Is ESG a factor of its own?
I would argue: No. All the known and well researched factors are in essence driven by human traits or biases. The value factor (or style, since a style is of a set of factors, actually) is driven by the natural tendency for bargain hunting – as we do it with all the goods and services we purchase. The momentum factor is driven by herding bias – we tend to buy things that are “en vogue” and everyone runs after. Be it a pair of ripped off, lousy looking jeans, fidget spinners or the newest iPhoneWhatever. The small cap factor might be just partly driven by human traits, but also by the plain technical fact that less liquid stocks are driven up more by increasing demand than are large caps. If you combine the momentum factor with an illiquidity premium you might end up with the small cap factor. Last but not least – and now I get to the crucial point – there’s the quality factor.
People like me like to buy stocks that have a sound, sustainable business model with accordingly developing revenues, a decent management and strong financials, i.e. a strong balance sheet. If you now compare these criteria to the ones screened by ESG analysis, you can’t but come to the conclusion that the quality style inherently carries a large part of the “ESG DNA”.
According to the Financial Times dozens of researchers around the world are crunching their numbers in order to find out whether there’s an ESG factor explaining some kind of outperformance. As with many models and reports in the last thirty years, the ESG factor will at best be overfitted to the data, but very distinctively explained with a lot of quant jargon by aspiring PhD students.
At the end of the day the good ol’ common sense approach of looking at the finance world with a critical, enlightened and disillusioned eye will lead us to the conclusion: ESG style investing is strikingly similar to the Quality style, but the marketing departments will tell their client advisors that there is this new ESG thing and that they should tell their clients. And they all lived well happily ever after.