Study shows ESG is a “particularly unique source of alpha”

Research by KBI Global Investors has concluded that ESG is a unique source of alpha and exploits an information set that conventional factors do not capture.

It further concludes that ESG exposure helps to improve diversification in a way that traditional metrics cannot achieve.

The analysis compared ESG performance and its correlation to existing styles, exploring the potential for synthetically creating ESG exposure.

The increased focus in recent years has seen considerable assets allocated to ESG investment. The greater demand may make it more expensive, causing a potential hit on performance In the future.

However, the research showed that since 2019, the relative expense of ESG as a factor has fallen for both North America and Europe and is at a more normal level. However, ESG has remained consistently cheap relative to its long-term average in Asia. It has not proved to become more expensive in developed markets.

It found an efficient information ratio in North America and Europe, and becoming more effective over time. In Asia, it is falling behind quality and growth. This could be related to investors forcing ESG on developed companies as a result of pressure from policymakers, lobbyists and shareholders and members.

Creating synthetic ESG proved unsuccessful, due to an instability in the correlation structure between ESG and traditional styles.

The use of traditional risk premia also makes it difficult to capture even a small amount of the ESG variability.

“Our analysis leads us to conclude that ESG is a particularly unique source of alpha, exploiting an information set all too often overlooked, and that ESG exposure helps immeasurably in enhancing portfolio diversification,” said John Griffith, senior vice-president, business development and client services.