Financial quality metrics and ESG factor can impact equity markets

Investors integrating environmental, social, governance (ESG) data into their process can mistakenly conflate ESG scores in practice with the more familiar financial quality metrics, according to Eaton Vance.

The firm’s new research, which explored the relationship between quality factors and ESG factors, aimed to answer the three questions:

  1. What is the relationship between quality and ESG data over time?
  2. What is the relationship between specific quality and ESG factors?
  3. Is there an opportunity to improve portfolio performance through understanding the dynamics between ESG and quality?”

According to Yijia Chen, ESG quantitative research analyst and Alexander Deleon, quantitative research analyst at Calvert Research and Management, an affiliate of Eaton Vance, the research showed that in large cap universes better ESG companies or higher quality companies had the potential to generate superior return performance over the sample period.

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“Interestingly, the data correlations between ESG and financial quality are uncorrelated while their factors returns are positively correlated suggesting that better ESG companies are not always higher quality companies but that both types of companies can outperform peer companies,” he said.

“When we create composite indictors using ESG and quality factors, we find that these factors can be combined to exhibit more positive return characteristics than do either factor alone.

“This suggests that ESG and quality factors have the potential to generate superior performance when combined, despite seeming to capture different kinds of companies when view through the singular lens of either ESG or quality.”

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