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ESG can drive Europe stock returns to 12% outperformance

Do ESG stocks outperform?The outperformance of European stocks with high ESG ratings can be as high as 12% a year - but in the US there is no outperformance attributable to ESG just yet, research suggests.

Investment Metrics studied ESG as an investment factor in stock returns, comparing ESG to more traditional factors such as momentum.

The results suggest ESG outperformance is a reality in Europe – but possibly a myth in the US where sector allocations, mainly to technology, is a probable greater cause of gains.

The firm looked at US and European stocks with high ESG scores as ranked by the MSCI ESG Overall Score.

In Europe, the very highest rated ESG stocks rewarded investors with 12% outperformance per year.

Stocks with rapidly improving ESG scores – called in the report ‘high ESG momentum’ stocks – also generated 2.8% annual outperformance during the period of study, even after sector and other factors were taken into account. 

“European high ESG and higher ESG momentum portfolios demonstrate persistent outperformance over their benchmark even after factor and sector adjustment,” the report said. 

However, with the European ESG momentum stocks (those rapidly improving their ratings), bias to other factors partially explained the outperformance and there was also no outperformance when European ESG momentum portfolios were not adjusted for sector biases.

Most outperformance that was seen in the European stocks was seen in the post-Covid rally.

In the US, sector allocation and the ‘quality’ investment factor (high gross profits to assets) explained outperformance. Without adjustment, high ESG portfolios did outperform by 40%, but this outperformance vanished when stocks were adjusted for sector allocations.

The report says the “ethical investing wave” could be a driver for Europe’s ESG stocks to outperform – and that this could also happen in the US when ESG takes off.

The report is called ‘ESG outperformance – myth or reality’. 

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