Sustainable factor investing: Where doing well meets doing good

Abstract

This paper investigates the impact of ESG integration on systematic factors in Australia. While excluding non-rated stocks leads to inferior performance, simultaneously exploiting ESG scores with past returns significantly improves the Sharpe ratio and the crash risk profile of the momentum strategy. Such outperformance is more pronounced during periods of slow growth, high inflation and high credit-spreads. The improved performance, which originates from the governance dimension, can be explained by sector tilts driven by ESG integration. Overall, our findings suggest that sustainable factor investing not only allows asset-owners to include their ethical preferences while offering strong potential for wealth generation, but also provides asset managers with the opportunity to mitigate risk.

Keywords: ESG integration; Size; Momentum; Quality; Crash risk

JEL Classification: G11, G30, Q56