Is there alpha in combining ESG scores with sustainability sentiment?
We highlight key findings from a Harvard Business School study that combines traditional ESG scores with alternative data sources that measure public sentiment momentum on corporate sustainability performance. The study finds that an ESG factor that goes long on firms with high or improving ESG performance and negative sentiment momentum, and short on firms with low or decreasing ESG performance and positive sentiment momentum delivers significant positive alpha. In this report we also outline where to find alternative sources of ESG sentiment.
The paper finds that public sentiment influences investor views about the value of corporate sustainability and governance activities, which in turn impacts both the price paid for corporate sustainably and the investment returns of portfolios that consider ESG data.
The evidence suggests that the valuation premium paid for companies with strong sustainability performance has increased over time and the premium increases as a function of positive public sentiment momentum. The positive association between ESG performance and market valuation is greater for firms with higher positive public sentiment momentum. According to an academic researcher, the increase in ESG performance affects the market valuation for firms with positive ESG sentiment momentum 2-3 times more than firms with negative sentiment momentum.
To find out whether the market undervalues strong ESG performance in the presence of negative sentiment or overvalues strong ESG performance in the presence of positive sentiment, the academic, constructs ESG factors based on ESG performance scores and/or the change in such scores.