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Amundi Finds ESG Alpha From Shorting European Stocks

European asset manager Amundi published an update to its “The Alpha and Beta of ESG Investing” this week, finding that selecting European equities based on ESG screens generates higher returns than doing the same with U.S. equities.

Amundi used ESG scoring data from four data providers across 1,700 companies to construct mock portfolios for European and North American stocks which went long the top 20% - or best-ranked – stocks and short the bottom 20% - or worst-ranked – stocks. The portfolio was re-balanced every three months from January 2018 to June 2019 on the last trading day of the quarter and each portfolio was equal-weighted.

The North American model returned an annualised +0.6% but the European portfolio returned +5.8%, and notably, the bulk of the contribution of these returns came from the short portfolio, which accounted for 4.6% of the returns. The benchmark portfolio – the equally-weighted portfolio of all the stocks that compose the universe – for the North American portfolio was +5.6%, meaning that the model didn’t generate any true alpha, but for the European portfolio, the benchmark return was only +0.4%, good for +5.4% of true alpha.

The transatlantic divide is a new development in Amundi’s research. In North America, they observed a decrease in alpha generation on all dimensions, and even a loss on the Environmental pillar, whereas in the Eurozone, the same positive dynamic still operates, with the Environmental and the Social pillars outperforming. The Social pillar is now delivering the best returns of the three; in the previous paper, Amundi found that the Social pillar’s integration lagged compared to Environmental and Governance between 2010 and 2017. However, since 2018, Social is now the best performing pillar. When a portfolio took a long position in the 20% best-ranked stocks and a short in the 20% worst-ranked stocks, this contributed to an annualised return of 2.9% in the Eurozone and 1.6% in North America. Similarly, optimized index management, in which the weighting of companies in the index is optimized to obtain the lowest possible tracking error, would have created an excess return of about 60 and 40 basis points in the Eurozone and North America for a tracking error of 50 bps.

Amundi says that a reason for the disparity in performance might be because they believe that ESG data are more robust and informative when it concerns Europe than the rest of the world, because the largest demand from ESG data comes from European investors.

“We also observe a larger mobilization of European investors than American investors, meaning that the imbalance between supply and demand is more pronounced for European stocks than U.S stocks. Also, it is obvious that anticipating a stronger regulatory environment has an impact on the performance of ESG investing. For instance, we notice that the worst pillar in the U.S over the last few years is Environmental. Certainly, the withdrawal of the US from the Paris Climate Agreement and the weak engagement of the public policy of the Trump administration for environmental issues may had have an impact on the relationship between the asset pricing of US stocks and the environmental risk”, said Thierry Roncalli, Head of Quantitative Research at Amundi.

Hedge funds running ESG strategies have been accused of ‘greenwashing’ as a way to raise capital, and others argue that the lack of consistency between ESG data providers and the lack of a defined framework from regulators means that it’s not possible to truly prove that a portfolio is ESG-compliant. That Amundi have found true alpha returns – which aren’t juiced with leverage, either – through shorting is no doubt positive news for hedge fund ESG bulls.

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