- We researched whether environmental, social and governance (ESG) and climate characteristics could have been integrated into MSCI’s USA Value and Growth Indexes while maintaining their investment styles.
- The simulated ESG indexes had higher relative ESG scores while the simulated climate-change indexes had greater exposure to low-carbon-solutions companies and lower carbon-emission intensity.
- Risk and return characteristics, as well as the style-factor exposure for the simulated USA Value/Growth ESG and Climate Indexes, were comparable to the underlying MSCI USA Value and Growth Indexes.
Investors may be seeking to align their value- or growth-oriented portfolios with climate and ESG considerations. The following research details several approaches for seeking to achieve these investment objectives without generating material trade-offs.
The integration of ESG and climate
Many investors focus on integrating ESG and climate into their investment process through the attention given to long-term ESG risks and opportunities, the transition to a low-carbon economy and the economic impact of climate events. To explore how style-factor investing can be potentially combined with ESG and climate investing, we applied the MSCI ESG Universal Index methodology as an overlay to the MSCI USA Value and MSCI USA Growth Indexes. Similarly, we overlayed the MSCI Climate Change Index methodology to create climate variants. We selected these methodologies to limit the number of exclusions from the hypothetical USA Value and Growth indexes, and to generate moderate systematic index weight tilts aligned with the desired objectives.1
For a value or growth index, a persistent and meaningful exposure to the target style-factor is key. Over the study period from November 2013 to March 2022, the USA Value and Growth ESG Indexes, as well as the climate index simulations, retained comparable exposures to the value and growth factors in their respective indexes (as shown below).
The persistence of value and growth style tilts
From Nov. 29, 2013, to March 31, 2022.
The simulated ESG and climate versions of the MSCI USA Value and Growth Indexes also had similar risk and return characteristics as compared to their underlying indexes over the sample period (as shown below). The ESG versions generally had lower tracking error relative to the underlying style-factor indexes, as compared to the climate-change versions.2 The variation in tracking error was largely explained by the variation in style-factor exposure.
ESG and climate-change variants’ relative performance
From Nov. 29, 2013, to March 31, 2022.
The simulated USA Value and Growth ESG indexes both improved their index-level ESG scores by approximately 8% with the integration of ESG factors. As a reference point, we note that the ESG score for the MSCI USA ESG Universal Index was 6.6 (not shown below) as of March 31, 2022.
The measurement of ESG scores
As of March 31, 2022.
The USA Value and Growth Climate Change indexes exhibited meaningful growth and value tilts. Compared to the underlying style indexes, they also increased exposure to companies participating in the transition to a low-carbon economy, while decreasing exposure to companies strongly exposed to transition risks or stranded assets (shown below).3
We gauged this impact of integrating climate change with value and growth investing, by looking at the carbon intensity (CI) and the MSCI Low Carbon Transition (LCT) scores. The CI score measures the tons of carbon-dioxide equivalents relative to the amount invested in a company, while the LCT score measures a company’s exposure to, and management of risks and opportunities associated with the transition to a low-carbon economy. Companies with risks of stranded assets have a score of zero, while companies focused on climate solutions receive a score of 10.
Enhanced climate metrics
Nov. 29, 2013, to March 31, 2022.
Value investors have historically been overweight the energy and utilities sectors, both generally have high carbon emissions and low carbon transition scores. The simulated USA value climate-change index was underweight energy (-4.2%) but maintained a slight overweight in utilities (+0.7%) on average from Nov. 29, 2013, to March 31, 2022.
For context, the MSCI USA Growth Index was well-aligned with the selected climate metrics. Incremental improvements to the simulated USA growth climate-change index’s CI and LCT scores were made by increasing underweighting to the energy and materials sectors, while adding to overweights of the information technology and consumer discretionary sectors.
Integration and preservation
While U.S. value stocks were found mainly in older-economy sectors with high-carbon intensity, their growth counterparts were more skewed to the newer-economy sectors with lower-carbon intensity and higher exposure to low-carbon solutions companies. Nevertheless, investors focusing on value and growth investing may seek to implement ESG and climate strategies by selecting indexes that integrate these considerations. Our research revealed that value and growth investors would have been able to create investment products from indexes that preserved style tilts and maintained the number of stocks held in corresponding style-factor indexes, while incurring modest tracking error.
The authors would like to thank Raina Oberoi for her contribution to the blog.
1Our analysis considered the hypothetical USA Value ESG Index, USA Value Climate Change Index, USA Growth ESG Index and USA Growth Climate Change Index. On average, over the analysis period from November 2013 to March 2022, the USA Growth Index held 340 stocks compared to 331 and 311 for the ESG and Climate variants, respectively. The USA Value Index held 357 stocks compared to 349 and 324 for the ESG and Climate variants, respectively.
2The simulated USA Value and Growth ESG Indexes had tracking error of 1.3% and 0.9%, respectively, relative to their underlying style indexes, while the simulated USA Value and Growth Climate Change Indexes had tracking error of 1.7% and 1.8%, respectively.
3In addition, MSCI’s Climate Change Index methodology looks to exceed the minimum standards of the EU Climate Transition Benchmark.