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Stock funds outperformed across global markets over the last five years if they were weighted toward companies with positive environmental, social and governance (ESG) scores, research from sustainability data firm ESG Book shared exclusively with Reuters this month showed.

ESG Book’s analysis of model portfolios containing 60 to 85 stocks on average showed performance varied widely by individual ESG component. Companies with better governance scores outperformed stronger than those with higher social scores, for example.

The analysis excluded companies with low market capitalizations and daily trade volumes to avoid distortion.

With trillions of dollars flowing into funds focused on ESG performance, whether and how much it impacts returns is increasingly a focus for investors.

A model portfolio of European stocks tilted toward ESG leaders was the best regional performer, with an annual average return 1.59 per cent above its unweighted benchmark from January, 2017, through April, 2022, according to the firm.

A similarly constructed portfolio of companies in Asia-Pacific (APAC) was close behind, beating its benchmark by an average of 1.02 per cent annually, while North American and global portfolios marginally outperformed, with excess returns of 0.17 per cent and 0.13 per cent, respectively.

Backed by groups including HSBC, Deutsche Bank and Swiss Re, ESG Book launched in December, 2021, to make corporate sustainability data more transparent and comparable.

Sustainable investors have been tested this year by a slump in tech stocks and a rally in their energy peers, which has caused many ESG equity funds to underperform, but ESG Book’s research adds to a growing body of evidence that ESG can still drive outperformance across extended periods.

“Over a long-term horizon, regardless of region, there are benefits and better risk-return profiles,” said Todd Bridges, head of ESG research and sustainable investing at ESG Book.

At the same time, ESG Book uncovered wide performance disparities when model portfolios were built around individual environmental, social and governance components.

Portfolios tilted toward companies with strong corporate governance metrics, for example, beat their benchmarks across the four regions ESG Book analyzed, with average annual outperformance as high as 2.17 per cent in Europe.

“It’s a very uniform signal that markets understand the importance of governance and have been seeing it as a value creator,” said Bridges.

By contrast, a bias toward companies with high social scores led to underperformance in the North American and global portfolios, but outperformance in the Asia-Pacific region and Europe.

“The markets are confused as to what it is, how to measure it and how to determine performance implications,” Mr. Bridges added.

There is slightly more consensus around the value of environmental factors, as companies seek to measure and cut their climate-related risks, said ESG Book Chief Executive Daniel Klier.

Companies that ESG Book scored highly on environmental metrics contributed to outperformance in all but the global portfolio, where performance was dragged lower by its exposure to emerging markets, lagging its benchmark by 0.82 per cent a year, on average.

This variability in performance shows why singular ESG ratings that blend all three elements into one score can be “meaningless” to investors, according to Mr. Klier.

“Unless you unpack a single score into the drivers, you will never get to the bottom of what’s driving performance,” he said.

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