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Optimizing ESG Factors in Portfolio Construction

For the last two decades, institutional investors have debated whether considering Environmental, Social and Governance (ESG) factors can lead to better financial returns.

We will examine how MSCI ESG Intangible Value Assessment (IVA) ratings by MSCI ESG Research can be combined with the Barra Global Equity Model (GEM3) to build optimized portfolios with improved ESG ratings.  The risk model allows us to separate systematic sources of active return - that is, common factor contributions - from asset specific return sources associated with IVA scores. While our study was designed primarily as an enhanced indexing exercise, focused on achieving benchmark returns comparable to the MSCI World Index, we also found three possible strategies during the observed period that can raise ESG ratings and improve active returns with minimal effects on benchmark tracking error.  The currently available dataset allowed us to compare these three strategies over the volatile market cycle from February 2007 through December 2012.

Which of these strategies attained the best performance results and how did they compare?

  • ESG worst-in-class exclusion
  • ESG best-in-class overweighting
  • ESG momentum toward ratings improvements

Listen to this recorded webinar on 'Optimizing ESG Factors in Portfolio Construction.' Our experts from MSCI ESG Research, MSCI Risk Management Analytics (RMA) and MSCI Portfolio Management Analytics (PMA) have outlined how under- and overweighting ESG ratings in portfolio construction can lead to better, risk-adjusted returns through application of MSCI's risk management analysis tool, BarraOne, and portfolio management tool, Barra Portfolio Manager. 

Read the MSCI Applied Research paper on 'Optimizing ESG Factors in Portfolio Construction here.

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