Doing Good by Doing Well? The 'Chicken and Egg' Problem in the ESG Alpha Debate

Abstract

We summarize the key findings and practical insights from our study on “Material ESG Alpha: A Fundamentals-Based Perspective.” Our research explores the association between ESG performance and stock returns amid the explosive growth of ESG investing and the growing gap among major US asset managers. Our core argument is that ESG scores do not change in a vacuum. More financially established firms relative to their sector are more likely to not only create material strengths but also resolve material weaknesses in their ESG scoring. This fundamental link is key to explaining prior evidence of material ESG alpha. We explore the value added of commercially available ESG scoring models, the challenges in using alpha for assessing the efficacy of the sustainability reporting standards, and the implications of our work for the SEC proposed rules on ESG disclosures. Our evidence on material ESG alpha gets to the heart of the SEC proposed rules for investment advisers and fund managers and provides a fundamentals-based framework for identifying when ESG factors are generally no more significant than other, non-ESG factors in the investment selection process.

Keywords: ESG Alpha, Materiality, SASB, ESG Ratings, SEC, ESG Disclosures

JEL Classification: G11, G12, G14, M14, M41, Q51