Combining environmental, social and governance assessments for companies into an aggregated score can present a trade-off in performance for investors.
The index provider investigated three approaches to ESG scores: equal weighting between the E, S and G; an optimized approach that set weights based on historical data; and industry-specific weights. The index provider used scores underlying MSCI's ESG ratings between December 2006 and December 2019.
The firm outlined its findings in a blog released Wednesday. Among the results was the finding that, under an optimized approach, attributing the highest weighting to the governance factor and the lowest weight to social gave the greatest improvement in exposure to higher-performing financial variables — those in the top quintile vs. those in the bottom.
Further, when investigating industry-specific weights, MSCI found that over the 13-year period analyzed, environmental factors averaged a 30% weighting, social factors averaged a 39% weighting and governance averaged a 31% weighting.
By comparing the three approaches, MSCI found that an industry-specific approach correlated to better stock performance over the 13-year period, with a lower level of cyclicality.
Over the short term, both equal-weighted and optimized approaches resulted in a heavier weighting to governance issues, although "short-term correlations did not mean long-term financial significance," the blog said. "The reverse was true for an approach that adjusted the weights of E, S and G key issues dynamically by industry; this approach displayed strong financial performance over the long term at the expense of short-term correlations to key financial variables."
MSCI concluded that weighting approaches can play an important role in perfecting ESG-rating methodologies, "enhancing their forward-looking assessment of ESG risks and how such risks may be reflected in the rating model."