Generate Alpha by Enhancing MSCI ESG Ratings with News Sentiment

RavenPack | November 05, 2019

Our study shows sentiment analysis enhances stock screening, leading to better performance and downside risk mitigation.

Environmentally-Friendly Stock Returns Improved By RavenPack

Companies with a positive record on ESG - ESG standing for Environmental, Social, and Governance issues - have been found to mildly outperform those without, according to research by MSCI, but at RavenPack we wanted to see if we could further increase this marginal advantage using our powerful news analytics database.

After exhaustive research, we found that by screening for stocks that had both a high level of environmental and social awareness and high positive news sentiment scores we could generate selections that substantially outperformed less environmentally-conscious stocks.

Using ESG Ratings Helps Downside Risk Mitigation

We discovered performance could be further enhanced by adding a third criterion.

Research shows that stocks with a high ESG rating tend to experience lower drawdowns during periods of negative news around ESG issues, and, more importantly when they do sell-off they usually overshoot temporarily before making a recovery.

This suggests that by timing stock purchases until after the release of negative environmental news caused a temporary pull-back in price, we could further enhance returns.

Average Maximum Drawdowns

Sentiment overlay to ESG ratings Improves Stock Screening

It was found that by adding this final timing rule the strategy was even more profitable, with the best returns generated by screening for 20 stocks and using all three criteria (entitled ‘Double Overlay’ in the chart below), which yielded a 3.3% annualized excess return.

The smaller stock selection also outperformed selections of 40 and 80 stocks.

Annualized Excess Returns

We have demonstrated how socially responsible investing can provide value for investors with longer-term holding periods. The use of ESG ratings as a stock screener is valuable and has shown to improve performance while mitigating downside risk. This paper further shows how a RavenPack sentiment overlay to ESG ratings can significantly improve stock screening and portfolio construction,” says Peter Hafez, Chief Data Scientist at RavenPack.

ESG Events and Sentiment Data

Easily implement the results of this White Paper using the RavenPack Analytics Platform, which includes ESG event and sentiment data on over 50,000 companies, available via dashboards or our web APIs. Request a trial today.

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