Sustainable Investment – Exploring the Linkage Between Alpha, ESG, and

SDG’s1
SSRN Working Paper
Geert Bekaert,3 Richard Rothenberg,2 Miquel Noguer2
November 2022

Abstract

Despite Environmental, Social and Governance (ESG) investing attracting much

attention in asset management this past decade, only a fraction of asset managers truly
consider ESG issues when making investment decisions. This is partly due to the
perceived conflict of ESG investing with an asset manager’s fiduciary duty and partly
due to low-quality ESG data despite the near ubiquity of sustainability reports. We
analyze the relationship between alpha generation and ESG metrics, and measure the
impact companies have on the U.N.’s Sustainable Development Goals (SDG´s). First,
we construct a sector-neutral portfolio using MSCI ESG momentum scores from
2013 to 2018, and determine that it is feasible to generate positive alpha vis a vis the
MSCI US index. Second, we utilize structured and unstructured data to determine a
company’s net influence on the SDGs, what we call its SDG ‘footprint.’ We show that
an ESG momentum portfolio both outperforms the MSCI US index and has a
relatively better SDG footprint than that of the index. Third, we establish a positive
contemporaneous connection between the portfolio’s ESG ratings momentum and its
SDG footprint. Thus, a positive linkage exists between ESG, alpha, and the SDG’s.

1
We thank the Office of Investment Management at the United Nations Joint Staff Pension Fund for
initiating the original idea of this research and their work on testing the alpha assumption of the active
ESG momentum portfolio and Madelyn Antoncic for early contributions to this research. The views
expressed in this paper are those of the authors and do not necessarily reflect the views of the United
Nations.
2
Global AI Corp.
3
Columbia Business School

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I. Introduction

“ESG” investing has become all the rage. Trillions of dollars are now invested taking
environmental (e.g., carbon emissions), social (e.g., fair labor practices) and
governance (e.g., internal corruption) (ESG) issues into account. ESG investing is
now the most popular form of “sustainable” investing, growing simultaneously with
companies focusing more on their long-term sustainability and the needs of all
stakeholders.

An important question is to assess how many asset managers are truly “walking the
talk.” A 2019 survey of RBC Global Asset Management found that less than 25% of
asset managers and asset owners “significantly” use ESG principles as part of their
investment approach and decision making (RBC Global Assets, 2019).

This may not be surprising as ESG issues may well conflict with the fiduciary duties
of asset owners and managers to act in the best interest of their beneficiaries. A
recent Department of Labor (DOL) proposal regarding the use of ESG risk factors in
Employee Retirement Incomes Security Act of 1974 (ERISA) accounts is consistent
with this view of a conflict. The new proposal states that “private employer-
sponsored retirement plans are not vehicles for furthering social goals or policy
objectives that are not in the financial interest of the plan. Rather, ERISA plans
should be managed with unwavering focus on a single, very important social goal:
providing for the retirement security of American workers.” (Department of Labor,
2020).

There is clearly also a “need for a systematic way to measure and assess how asset
managers execute ESG” (Kim and Yoon, 2020). However, there is a lack of generally
accepted agreed-upon standards and reporting requirements. While corporations now
largely self-report some ESG data, “the practice has been widely criticized for lacking
the rigor of traditional financial reporting,” which results in significant “green-
washing” and data biases. Thus, investors lack high-quality, firm-level ESG data, to
serve as key inputs in assessing, managing, and monitoring the ESG risks and
opportunities that a company faces” (Antoncic, 2019a). In fact, 63% of hedge funds
polled by KPMG responded to a recent survey that ESG investing is “hampered by
the lack of robust reliable data.” (KPMG, 2020).

Due to the lack of agreed ESG standards, major discrepancies exist across vendors
who rate, rank and provide company ESG scores. In fact, comparing a company’s

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ratings from the different raters and rankers shows a company’s ESG rating and
ranking varies substantially across the data providers, with the ratings showing little
correlation (Antoncic, 2020; Kotsantonis and Serafeim, 2019).

In this paper we propose a new alternative to investing through a sustainability lens

based on the United Nations Sustainable Development Goals (United Nations (2020)
coupled with the use of large-scale unstructured data, which can help overcome
existing shortcomings of measuring the sustainability footprint of companies.

The U.N. Sustainable Development Goals (SDGs) are a much broader set of
sustainability issues than traditional ESG issues and focus on “good health and well-
being, the elimination of poverty, zero hunger, quality education, clean water and
sanitation, reduced inequity,” as well as the environment and other issues
encapsulated in ESGs. Most importantly, the SDGs call for “leaving no one behind.”
The SDGs have more factors and address the full spectrum of global macro systemic issues
that matter to all stakeholders, all businesses and all countries. The SDGs “are a
universal call to action” established in 2015 by 193 countries “to end poverty, protect
the planet and ensure that all people enjoy peace and prosperity by the year 2030.”
(United Nations (2020).

Big Data developed through cutting-edge statistical models, provides a potential

solution for ESG/SDG reporting, scores, rankings, ratings and benchmarking. Big
Data enhances reported data with ‘alternative data’ using artificial intelligence
algorithms (AI), including natural language processing (NLP) and machine learning
(ML) to cull through tens of thousands of data and reports in dozens of languages
providing ESG and SDG information for thousands of firms. Thus, relevant
information can be made available at high frequencies, going beyond the information
in unaudited, self-reported annual firm reports (see also Antoncic, 2020).

In this article, we explore the possibility of creating an active portfolio that achieves the
goals associated with ESG investing but still generates alpha, consistent with fiduciary
duties. In addition, we measure the SDG impact of the resulting active portfolio relative
to the benchmark. Specifically, we consider the US MSCI Index as the benchmark to
beat. Among the roughly 600 stocks in the index, we create an active portfolio of about
50 stocks using the MSCI ESG ratings which show positive ESG momentum, to
measure ESG performance and track its performance relative to the index. We find
that the portfolio significantly outperforms the index when relative momentum is used
and this outperformance persists when controlling for the Fama French three- (Fama
3

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and French, 1993) or Fama and French five-factor models (Fama and French, 2014).
We then rely on data from Global AI Corp.1 to measure the SDG impact of the active
portfolio relative to the benchmark. Global AI Corp. uses state-of-the-art Big Data
techniques to examine a comprehensive set of unstructured data, including news
articles, self-reported company data, blogs, NGO reports and social media and then
creates daily SDG scores at the company level. The scores are available at the individual
SDG level, (i.e., company scores are available for each of the 17 SDGs as well as an
overall SDG rating), and can be interpreted as z-scores reflecting sentiment regarding
a particular SDG in recent information releases involving the company. Overall, the
ESG portfolio shows better sustainability footprint than the benchmark, which persists
for at least a year.

The remainder of the paper is organized as follows. Section II describes the ESG data,
the methodology to create an active portfolio, and contains detailed portfolio results.
Section III describes the SDG scores in some detail, and characterizes the SDG
footprint of the selected portfolio. Section IV concludes.

II. ESG Investing and Asset Returns

In this section, we describe the ESG data, the active portfolio construction, and its
performance.

ESG Database

MSCI ESG ratings are widely used by the investment community as a proxy for ESG
performance.2 The MSCI coverage universe is based on major MSCI indices (such as
the MSCI World Index), which include the world’s largest and most liquid stocks. For
a detailed description of the MSCI’s methodology, see MSCI (2019) and Serafeim
(2020); we provide a short summary here.

MSCI attempts to quantify the risk and opportunity exposure of each company on 37
so-called “Key Issues.” These issues are divided into three pillars (environmental,
social and governance) which correspond to one of ten macro themes identified by
MSCI as a concern to investors, inter alia; climate change, pollution and waste,
1
Two of the authors work for Global AI, whereas the first is an external consultant to the company.
2Alternative ratings are available, see Walter (2019) for a survey, and a discussion of some
conceptual and practical issues plaguing such ratings. Berg, Koelbel and Rigobon (2019)
quantitatively studies the differences across ratings from different rating agencies.
4

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product liability, social opportunities, and corporate governance. For issues focusing
on a firm’s risk exposure, both the firm’s exposure and risk management are taken
into account. Specifically, a company is not penalized for minimal risk management
strategies on a low exposure risk issue, however, must have strong risk management
practices in place for large exposure issues. For issues quantifying opportunity, such
as opportunities in renewable energy, ‘risk exposure’ indicates the relevance of this
opportunity to a given company given its location and business focus, whereas ‘risk
management’ means the capacity of the firm to seize the opportunity. The MSCI
ESG scores use company-specific operations data from annual reports and financial
and regulatory filings, coupled with information from a variety of other sources,
including news media, and trade and academic journals. They also use relevant macro-
level data associated with a key issue and related to a company’s geography of
operations and business segments. In addition, MSCI directly communicates with
companies to verify the accuracy of company data for all MSCI ESG research reports.

MSCI aggregates the key issue data to an overall score where each key issue is weighted
according to its assessed materiality in each industry. Given that ESG issues tend to
vary systematically across industries, MSCI calculates an industry-adjusted score so that
the actual ratings are industry specific and comparisons across industries are not
meaningful.

ESG Investing

Incorporating ESG into the investment process is not without challenges. If firms with
high ESG scores manage to lower their cost of capital by their ESG actions and/or
increase their future cash flows by avoiding certain risks, all else equal, firms with good
ESG performance would be valued more highly than similar firms with less exemplary
ESG performance.1 If a lower cost of capital is the source of the valuation premium, it
should be associated with lower returns going forward. Clearly, this might clash with
the fiduciary duty of some institutional investors.

Several research papers written by MSCI show evidence that MSCI ESG rating changes
(“ESG momentum”) may be a useful financial indicator (Giese et al., 2019; Giese and
Nagi, 2018). Companies with higher ESG ratings, on average, experienced fewer stock-
1
Recent research from AMUNDI, a large French asset management company (Bennani, Le
Guenedal, Lepetit, Ly, Mortier, Roncalli, Sekine, 2019) suggests that ESG could become a risk factor
itself, if most investors use ESG scores in their decision to over- or under- weight a company’s stock
in their portfolio.
5

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specific risks and smaller drawdowns, suggesting ESG represents a “risk-mitigation
premium.” In this article, we focus on the return implications of investing in ESG
momentum, which may not entail paying valuation premiums. ESG performance
measurement is complex and uncertain, and in a world where capital may move slowly
to eliminate mispricing (Duffie, 2010), active portfolios that incorporate ESG
momentum may succeed in creating alpha while satisfying the goals of ESG investing.
One caveat applies to all current research regarding ESG investing: the available sample
periods are relatively short (our data go back to 2013), and ESG ratings have a much
shorter history than traditional factors, rendering the statistical confidence regarding
statements about ESG factors and investing rather limited. Moreover, as discussed
above, the ESG data are far from perfect.

ESG Momentum Portfolio Construction Process

To test the potential alpha due to the change in a US stock’s ESG score, we construct
two sector neutral portfolios – one on the basis of the relative percentage change in
the industry-adjusted ESG score, and the other on the basis of the absolute change in
industry-adjusted ESG scores. Using the 11 GICS (Global Industry Classification
Standard) sectors stocks in each sector are ranked, at the end of each year, based on
their absolute and relative ESG momentum. The 10% highest ranking stocks in each
of the 11 GICS sectors based on their absolute and relative ESG momentum are then
selected for inclusion in the portfolios. These stocks are held for a full year, after
which the portfolios are rebalanced. The stocks within each industry, and the industry
-portfolios themselves are market value-weighted. Appendix A describes the portfolio
construction in more detail. 1

The portfolios performance over the past 6 years is then analyzed against its relevant
benchmark, using the MSCI US index. We chose the MSCI US index as a benchmark

1
In this paper we use the United Nations joint Staff Pension Fund portfolio, which excludes the
tobacco and weapons industries. ESG investing raises an important question of whether there is a
“cost to being good, ” which is particularly vexing because of the poor quality of the data and the
fact that ESG funds frequently exclude companies based on various criteria, which can create
conflicts with fiduciary duty. SDG investing does not seek to exclude any company but instead
measures their impact to society across a variety of angles. This means that while the ESG approach
may well reduce investment flows to certain sectors, an SDG-focused approach can be used as an
objective investment tool for the assessment of non-financial risks and can help identify positive and
negative spillover effects that go far beyond the narrow ESG lens. The fact that SDGs are applicable
to investments at the corporate, infrastructure, and sovereign levels, makes it a powerful alternative
to traditional ESG investing.
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since it is more comprehensive than the S&P 500 Index, featuring close to 640
constituent stocks, and it provides the universe for our active stock selection.

Portfolio Results and Alpha Analysis

Our analysis tracks both the daily and monthly returns of the active ESG portfolio and
the MSCI US index for the selected sample January 2013 - December 2018. Figure 1
plots the cumulative return performance over the sample period, showing the relative
ESG momentum portfolio having the best performance followed by the absolute ESG
momentum portfolio, and the benchmark index performing worst. For the purposes of
this analysis, the most important test is whether the portfolio provides alpha with
respect to the relevant benchmark. Table 1 (Panel A) reports the constructed portfolio
alphas and the betas with respect to the index return (Market Model). The portfolio
alphas are also shown relative to the Fama-French three- and five-factor models. In
addition, we report the factor exposures to verify whether the ESG portfolios show
particular tilts relative to existing factors. The Fama-French (1993) three-factor model
adds two portfolios to the market model: the Small Minus Big (SMB) portfolio,
representing the return difference between an index of small versus an index of large
capitalization firms, and the High Minus Low (HML) portfolio, representing the
difference between returns on portfolios of value and growth firms. The relatively new
five-factor model (Fama and French, 2015) complements the three-factor model with
the Conservative Minus Aggressive (CMA) and Robust Minus Weak (RMW) spread
portfolios. CMA represents the return difference of a portfolio investing in firms with
conservative investment strategies minus a portfolio investing in firms with aggressive
investment strategies. RMW represents returns on firms with robust operating
profitability minus returns on firms with weak operating profitability.

The beta with respect to the index is 0.96; not surprisingly, close to 1. Importantly, the
relative momentum portfolio generates an alpha of 0.47 basis points (or 5.64% per
year), with a standard error of less than 15 basis points. The alpha is thus highly
statistically significant. Relative to the Fama-French three-factor model, the ESG
portfolio still generates an alpha of 0.47% per month, and the alpha remains statistically
significant. Adding two additional factors does not change this conclusion.

The SMB and HML loadings are not statistically significantly different from zero,
suggesting the ESG portfolio has neither a value nor a size bias. In the five-factor
model, the CMA exposure is borderline statistically significant and negative. The

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negative CMA exposure suggests the ESG portfolio includes firms with aggressive
investment strategies, which is typically associated with low future returns.

While the alphas for the relative momentum portfolio are significantly different from
zero, the alphas for the absolute ESG momentum portfolios, reported in Panel B of
Table 1, are positive but no longer statistically significant. The factor exposures of the
absolute ESG momentum portfolio are very similar to those of the relative ESG
momentum portfolio.

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Table 1. Alphas Relative to the Market Model and Fama-French Factors
Panel A: Relative Returns
Market Model Fama-French Fama-French
3 Factor 5 Factor
Model Model
Estimate 0.0047 0.0047 0.0047
Alpha (Standard
(0.0014) (0.0015) (0.0014)
Error)
Estimate 0.9594 0.9628 0.9502
Market (Standard
(0.0451) (0.0473) (0.0465)
Error)
Estimate -0.0175 -0.0566
SMB (Standard
(0.0580) (0.0642)
Error)
Estimate -0.0063 0.0984
HML (Standard
(0.0613) (0.0794)
Error)
Estimate -0.1086
RMW (Standard
(0.1047)
Error)
Estimate -0.2307
CMA (Standard
(0.1249)
Error)

Panel B: Absolute Returns

Market Model Fama-French Fama-French
3 Factor 5 Factor
Model Model
Estimate 0.0023 0.0022 0.0021
Alpha (Standard
(0.0014) (0.0014) (0.0014)
Error)
Estimate 0.9786 0.9879 0.9771
Market (Standard
(0.0435) (0.0454) (0.0450)
Error)
Estimate -0.0471 -0.0492
SMB (Standard
(0.0557) (0.0621)
Error)

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 Estimate -0.0050 0.0986
HML (Standard
(0.0589) (0.0767)
Error)
Estimate 0.0193
RMW (Standard
(0.101406)
Error)
Estimate -0.2472
CMA (Standard
(0.120968)
Error)

Note: The analysis uses monthly returns. Standard errors are reported in
parentheses. The market model uses the MSCI index as the benchmark.

Figure 1. Cumulative Return Performance

Performance Comparison Between ESG Relative Momentum, ESG Absolute

Momentum, and MXUS Index Portfolios
300

250

200

150

100

50

0
1-Jan-13 1-Jan-14 1-Jan-15 1-Jan-16 1-Jan-17 1-Jan-18

Absolute Mom Portfolio Benchmark Value Relative Mom Value

One possible explanation for this result is that the relative measure has more chance of
selecting firms that have low absolute ESG scores, i.e., firms that may be less likely to
be on investors’ radar screens as potential ESG target firms. However, it also raises the
possibility that the selected firms may not rank very high on ESG performance in an
absolute sense. Indirect evidence addressing this issue is presented in the next section.

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III. Measuring the SDG Footprint of an Investment Portfolio
In this article, we broaden the dialogue of sustainable investing beyond just ESGs
to measuring the societal impact of a portfolio on the UN Sustainable Development
Goals (SDGs). From a societal perspective, building a framework which measures
the net SDG contribution of entities can potentially incentivize public corporations
and investors to mobilize capital towards achieving the SDGs.
The SDGs are a much broader measure of sustainability risks and opportunities
than the ESGs. The SDGs have more factors and address the full spectrum of global
macro systemic issues that matter to all stakeholders, all businesses and all countries.
We propose to measure a company’s SDG ‘footprint,’ as its ‘reputational footprint’ in
publicly available information regarding SDG. Such a footprint may reveal hidden risks
that can impact its long-term performance and global perception across the world. This
creates incentives for corporations to quantify and increase their net SDG contributions
and SDG score in order to become more attractive to investors controlling trillions in
assets under management and concerned with sustainable investments. It can also
provide increased transparency for investor engagement strategies.
Asset owners can thus potentially contribute to more long-term centric practices
among corporations through the lens of an SDG investment strategy, going beyond the
sustainability goals embedded in ESGs.

Measuring the SDG Footprint of Companies

While corporations now largely self-report some sustainability data, due to the lack of
standards and metrics, significant 'green-washing' and self-reporting data biases, ESG
scores contain a significant amount of noise and thus are of limited use for investment
purposes. In fact, typically, companies carry out voluntary reporting on their
sustainability performance in order to assure their shareholders and investors of their
compliance to regulations (Braam and Peeters, 2017). However, as more companies
are wary of the adverse impact of negative sustainability performance on investor
decisions, they may fail to disclose negative information (Reimsbach and Hahn, 2013).
A useful complement to the reported sustainability data, is Big Data leveraging
Artificial Intelligence technologies to extract, process, and analyze large-scale
structured and unstructured data on ESG and SDG-related factors, which can then
enable the integration of these sustainability factors into the decision-making of global

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investors. The data include news items, social media, and reports in dozens of
languages, providing up-to-date information beyond what is in unaudited annual firm
reports or firms’ marketing efforts. Moreover, Big Data can make this information
available daily for investors, governments, and all stakeholders – not just annually
when a firm generates an unaudited sustainability report. Thus, a Big Data approach
significantly reduces self-reporting bias and ‘greenwashing’ and can show which firms
are effectively having a positive or a negative SDG footprint.

There are scenarios in which the technology can go wrong or provide imperfect
information; relying on publicly available information such as newspaper articles, may
lead to false or biased scores, for example. Other issues include fake news, articles that
commemorate negative events from the past, major discrepancies between reported
and third-party data, etc. For these reasons, it is necessary to perform extensive manual
verification of data to evaluate if the analysis corresponds to reality and implement
preventive measures. Extreme scores should be further examined using the underlying
data sources.

In this paper, we use Global AI Corp.’s (GAI) specific SDG scores. The company
extracts, filters, and cleans massive amounts of structured and unstructured data,
including self-reported company data, news articles, blogs, NGO reports, social media,
etc. to provide “raw,” short-term and long-term scores. The full data set covers
information across 60 languages from more than 100 countries. Specialized algorithms
map the raw data to specific companies and associated entities, such as subsidiaries,
using different combinations of company names, abbreviations, tickers, and ISINs.
Proprietary technology then ranks and filters content by relevance using domain-
specific taxonomies based on the SDGs.

The algorithms analyze the filtered content at a daily level: recording the number of
relevant news items, providing a sentiment score per news item, and tracking volume
and dispersion of sentiment across news items. This information is aggregated into
daily, company-specific “raw” scores, which represent aggregate sentiment of the SDG
data. GAI then aggregates data from 7 days of information, using statistics on the
precision of the scores and the volume of the news sources, accommodating sparsity in
the data while weighting recent information more heavily. For each company scores are
available for all 17 SDGs, and the system also provides an overall company score
measuring the overall SDG footprint of a company. The scores can be interpreted
roughly as “z-scores,” varying mostly between -1 and +1, and having a standard

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deviation of roughly 1. While we use the short-term scores in our current analysis,
longer-term scores are also available.

The higher the score, the more positive the news is in relationship to each SDG, and
vice versa. For example, for SDG 13 (climate action), a company would get a more
negative score after a chemical spill that pollutes the ecosystem than a company that
increases its carbon emissions by 5%. The combination of positive and negative SDG
scores can be used to better assess non-financial risks and calculate a 'net' SDG
footprint that measures the effect of positive and negative externalities at both long-
and short-term frequencies.

SDG Footprint of the ESG momentum Portfolio

We use GAI’s data across the MSCI US index universe over the Jan-2015-Dec. 2019
period to measure the SDG footprint of the active portfolio relative to the benchmark.
For this purpose, we apply the portfolio and benchmark weights to the SDG scores,
averaged for each year.

Our analysis addresses two different questions. Firstly, we verify whether ESG
momentum relative to the benchmark coincides with positive SDG footprint in the year
the ESG momentum was detected for the active portfolio constituents. In other words,
we test whether an ESG momentum strategy selects firms with an SDG footprint that
is better than that of the benchmark. Secondly, we investigate the SDG footprint of the
selected companies in the investment year (the year after ESG momentum was
observed). This exercise measures whether firms with ESG momentum continue to
relatively improve their SDG footprint in the year after their ESG scores increased and
whether ESG momentum is associated with a persistent (relative) positive SDG
footprint. Neither question needs to necessarily receive a positive answer. Because the
SDG scores are relatively fast moving, it is conceivable that they pick up certain ESG
issues even before the MSCI ESG rating change occurs. Unless companies continue to
generate (relatively) positive SDG contributions for a few years, it may not show up in
our measurement.

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Figure 2: SDG Footprints of Momentum Portfolio
Contemporaneous Raw SDG Scores

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Figure 2 shows “contemporaneous” sentiment scores of SDG content for the
portfolio and the benchmark. The years indicated are the investment years, while as
indicated above the scores are contemporaneous with the time ESG momentum was
measured and which was one year before the investment year recorded. The so-
called polar plots arrange the scores for the first 16 of 17 SDGs, around a circle.
Appendix B contains a list of the 17 SDGs, taken from “United Nations Sustainable
Development Goals” (UN, 2020). Each SDG is on a radius from the center, with
the center representing a negative score of between -2.0 or -1.5 depending on the year
analyzed. Moving away from the center outward represents an improvement in SDG
scores. Thus, for example in 2017, one can see in the polar plot SDG scores range
from a low of -2.0 to a high of 1.0. The portfolio’s scores are in blue, the benchmark
portfolio scores are in red. Thus, if the portfolio has better SDG footprint than the
benchmark, the red lines should be inside the blue lines. Note that in any particular
year, this is true for the majority of SDGs. For SDGs 1 through 4, 7, 11, 12 and 16
this is true for all three years. The first four SDGs, represent “End poverty in all its
forms everywhere” (Goal 1), “End hunger, achieve food security and improved
nutrition and promote sustainable agriculture” (Goal 2), “Ensure healthy lives and
promote well-being for all at all ages” (Goal 3), and “Ensure inclusive and equitable
quality education and promote lifelong learning opportunities for all” (Goal 4). Goal
7 is to “Ensure access to affordable, reliable, sustainable and modern energy for all;”
Goal 11 is to “Make cities and human settlements inclusive, safe, resilient and
sustainable;” and Goal 12 to “Ensure sustainable consumption and production
patterns.” Finally, Goal 16 aims to “Promote peaceful and inclusive societies for
sustainable development, provide access to justice for all and build effective,
accountable and inclusive institutions at all levels.” The portfolio does not do as well
on environmental issues, with its footprint with regard to Goal 13 “Take urgent
action to combat climate change and its impacts,” Goal 14 “Conserve and sustainably
use the oceans, seas and marine resources for sustainable development” and Goal 15
“Protect, restore and promote sustainable use of terrestrial ecosystems, sustainably
manage forests, combat desertification, and halt and reverse land degradation and halt
biodiversity loss” only being better than the benchmark in one of the three years.

The last plot in Figure 2 averages the scores over the three years. Averaged over all
three years, the SDG footprint of the portfolio is better than the footprint of the
benchmark for all SDGs except for Gender Equality, SDG 5. The differences are
relatively small, however, and most of the scores (14 out of 17) are negative. This is not

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surprising as companies on average have not yet fully internalized SDG goals with many
companies still on their journey of understanding the role of the private sector in
delivering on the SDGs by 2030.

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Figure 3:

Figure 4:

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In Figure 3, we juxtapose the 2016-2018 scores using “raw” SDG scores from Figure 1
with the same results for GAI’s actual 7-day scores. These scores use the last 7 days of
SDG information, using a weighting scheme to weight the most recent data with older
information downweighed, and adjust the sentiment of the daily information source for
accuracy. The results are largely the same with some small differences, e.g. the portfolio
performs slightly better on Gender Equality (SDG 5), but worse on Clean Water and
Sanitation (SDG 6), and Responsible Consumption and Production (SDG 12), relative
to the benchmark.

In Figure 4, we focus on the persistence of the outperformance of the portfolio in terms

of SDG footprint, by looking at the SDG footprint of the portfolio relative to the
benchmark in the investment year. We show the same summary graphs over all years
for the raw scores and the 7-day scores. Because we focus on the SDG scores during
the investment year, we can add 2015 to the computations. The SDG footprint of the
portfolio is again better than that of the benchmark, but the differences are often small.
An exception for the raw scores is SDG 15, an environmental goal regarding life on
land, where the benchmark performs better. For the 7-day scores, there are 6 SDGs (3,
6, 9, 11, 12 and 16) for which the benchmark has slightly better scores than the
portfolio, suggesting the better SDG footprint may not always do better over a period
of several years.

Statistical Significance

The polar plots show that the SDG footprint of the ESG portfolio is better both in the
year ESG momentum was observed (“contemporaneous”) and the subsequent
investment year. We now verify whether the differences are statistically significant. The
lack of observations prompts us to increase statistical power by comparing SDG
footprints on a monthly basis. For the contemporaneous comparison we have 3 years
of data, or 36 monthly observations; for the investment year we have 4 years, or 48
monthly observations. A simple t-test is performed to address whether the average
difference between the monthly SDG footprint of the portfolio and the benchmark is
statistically significantly different from zero. These observations may be serially
correlated which we control for by using 6 Newey-West (1987) lags in the creation of
our standard errors.

Table 2 reports the results, both for the raw scores and the short-term SDG scores. As
observed from the polar plots, all differences are positive, indicating that the SDG
footprint of the portfolio is better than that of the benchmark. Moreover, these
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differences are larger in the year ESG momentum was established relative to the
investment year, which is consistent with the idea that relatively greater SDG footprint
persists, but the differences may not be permanent. Finally, the differences are not
statistically significant for the 7-day scores, but they are statistically significant for the
raw scores in both reported cases. The statistical significance is highest for the
contemporaneous case, with a t-statistic of 3.38.

Table 2:

Raw Scores Short-Term

Scores
Coefficient 0.1411 0.0438
Contemporaneous
(Standard Error) (0.0417) (0.0408)
Coefficient 0.1138 0.0295
Investment Year
(Standard Error) (0.0593) (0.0480)

IV. Conclusion

Assessing company performance regarding ESG issues and SDG fitness profile is
challenging for the investors, academia, and NGOs. Because companies with good
ESG performance may enjoy a valuation premium, ESG investing has been thought
to create a potential conflict for asset owners who have a fiduciary duty not to
sacrifice long-term return opportunities. In this paper we dispel that view. We
investigate the SDG footprint of an active ESG portfolio using algorithms and
alternative data. We show it is feasible for an asset owner to both uphold his/her
fiduciary duty and have a positive impact on achieving the SDGs.

We explore the possibility of creating an active ESG portfolio to consistently generate

alpha, considering the MSCI US Index as the benchmark to beat. Our research shows
that the active ESG portfolio significantly outperforms the index when relative
momentum is used, and this outperformance persists when controlling for the Fama-
French three- and five-factor models. In the next step, we verify the ESG portfolio’s
congruence with the SDGs, utilizing SDG scores from Global AI Corp. relative to the
benchmark. These daily SDG scores at the company level reflect a comprehensive set
of unstructured data, including news articles, self-reported company data, blogs, NGO
reports, and social media regarding SDG-related issues. The scores can be interpreted

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as z-scores reflecting sentiment, or SDG fitness, regarding an SDG in recent
information releases involving the company. We find that the active ESG portfolio
shows a higher SDG footprint than the benchmark over the full period, but this is not
true for every SDG and every sub-period. This paper underpins that the positive linkage
between ESG, alpha, and SDG footprint is fully consistent with asset owners’ fiduciary
duty. There is no trade-off between financial returns vs. positive societal footprint. Our
research shows that these elements reinforce each other.

There is hope that Big Data can help investors better understand the underlying risks
in corporate behavior, and ultimately, make more sustainable investment decisions.
Objective data on the SDG footprint of companies and countries may also contribute
to better policy making regarding the realization of the SDGs. In future work, we
will also verify the relationship between financial returns and SDG footprint directly,
rather than through the narrower ESG lens.

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 Appendix A – Portfolio Construction

1. Universe: Determining the customized benchmark

a. MXUS Index members stocks list for each Dec 31st of 2012, 2013, 2014,
2015, 2016, and 2017.
b. Remove the stocks that either did not have MSCI industry adjusted ESG
scores or were no longer listed or were acquired since then.
c. Remove the stocks belonging to the tobacco and weapons industries.

2. Security Selection from the customized benchmark: Determining portfolio

stocks for each year
a. Determine the number of stocks to be used in the investment strategy
portfolio as 1/10th of the number of stocks in each sector in the
customized benchmark on a particular rebalancing date. For e.g., If IT
sector had 62 stocks in the customized benchmark on a particular
rebalancing date, it would have 6 stocks in the strategy portfolio.
b. Relative Momentum: Calculate the ESG 1 year Momentum for each stock
in the customized benchmark. Formula used: ESG_MOM_1Y =
ESG_Score(t)/ ESG_Score(t-1) – 1 {Here ESG_Score is the MSCI
published Industry Adjusted ESG Score}
c. Absolute Momentum: using the following formula: ESG_MOM_1Y =
ESG_Score (t) - ESG_Score (t-1)
d. Remove the stocks that had infinite calculated 1-year ESG Momentum as
such companies had only recently started disclosing their ESG metrics and
this infinite momentum was not an accurate representation of
improvement in their ESG practices.
e. Within each sector group, rank the stocks in the descending order of their
ESG Momentum values.
f. For each sector, select the highest ranked stocks (number of stocks to be
selected is determined using Step 2.a.). E.g.: 9 stocks selected in
Information Technology sector on 31 Dec 17 will have the highest 1-year
ESG momentum in the IT sector on that particular day.

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 g. Same logic would be applied to all the other sectors to select the top
ranked stocks. Finally, we end with the total number of stocks for a
particular year. For E.g. 46 stocks selected on Dec 31, 2012, will be held
in the portfolio till Dec 30, 2013.

3. Portfolio Allocation: Determining Stocks weights- The stock weights are

determined such that the final portfolio stays sector-neutral with respect to the
custom benchmark at the different rebalancing dates. This step is implemented
through the following steps:
a. Calculate the sector weights % (Si) for all 11 sectors in the customized
benchmark for each of the 6 rebalancing dates (i.e. 31 Dec of each year
from 2012 to 2017).
b. Determine the market cap value (Ms) of each stock on the corresponding
rebalancing date when the stock was selected.
c. Calculate the total market cap (MT) of the selected stocks for each year as
the sum of market cap values of all stocks selected in that year.
d. Calculate the sector weight value (Sa) to be allocated to each sector each
year as
Sa = Si * (MT)
e. Calculate the annual sector weight value (Sv) of selected stocks by
summing up the market cap values of all stocks in each sector each year.
f. Calculate the stocks’ final value weight (Sf) to be allocated each year as –
(Sf) = ((Ms) /(Sv)) * (Sa)
g. Determine the stocks’ final % portfolio weight (Ws) as –
(Ws) = (Sf)/ (MT)

4. Portfolio Rebalancing:
a. The selected stocks will remain in the portfolio for 1 year until the next
rebalancing date (i.e. 31 Dec of next year).

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 Appendix B: List of SDGs
For ease of reference, we copy the UN’s list of SDG’s here (see “Sustainable
Development Goals,” available at https://www.un.org/sustainabledevelopment/sustainable-
development-goals/)

• Goal 1. End poverty in all its forms everywhere

• Goal 2. End hunger, achieve food security and improved nutrition and promote
sustainable agriculture
• Goal 3. Ensure healthy lives and promote well-being for all at all ages
• Goal 4. Ensure inclusive and equitable quality education and promote lifelong
learning opportunities for all
• Goal 5. Achieve gender equality and empower all women and girls
• Goal 6. Ensure availability and sustainable management of water and sanitation
for all
• Goal 7. Ensure access to affordable, reliable, sustainable and modern energy for
all
• Goal 8. Promote sustained, inclusive and sustainable economic growth, full and
productive employment and decent work for all
• Goal 9. Build resilient infrastructure, promote inclusive and sustainable
industrialization and foster innovation
• Goal 10. Reduce inequality within and among countries
• Goal 11. Make cities and human settlements inclusive, safe, resilient and
sustainable
• Goal 12. Ensure sustainable consumption and production patterns
• Goal 13. Take urgent action to combat climate change and its impacts
• Goal 14. Conserve and sustainably use the oceans, seas and marine resources for
sustainable development

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• Goal 15. Protect, restore and promote sustainable use of terrestrial ecosystems,
sustainably manage forests, combat desertification, and halt and reverse land
degradation and halt biodiversity loss
• Goal 16. Promote peaceful and inclusive societies for sustainable development,
provide access to justice for all and build effective, accountable and inclusive
institutions at all levels
• Goal 17. Strengthen the means of implementation and revitalize the global
partnership for sustainable development

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