ESG Affects Equity Valuation, Risk and Performance.” Journal of Portfolio Management, July 2019.

5 This the longest period for which live track records are available for MSCI ACWI ESG Leaders and MSCI ACWI SRI. MSCI ACWI ESG Focus and MSCI ACWI ESG Universal were launched on Aug. 11, 2016 and Feb. 8, 2017, respectively. For the time period before the launch, backtested index data was used for the purpose of this study. This report contains analysis of historical data, which includes hypothetical, backtested or simulated performance results. There are frequently material differences between backtested or simulated performance results and actual results subsequently achieved by any investment strategy. Past performance — whether actual, backtested or simulated — is no indication or guarantee of future performance. None of the information or analysis herein is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision or asset allocation and should not be relied on as such.

6 The MSCI ACWI ESG Focus Index excludes red flag controversies, controversial weapons and tobacco producers.



Further Reading

Understanding MSCI ESG Indexes

Foundations of ESG Investing

Resilient carbon-transition portfolios: a road map

Investment risk in carbon-dependent industries