The added value of ESG in emerging markets equity portfolios

By 6 minute read

In the last few decades, interest in Environmental, Social and Governance (ESG) investing has increased significantly. In the financial literature, research with respect to investment strategies based on ESG criteria largely focuses on developed markets. Research with a focus on emerging markets is relatively scarce. We explore the added value of ESG scores in constructing emerging markets equity portfolios. Although it is too early to say based upon the data currently available, this analysis suggests that incorporating ESG does not lower returns and may even enhance returns.

Companies publish more and more data on ESG. As well as the increased demand from investors, stricter regulations regarding investors' ESG policies play an important role. This article analyses the historical performance of a number of emerging market equity portfolios, which are formed using ESG criteria set by MSCI, one of the largest companies assigning ESG scores.

Four portfolios

In this research four different equity portfolios are constructed. Companies are ranked in order of their scores for each of the Environmental, Social, and Governance elements as well as a weighted average of the three. We then add the top-rated companies (working down the ranking from the highest scoring) until we have formed a portfolio which represents 20% of the total market capitalization of the index. The analysis begins in January 2007 and the composition of the portfolios is changed every year based on the updated ESG scores and market capitalization. The portfolios are equally weighted on each rebalancing date. In this article we call these portfolios the 'Environmental portfolio', 'Social portfolio', 'Governance portfolio', and 'ESG portfolio'.

As well as the absolute ESG scores, we also consider the changes in these scores. We consider two equity portfolios in which the companies are selected with the most significant increase or decrease in ESG scores in the last year. In this article we call them the 'Risers portfolio' and 'Fallers portfolio' respectively. Both portfolios start in January 2008 and the composition is changed at the beginning of each year.


We use ESG data from MSCI. MSCI scores companies on each of the following categories: Environmental, Social and Governance. These scores are based on publicly available information, information from companies themselves and other media. This research considers the period January 2007 – August 2017 and takes into account the companies that are headquartered in countries which are classified as emerging markets by MSCI.

In the analysis we only consider companies which received their most recent ESG rating in the last twelve months. As shown in Figure 1, in the period 2007 – 2012 only a small fraction of the companies which are part of the MSCI Emerging Market Index have an ESG score. Starting in 2013, more companies have received an ESG score and after 2013 the number of companies with an ESG score is higher than the number of companies in the main index.

Figure 1: Number of companies in the database per January 1st of each year with ESG score and in MSCI Emerging Market index. Source: MSCI.

This strong increase in the number of companies with an ESG rating since 2013 can be explained by the fact that MSCI started expanding the number of companies assessed in emerging markets in 2012. They did this in preparation for the launch in June 2013 of a new index for emerging markets, the MSCI Emerging Markets ESG Leaders Index. Our research compares the results of the investment portfolios with the 'standard' MSCI Emerging Markets Index. Given the limited availability of data before 2013, this research focuses on the results in the period 2013-2017.

Returns of the equity portfolios

The figures below shows the historical cumulative price returns of the portfolios. These are calculated on the basis of the portfolio values in euros. What is striking is that the portfolios, based on the individual Environmental, Social and Governance pillars, have a cumulative return that falls short of the return on the MSCI Emerging Markets Index. However, the ESG portfolio performs better than this index.

Figure 2: Cumulative price return of different ESG portfolios (2013-2017). Source: TKP Investments.

The better performance of the ESG portfolio than the portfolios that score highly on only one component may be explained by the fact that high scores in all three areas can indicate the high level of attention paid to by the management of companies in these areas, which ultimately results in better financial performance. Secondly, this attention can also ensure that these companies run fewer risks in areas such as scandals and environmental pollution, which ultimately also results in better performance.

The whole is more than the sum of the parts

The analysis shows that the combination of Environmental, Social and Governance scores has more value than the portfolios which are constructed by considering only one of these three aspects. For example, the ESG portfolio has a higher cumulative return. Portfolios have also been created based on changes in ESG scores, which offers added value from an economic perspective.

Based on the data currently available, it is too early to say that there is convincing evidence that investment strategies based on ESG criteria lead to outperformance in emerging markets. However, by taking into account ESG scores, investors contribute to a better world and there may thus also be an additional return.

Sibrand Drijver

About Sibrand Drijver

Investment Solutions Consultant