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Portfolio > Portfolio Construction > ESG

Are ESG Ratings the New Credit Rating for Stock Prices?

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In a recently released study by MSCI, findings indicate that not only do strong ESG ratings add to a company’s share value, but the ebbs and flows of ESG ratings have a direct “causal” impact on the company’s stock price.

“How Markets Price ESG,” is the second study on this topic, but this time taking it a step further, says the study’s author, Guido Giese, MSCI director of Applied Equity Research. Giese says that in their 2017 study, they clearly found that ESG ratings were a “descriptor of risk.”

Although the assumption from there was that a change of rating would impact the stock price, the second study was done to determine if that assumption was correct.

“The economic logic was there but what was surprising was how it worked out,” Giese told ThinkAdvisor.  “We did also study controlling for other factors, so trying to understand maybe another factor explained the change in stock price, but there wasn’t; so no other factor in our risk model could explain why ESG rating upgrades have outperformed ESG downgrades. Surprising how clear the results were in the end.”

The top findings showed that:

  • The change in ESG characteristics showed the strongest move in equity prices over a one-year time horizon compared to both shorter and longer timeframes.
  • Equity markets reacted most sensitively to ESG information for companies that do not have extreme ESG scores (neither very low nor very high).
  • Equity markets showed a stronger reaction to improvements in ESG characteristics than to declines in ESG performance.

Giese said it was interesting that ESG ratings work similarly to credit ratings.

“Investors look at credit ratings [to give] them an idea of how safe the stock is, but also [they watch] upgrades and downgrades, and see that if something is changing in that company, they need to reassess the bond rating,” he said, adding it was similar with ESG ratings they studied. “ESG rating is a measure for risk profile, [that is] on how well the company is managed.”

In a nutshell, he said, “Investors should think about using ESG ratings and ESG rating changes in the same way as they got used to using credit ratings and credit rating changes. Both are important, and both can be used for information in the investment process.”

He added that they have shared the findings with some clients, who asked if the ESG momentum idea could be turned into an investable index, which is something their index engineers are working on now.

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