Morningstar - Q4 2021 - 47

EXHIBIT 4
Conclusion
Stocks with a lower ESG Risk Rating significantly
outperformed stocks with a higher ESG Risk Rating.
The annual arithmetic return for the portfolio with
the lowest ESG Risk Ratings was 6.81 percentage
points higher than the highest-rated portfolio over
the past 11 years. The Sharpe ratio for the lowest
ESG-rated portfolio was 2 times more than that for
the highest-rated portfolio. More importantly,
stocks with a low ESG Risk Rating provided better
tail risk protection than stocks with a high rating,
and the maximum drawdown, which occurred
during the COVID-19 crisis, was reduced by 18.7
percentage points.
Further analyses show that the energy sector
accounted for much of the underperformance for
the highest ESG-risk-rated portfolio. When I
excluded stocks in the energy sector, the
outperformance of the portfolio with the lowest
ESG Risk Ratings declined to 2.61 percentage
points. However, this portfolio still provided
meaningful tail risk protection, with a reduction of
max drawdown by 7.87 percentage points. K
James X. Xiong, Ph.D., CFA, is head of scientific investment
research at Morningstar Investment Management.
The author thanks Thomas Idzorek, Claudia Volk, and
Patrick Wang for helpful insights and comments.
References
Ammann, M., Bauer, C., Fischer, S., & Müller, P. 2019. " The
Impact of the Morningstar Sustainability Rating on Mutual
Fund Flows. " European Financial Management, Vol. 25,
No. 3, PP. 520-553.
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Portfolio Management, Vol. 45, No. 4, PP. 67-81.
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Zhou, X. 2019. " ESG Shareholder Engagement and
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Sustainable Outperformance The least sustainable portfolio substantially
underperformed the three most sustainable portfolios.
Growth of $1 for the Five ESG Risk Rating Portfolios
Q1 (Lowest ESG Risk)
Q2
Q3
Q4
Q5 (Highest ESG Risk)
Growth of $1
$6
3.65
4.88
5.24
5.48
2.30
5
4
3
2
1
08/2009
Source: Morningstar.
08/2013
08/2017
11/2020
EXHIBIT 5
ESG Risk Rating Performance, Excluding Energy Without energy stocks, the
performance of the quintiles was directionally similar to the results in Exhibit 3,
although magnitude was less.
Market-Cap-Weighted Performance of the Five ESG Risk Rating Portfolios, Excluding the Energy Sector
(August 2009 to November 2020)
Q1
(Lowest ESG
Risk Rating)
Arithmetic Mean (%)
Geometric Mean (%)
Standard Deviation (%)
Sharpe Ratio
Skewness
Kurtosis
Max Drawdown (%)
Alpha (%)
Alpha T-Stat
Source: Morningstar. Data as of 11/30/2020.
16.10
14.91
14.54
1.07
-0.15
3.83
-18.63
0.20
0.18
Q2
17.78
16.66
14.01
1.23
-0.33
4.18
-20.51
1.93
1.85
Q3
17.53
16.41
13.96
1.21
-0.41
4.22
-19.45
2.01
1.87
Q4
15.27
14.04
14.89
0.99
0.04
3.92
-20.03
-0.98
-0.76
Q5
(Highest ESG
Risk Rating)
13.49
12.01
16.32
0.79
-0.32
4.99
-26.50
-1.25
-0.71
477, Royal Institute of Technology, Centre of Excellence
for Science and Innovation Studies.
Pastor, L., Stambaugh, R.F., & Taylor, L.A. 2020.
" Sustainable Investing in Equilibrium. " Working Paper.
Sustainalytics. 2018. " ESG Risk Ratings: A Consistent
Approach to Assess Material ESG Risk. "
https://www.sustainalytics.com/esg-data/
morningstar.com/lp/magazine
47
Wigglesworth, R. 2020. " The ESG Revolution Is Widening
Gaps Between Winners and Losers. " Financial Times,
Feb. 3.
Xiong, J.X. 2021, " The Impact of ESG Risk on Stocks. "
The Journal of Impact & ESG Investing, Fall.
https://www.sustainalytics.com/esg-data/ http://www.morningstar.com/lp/magazine
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