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Research and White Paper

Portfolio Research | Combining ESG Risk and Economic Moat

In this report, we look at the potential synergies between Sustainalytics’ ESG Risk Ratings and Morningstar’s Economic Moat Rating. As a part of our research, we constructed a back-testable investment strategy and portfolio by segmenting stocks with low ESG risk and a wide moat. While both metrics worked independently, they performed exceptionally well in combination.

To test whether there is value in overlaying an ESG signal on top of a moat signal (or vice versa), we looked at two timeframes: the COVID-19 sell-off and subsequent market recovery (Dec. 31, 2019 to Aug. 6, 2020) and a three-year time period (June 30, 2017 to June 30, 2020).

  • During the COVID-19 period, the highest return spread we found was by comparing the lower risk/wide moat bucket with the higher risk/no moat bucket. The difference between the average returns of companies in these two buckets is 22.8 percent.
  • Over the three-year period, negligible/low ESG risk and wide moat companies returned 55 percent to shareholders, while no moat and high/severe ESG risk companies led to losses for investors of 20 percent. The negligible/low ESG risk and wide moat companies group consistently generated higher returns year after year. It also showed the lowest volatility of returns over this period.

Overall, our research shows that economic moat and ESG risk can be combined to create investment strategies that generate value both in terms of returns and portfolio risks.

CATEGORIES: Investment Style: ESG