ESG Investments: Can ESG Momentum Add Alpha?

Melanie Christina Damm & Julie Arvad Tranemose

Student thesis: Master thesis


This thesis contributes both to analysing the relationship between companies’ environmental, social and corporate governance (ESG) and financial performance as well as to re-evaluating the existing empirical evidence pertaining to this link. The authors investigate changes in companies’ ESG scores, referred to as “ESG momentum”, and examine their signal value for predicting stock returns. The data includes ESG data from the MSCI database as well as accounting and stock price data from the S&P 500 IQ platform from 2014 to 2019. The econometrical framework applies an portfolio approach using the Capital Asset Pricing Model and as well as a multi-factor model based on Fama & French (1992) and Carhart (1997). Using these models, the authors compare portfolios consisting of the top improving companies (“positive ESG momentum”) to portfolios containing the bottom decreasing companies (“negative ESG momentum”) of the ESG momentum spectrum. ESG momentum is constructed separately for developed as well as emerging markets and is further investigated conditional on the initial ESG score. Although previous empirical research indicates a positive relationship between ESG scores and returns, the results do not exhibit a significant and systematic pattern in the price effects of positive ESG momentum over holding periods of 6, 12, or 18 months. The authors find trading on positive as well as negative ESG momentum to yield positive alphas. In developed markets, they observe that trading on positive ESG momentum yields significant positive alpha in some of the models. However, the evidence is not convincingly a result of positive ESG momentum, as a negative ESG momentum also yields significant alphas. Nevertheless, compelling evidence of positive ESG momentum yielding a positive alpha contingent on a relatively high initial ESG score in developed markets is present. The authors do not find convincing evidence that trading on positive ESG momentum in emerging markets yields abnormal returns in any of the models. In contrast, they find negative ESG momentum yields high abnormal returns dependent on the performance group in emerging markets. Across all regression models, they find the price effects of ESG momentum in emerging markets to be generally higher than in developed markets and that the significant findings are tilted towards a 6-month holding periods in both markets. Nonetheless, past key performance indicators reveal that positive ESG momentum portfolios show financial outperformance in terms of risk-adjusted returns, especially in developed markets. For emerging markets, positive ESG momentum can act as a protection against downside risk. This thesis concludes by discussing the value of ESG scores in reflecting superior ESG activities and signalling changes in stock prices.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
Publication date2020
Number of pages156
SupervisorsMads Stenbo Nielsen