ESG investing. Sometimes the journey is more rewarding than the destination.

By 2025, Global ESG assets are on track to exceed $53 trillion, representing more than a third of the $140.5 trillion in projected total assets under management, according to Bloomberg. While these projections represent real progress, an unintended consequence may be the distortion of the valuations of the ESG ‘darlings’.

Recent research published by Rockefeller Asset Management (RAM), found that the market tends to value ESG Leaders too highly while undervaluing companies that are in the process of improving their ESG footprint. RAM focused on the US all-cap equities from 2010 – 2020 and found that the top quintile ESG improvers outperformed bottom quintile decliners by 3.8% annualized.

Finding differences between price and value is widely accepted as a cornerstone of an effective investment strategy, and investing in businesses that are committed to improving their ESG footprint can reduce the risk of over-paying. The research indicates that it may be better to ‘travel’ than ‘arrive’ when it comes to ESG investing, and by doing so, reducing the valuation risk associated with integrating ESG factors in your portfolio.

Using MSCI’s ESG data to test this hypothesis, Alliance Bernstein recently found that companies that received ESG rating upgrades outperformed an equal-weighted MSCI ACWI Index during the following 12 months by 0.93%, while stocks that were downgraded lagged (Exhibit below).

Companies that received ESG rating upgrades outperformed the Index during the 12 months that followed

The outperformance isn’t driven by great companies improving, instead, companies that were previously poorly ranked (with a CCC rating) but subsequently received a two-notch upgrade generated the strongest outperformance over the following 12 months (Exhibit below). Additionally, ESG upgrades were associated with improvements across the board.

Active equity investors can identify these opportunities through fundamental research and by engaging with companies that are accelerating ESG improvements before they are reflected in the ESG scores and valuations. Additionally, improving ESG practices have the potential to increase brand value, enhance customer and employee loyalty, reduce costs (including the cost of capital), and create long-term competitive advantages.

This finding may seem at odds with the traditional ESG exclusion approach, where investors largely shy away from those companies that are improving and focus on investing in best-in-class companies. However, as best-in-class names become more crowded, one might expect to find more alpha opportunities by identifying ESG improvers, as well as being afforded further opportunities to engage with company management to ensure agreed milestones are being met. This will not only help companies change for the better but also deliver attractive returns to investors.

Amazon is an example from our portfolio of companies that has a number of well-known ESG and sustainability issues, some of which are embedded into their business model. However, they are also making significant improvements, particularly with regard to labour practices and the utilization of renewable energy. So, although our Risk Rating for the company has been downgraded to reflect the ESG profile and the nature of the business, it is held in the portfolio, albeit at a lower weighting, reflecting the performance potential associated with the ESG improvements it is making.

As a fundamental principle, The Pengana Axiom International Ethical Fund seeks to own companies that are undergoing positive changes, and where those changes are not yet recognized in consensus, expectations, or valuations. This is very much the case with ESG considerations, which when considered along with other factors, can be a strong source of alpha generation and a lens into management quality. This is keeping with their philosophy of looking forward to investing ahead of the curve. This approach has been further endorsed by Unilever (widely recognized as one of the leading thinkers on ESG and sustainability), who selected Axiom to manage their corporate pension plan.

The investment team (Axiom) integrates ESG into the decision-making process for all securities, and the internal ESG assessment will directly impact decisions to purchase or sell a company, as well as influence position sizing while the Fund is invested in each company. Axiom will invest in a mix of ESG stocks ranging from “ESG leaders” with strong environmental, social, and governance practices, to companies who are improving their ESG practices, where the ESG improvement is a noteworthy returns driver and/or risk mitigator for the enterprise. Supply chain and human capital are two of many ESG factors considered by Axiom.


ESG Improvers: An Alpha Enhancing Factor 29th September 2020. Rockefeller Capital Management
Global ESG/Quant Research: ESG in Action – Why ESG improvers are the new source of alpha. Alliance Bernstein 20th April 2021

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