...Instead of conducting a pure correlation-based analysis [between companies with strong environmental, social and governance (ESG) characteristics and corporate financial performance], we focused on understanding how ESG characteristics have led to financially significant effects.

...This analysis not only provides support that strong ESG characteristics have led to positive stock performance (showing causality), but that ESG momentum may be a useful financial indicator in its own right and investors may choose to use this signal in addition to ESG ratings in portfolio construction methodologies…

Our research indicated that ESG has affected the valuation and performance of companies both through their systematic risk profile (lower costs of capital and higher valuations) and their idiosyncratic risk profile (higher profitability and lower exposures to tail risk). Thus, the transmission from ESG characteristics to financial value was a multi-channel process, as opposed to factor investing where the transmission mechanism is typically simpler and one dimensional.

In addition, ESG ratings have experienced a longer life than some factors, potentially making them suitable for inclusion in the asset allocation process and policy benchmarks…