How to work sentiment for extra alpha in ESG investing


Recent research by Harvard Business School has shown an increasing price premium for stocks which rate highly on an ESG scale over others, and that much of the premium increase can be attributed to investor sentiment. As always, though, investors need to watch for value.

With the help of TruValue Labs, which provided data and other assistance for the study, George Serafeim, a professor of administration at Harvard Business School, found in his report – ‘Public Sentiment and the Price of Corporate Sustainability’ – that the highest alpha, though, is found with firms that have strong ESG factors but low sentiment momentum.

The report says: “An ESG factor going long on firms with superior or increasing sustainability performance and negative sentiment momentum and short on firms with inferior or decreasing sustainability performance and positive sentiment momentum delivers significant positive alpha. This low sentiment ESG factor is uncorrelated with other factors, such as value, momentum, size, profitability and investment.

“In contrast, the high sentiment ESG factor delivers insignificant alpha and is strongly negatively correlated with the value factor. The evidence suggests that public sentiment influences investor views about the value of corporate sustainability activities and thereby both the price paid for corporate sustainability and the investment returns of portfolios that consider ESG data.”

TruValue Labs is a San Francisco-based global firm which provides real-time data on ESG matters for investors. Its platform is known as ‘Insight360’. The firm, launched in 2013, has an Asia Pacific office based in Sydney, run by Hunter Page, the regional director.

In his study, Professor Serafeim says that in 2018 there were more than 250,000 unique articles focusing on ESG issues, across 8,000 companies globally. In his paper, he analyses how public sentiment influences the market pricing of firms’ sustainability activities and thereby the future stock returns of portfolios that integrate ESG data.

“Thousands of companies are investing resources to reduce energy consumption, waste and carbon emissions and to provide products that improve environmental and social outcomes. For example, developments in healthy nutrition, access to wellbeing services, low carbon transportation, and green buildings have provided billions in revenues for companies that developed products for these markets [according to Al Gore’s fund manager, Generation Investment Management, 2017]. Similarly, companies spend significant resources to improve employee safety and well-being and to conduct business with integrity avoiding corruption. These activities, typically referred by companies as corporate sustainability activities, are under the supervision of a Chief Sustainability Officer and are disclosed in sustainability reports. “The data from sustainability reports and other sources that might also reflect controversies around human rights, pollution, discrimination and corruption, are collected by data set of vetted, credible, and reputable resources (e.g. NGOs, industry analysts, think tanks, media) in the past 12 months. I expect a lower valuation of corporate ESG performance in the presence of negative sentiment momentum for multiple reasons:

  • Firms with strong ESG performance and occasional or temporary societal controversies might be judged as weak ESG performers. Similarly, firms with weak ESG performance that have strong marketing campaigns to advertise their ESG activities might be judged as strong ESG performers.
  • Negative news on a specific topic (e.g. supply chain controversies) might affect investor views about other ESG issues (e.g. climate change strategy or human capital development) leading them to undervalue strong ESG performance in those other issues. Second, investors might assign a higher discount rate to a firm’s ESG performance in the presence of negative sentiment momentum because they expect future reputational, legal, or operating costs.
  • Even if investor views about a firm’s ESG performance are unaffected by sentiment, their incentives might lead them to ignore firms with strong ESG performance and negative sentiment momentum (or to hold firms with weak ESG performance and positive sentiment momentum). If institutional asset owners and retail investors value holding/avoiding companies with positive/negative sentiment momentum, asset managers will act to satisfy their clients’ preferences.

“I estimate market valuation models, where the dependent variable is a firm’s market-to-book ratio at the end of each month and independent variables include a firm’s ESG performance as a well as control variables for a firm’s size, profitability, past returns and revenue growth, leverage and industry membership,” he says.

“I find that the valuation of corporate ESG performance increases as a function of public sentiment. The positive association between ESG performance and market valuation is stronger for firms with more positive public sentiment momentum. An increase in a firm’s ESG performance has nearly two to three times the effect on a firm’s market valuation for a firm with positive relative to a firm with negative public sentiment momentum.”

– G.B.