Sustainable Factor Investing: Where Doing Well Meets Doing Good

50 Pages Posted: 18 Apr 2019 Last revised: 6 Nov 2019

See all articles by John Hua Fan

John Hua Fan

Griffith University - Department of Accounting, Finance and Economics

Lachlan Michalski

Griffith University - Department of Accounting, Finance and Economics

Date Written: November 5, 2019

Abstract

This paper investigates the impact of ESG integration on systematic factors in Australia. Whilst negative screening leads to inferior performance, simultaneously exploiting ESG scores with past returns significantly improves the Sharpe ratio and the crash risk profile of the momentum strategy. Such outperformance is more pronounced during periods of slow growth, high inflation and high credit-spreads. The improved performance, which originates from the governance dimension, can be explained by sector tilts driven by ESG integration. Moreover, since forcing allocations across industries leads to inferior factor performance while ESG integration no longer delivers improvements, managers should clearly communicate the opportunity costs arising from mandated sector diversification. Overall, our findings suggest that sustainable factor investing not only allows asset-owners to include their ethical preferences while offering strong potential for wealth generation, but also provides asset managers with the opportunity to mitigate risk.

Keywords: ESG integration; Size; Momentum; Quality; Crash risk

JEL Classification: G11, G30, Q56

Suggested Citation

Fan, John Hua and Michalski, Lachlan, Sustainable Factor Investing: Where Doing Well Meets Doing Good (November 5, 2019). Available at SSRN: https://ssrn.com/abstract=3361445 or http://dx.doi.org/10.2139/ssrn.3361445

John Hua Fan (Contact Author)

Griffith University - Department of Accounting, Finance and Economics ( email )

Brisbane, Queensland 4111
Australia
+61 (0)7 3735 3948 (Phone)
+61 (0)7 373 57760 (Fax)

Lachlan Michalski

Griffith University - Department of Accounting, Finance and Economics ( email )

PMB 50
Gold Coast Queensland 9726
Australia

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