- Massimo Garbuio
- Jun 9
- 3 min read
Environmental, social, and governance (ESG) investing has become a popular approach for investors seeking to align their portfolios with ethical values while aiming for strong financial returns. Many believe that investing in ESG leaders—companies already excelling in ESG metrics—guarantees better performance. Our recent research challenges this assumption. We tested ESG investing claims and found that simply choosing ESG leaders or following traditional ESG strategies does not deliver superior returns. Instead, companies that show sustained improvement in ESG performance over time outperform not only the market benchmarks like the S&P 500 and ASX 200 but also peer portfolios and traditional ESG leaders.
This post explores the findings of our study, explains why sustained ESG improvement matters, and offers practical insights for investors looking to build portfolios that truly benefit from ESG factors.
Why Traditional ESG Leadership Strategies Fall Short
Many ESG investment strategies focus on companies that already rank highly on ESG ratings. These companies are often labelled as "ESG leaders." The assumption is that these leaders have lower risks and better management practices, which should translate into better financial performance.
Our research tested this assumption by comparing portfolios of ESG leaders against the broader market and portfolios focused on companies with sustained ESG improvement. The results showed:
No significant outperformance by ESG leaders compared to the S&P 500 or ASX 200.
ESG leader portfolios often underperformed peer portfolios that did not emphasise ESG.
Traditional ESG strategies failed to capture the dynamic nature of ESG progress.
This suggests that simply investing in companies with high ESG scores at a single point in time does not guarantee better returns.
The Power of Sustained ESG Improvement
Instead of focusing on static ESG leadership, our study highlights the value of companies that continuously improve their ESG performance. Sustained ESG improvement means companies actively addressing environmental, social, and governance issues over time, showing measurable progress year after year.
Key findings include:
Portfolios built around companies with sustained ESG improvement outperformed the S&P 500 and ASX 200 by a significant margin.
These portfolios also beat traditional ESG leader portfolios and peer groups.
The outperformance was consistent across different sectors and regions.
This indicates that investors benefit more from tracking ESG momentum rather than static ESG ratings.
How Sustained ESG Improvement Drives Returns
There are several reasons why sustained ESG improvement may lead to better financial outcomes:
Risk reduction: Companies improving ESG practices reduce exposure to regulatory penalties, environmental liabilities, and social controversies.
Operational efficiency: ESG improvements often reflect better resource management, energy efficiency, and employee engagement, which lower costs.
Innovation and growth: Firms committed to ESG progress tend to innovate in products and services, opening new markets.
Investor confidence: Continuous ESG improvement signals strong management and long-term vision, attracting more investment.
By focusing on companies with ongoing ESG progress, investors tap into these benefits, which translate into higher returns.
Practical Steps for Investors
Investors interested in leveraging sustained ESG improvement can take the following steps:
Look beyond ESG scores: Use data that tracks ESG performance over multiple years to identify companies with positive momentum.
Monitor ESG initiatives: Review company reports and disclosures for evidence of concrete ESG actions and improvements.
Diversify across sectors: Sustained ESG improvement can occur in any industry, so avoid limiting investments to traditional "green" sectors.
Engage with companies: Active ownership and dialogue can encourage continued ESG progress.
Use dynamic screening tools: Employ investment platforms that incorporate ESG trend data rather than static ratings.
These approaches help build portfolios that benefit from real ESG change rather than just reputational labels.
Examples of Sustained ESG Improvement in Action
A manufacturing company that reduced its carbon emissions by 30% over five years while improving worker safety saw its stock outperform the sector average.
A financial services firm that enhanced board diversity and strengthened governance policies consistently improved its ESG scores and delivered above-market returns.
A technology company investing in renewable energy and community programs showed steady ESG progress and attracted long-term investors.
These examples illustrate how sustained ESG improvement aligns with financial success.
What This Means for the Future of ESG Investing
Our findings suggest a shift in ESG investing focus is needed. Instead of chasing ESG leaders, investors should prioritise companies demonstrating real, ongoing ESG progress. This approach offers a clearer path to both positive impact and financial gain.
As ESG data quality improves and investors demand more transparency, tracking sustained improvement will become easier and more reliable. This will help investors avoid greenwashing and make better-informed decisions.
The original research: https://www.sciencedirect.com/science/article/pii/S1544612326004344