How ESG Risk Management Can Impact Security Risk

The process of splitting out the E and S risk management elements from the total ESG score gives investors an indication of how much of the overall E and S risks and opportunities of a company are determined by external and often longer-term issues and how much they are determined by the specific attributes of an individual company.

Building on the results of MSCI’s Foundations of ESG Investing papers, we analyzed how the E and S risk management scores and the governance-pillar score, rather than the overall MSCI ESG Ratings score, can be assessed against idiosyncratic, or stock-specific, risk.

We grouped constituents of the MSCI ACWI Index in quintile portfolios according to their E and S risk management scores, with companies with low risk management scores in the bottom quintile (Q1) and companies with high risk management scores in the top quintile (Q5). We applied equal weights inside quintiles.

Examining the results for all quintiles over the entire period from January 2017 to September 2022 we saw a consistent long-term trend in the relationship between E and S risk management and stock-specific risk.

To establish the strength of the relationship between E and S risk management and stock-specific risk, we ran a cross-sectional regression analysis, which showed that the relationship was significant throughout the 2017-2022 period (p-value ~0.0).

E and S weighted average risk management scores by quintile vs. GEMLT-specific risk (MSCI ACWI Index constituents)

The pronounced rise in overall market risk in March 2020 was due to the significant volatility in the global equity market at the outbreak of the COVID-19 epidemic and can be seen across all the Barra Global Equity Model risk factors, not just specific risk. Data from Jan. 31, 2017, to Sept. 30, 2022, using constituents of the MSCI ACWI Index. Source: MSCI ESG Research