Is there ESG Awareness in Alpha-Driven Stocks?

With the inauguration of the 46th US president just days away, there has never been a riper time for the fruit of socially responsible investing. President-Elect Biden has promised to directly address the environmental, social, and governance issues that are bound to plague society if left with no focused intervention.

Given Biden’s proposed initiatives to enact environmental and social change starting on day 1 of his presidency, it’s no surprise that companies that incorporate ESG aware practices into their operations generally outperformed the general market in 2020. Using the iShares MSCI USA ESG Select ETF (SUSA) as a proxy for ESG aware assets, we can see that these assets outperformed the MSCI USA index by almost 9.4% in 2020.

Forbes points out that ESG aware investing comprised over $17 trillion in assets under management at the end of 2020. This represents one-third of all professionally managed US assets! With this in mind, we’ll be wrapping up our “Where’s the Alpha” series by applying MSCI’s ESG ratings framework to the alpha-driven, factor-driven, and neutral stocks identified in last week’s Factor Spotlight.

Methodology Review

The last two weeks of Factor Spotlight have focused on identifying alpha-driven stocks, which we define as securities where 67% or more of the expected risk is idiosyncratic, as defined by a risk model. We went a step further and used two risk models, the Axioma US 4 Medium Horizon (“Axioma US4”) risk model and MSCI Barra Global Total Market Equity Model for Long-Term Investors (“Barra GEMLT”), to narrow to a group of stocks where both risk models agree on the alpha-driven classification, which we refer to as the “true” alpha-driven stocks. We ran the same exercise for factor-driven securities (67% or more of expected risk is systematic, as determined by both Axioma US4 and Barra GEMLT) and neutral securities (neither factor-driven or alpha-driven, as determined by both Axioma US4 and Barra GEMLT) in the analysis.

For this week’s ESG-focused analysis, we used MSCI’s industry leading ESG ratings, which are available via the Omega Point platform. This dataset provides extensive and detailed data across all three ESG pillars and the table below shows the key issues that are considered in each theme.

We’ll be using the composite scores for the Environment, Social, and Governance pillars to analyze how ESG aware our alpha-driven, factor-driven, and neutral stock groups are relative to the overall Russell 3000 universe.

ESG Awareness of Alpha-Driven Stocks

The composite pillar scores, which range from 0 - 10 (10 is best, 0 is worst), onto our stock groups and calculated the median exposure for each factor across our groups as well as for the total Russell 3000 universe.

‍Environment Pillar Score

The Environment pillar score is an area where the alpha-driven group shines, especially relative to the factor-driven stocks. The alpha-driven stocks had the highest median Environment score, which was consistently between 5 and 6 out of 10. The factor-driven stocks had a rocky start to the year, with a median score between 2 and 3.5, before increasing to 4.5 after the COVID-19 market downturn. This group’s score has been on a steady decline since. These trends show that the 2020 alpha-driven stocks tended to be more environmentally friendly than the factor-driven counterparts. This indicates that in 2020, investors had more opportunity to find both alpha and environmentally aware investment options.

‍Social Pillar Score

On the Social pillar, the landscape is much less diverse across the alpha-driven, factor-driven, neutral, and total Russell 3000 groups. All 4 universe medians start the year with a Social score of just above 4. While the neutral group shows a slight uptrend through 2020, the factor-driven group shows an almost equally-sized downtrend throughout the year, with the alpha-driven stocks remaining relatively constant. Investors with mandates to maintain certain thresholds for the Social score may have found it more challenging to align the alpha opportunity with these mandates. It appears that the Social pillar is an area where there is room for improvement and differentiation across all of the groups.

‍Governance Pillar Score

The Governance pillar is where overall the stock universe seemed to rank the highest, although the alpha-driven stocks lagged the other groups throughout the year. The factor-driven groups shined in this area by maintaining the highest median Governance score, despite a downtrend at the end of the year. Again, managers who look to invest in assets with the top rankings in the Governance pillar may have found it challenging to find alpha. This is yet another place where the alpha-driven companies can improve in order to attract top investors who will no doubt be increasingly concentrated on making ESG aware investments.

Will There Be Alpha in ESG Aware Assets in 2021?

Going into 2021, the median alpha-driven stock scores relatively:

• higher for the Environment pillar (trending flat)
• similar for the Social pillar (trending flat)
• lower for the Governance pillar (trending up)

We hope to see throughout 2021 and beyond that the securities across all of our groups advance on the ESG scale and improve their scores. Alpha-driven stocks are well positioned on the Environment pillar, but are lagging on the Social and Governance pillars and have room for improvement. As investors continue to fixate on ESG-aware investing and shift assets to align with this focus, we anticipate that companies will similarly realign and make meaningful adjustments to their businesses that can enact real change in 2021.

US & Global Market Summary

US Market: 01/11/21 - 01/15/21

• The stock market rally retreated from record highs as the Dow Jones Industrial Average fell 0.9% while the S&P 500 index and Nasdaq composite sank 1.5%.
• Stocks dipped as traders considered details of President-elect Joe Biden’s newly unveiled stimulus proposal and weighed the likelihood of the package getting advanced quickly through Congress.
• COVID-19 concerns also flared anew as stay-in-place restrictions tightened across parts of Europe.
• The U.S. Commerce Department announced that retail sales fell 0.7% in December, below consensus expectations.
• U.S. crude oil prices settled the week lower as the renewed lockdowns in Europe reignited fears of weak demand for travel and fuel.

Normalized Factor Returns: Axioma US Equity Risk Model (AXUS4-MH)

• Momentum continues its rocket trajectory and is the week’s biggest gainer for the 6th week in a row, approaching overbought territory and far away from its early December oversold status.
• Earnings Yield finishes as this week’s runner up and moving upward for the 4th week in a row.
• Value finally showed some pop after putting on the breaks last week halting a performance slide and approaches positive territory once again.
• Profitability showed promising movement to round out this week’s gainers along with Growth.
• Volatility continues to freefall and slide deeper into negative territory.
• Market Sensitivity finishes as this week’s biggest loser and continues to slide negative.
• US Total Risk (using the Russell 3000 as proxy) decreased by 32bps.

‍Normalized Factor Returns: Axioma Worldwide Equity Risk Model (AXWW4-MH)

• For the 6th week in a row, Momentum and Growth finished the week either #1 or# 2 as they keep marching deeper into positive territory.
• Profitability showed positive movement for the 2nd straight week following a slow month-long slide.
• Market Sensitivity and Volatility continue to show weakness, extending their stay in the negative territory.
• Exchange Rate Sensitivity was the week’s biggest loser pushing aside Size which continued its negative move.
• Global Risk (using the ACWI as proxy) decreased by 29bps.

Regards,
Alyx