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Combined Rating Mitigates ESG Noise

Investors can combine different ESG (environmental, social, and governance) rating systems to mitigate the noise of each individual ESG index provider, says research from MIT’s Sloan School of Management. The inconsistent standards adopted by the various ESG index providers have frustrated many investors in the ESG space. However, by combining different ESG indices investors can also generate better ESG returns. From 2014 to 2020, individual ESG indices generated average annual excess returns of 4.8 per cent, 2.9 per cent, and nine per cent in the United States, Europe, and Japan, respectively. Merging the ESG indices using different aggregation methods can generate significantly higher returns. When combined, the six indices achieved excess returns of six per cent in the U.S. and Europe and 9.6 per cent in Japan, according to the paper.

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