ESG scores are already well-established, and nobody doubts that the scores affect investors or companies. Investors seem to care more and more about the other aspects of the stocks and not just the profits – the human welfare, ecology or social aspects of our lives. Additionally, numerous researches point out that the the ESG scores can positively affect also the portfolios. However, the novel research by Colak et al. (2020), has examined other implications of the ESG scores: how the ESG affect the CEOs. To be more precise, how the adverse ESG events and subsequent negative media attention affects the longevity of the CEOs. The finding is that negative event significantly increase the probability of the CEO being replaced. Overall, the research paper highlights the importance of ESG scores in the corporate world.

Nobody can doubt that in the recent period, ESG investing has significantly grown and is a staple part of the financial markets. The academic literature has also grown with the popularity of ESG investing. The negative, mixed and positive results for ESG scores in portfolios have evolved, and generally, there is a consent that ESG scoring can be a vital part of the portfolio management process. It can be observed that in the past, the ESG scores were not priced in the equity market and still, the ESG is not priced in the corporate bond market (apart from Europe). Nowadays, the investors react to the ESG scores, but the research paper of Cui and Docherty (2020) has novel insights that investors may react too much to the ESG. Their research shows that investors overreact to the negative ESG events and stocks connected with negative ESG events sharply fall, but the prices have mean-reverting properties. As a result, there is a reversal after bad ESG events. Stocks firstly sharply fall, but then their prices are reverted to the previous values. Therefore, this paper is interesting from the market pricing or efficiency point, but it also can be utilized by a reversal investor.

Corporate bonds and equities of the same firm should share the same fundamentals, but does this preposition hold for the ESG scores and their implications? In the equity market, there is convincing literature that states that ESG scores lower risks or even can improve the performance of portfolios. However, it was shown that the ESG implications could not be universally applied to all countries and their markets. Novel research by Slimane et al. (2020) examines the role of the ESG in the fixed market. The paper shows that the fixed income market is probably some years behind the equity market, but the ESG is also emerging in the fixed income. The performance of ESG outperformers compared to underperformers is continually rising. In Europe, the difference is already economically significant; the rest of the world seems to lag a little. Therefore, the ESG might have a bright future also in the corporate bond market. So far, the results are promising…

Our own research paper ESG Scores and Price Momentum Are More Than Compatible utilized the Knapsack problem to make the ESG strategies more profitable or Momentum strategies significantly less risky. The implementation of the Knapsack problem was created in R, using slightly modified Simulated annealing optimization algorithm. Recently, we have been asked about our implementation and the code. The code is commented and probably could be implemented more efficiently (in R or in another programming language). For example, R is more efficient with matrices, but the code would not be that “straightforward”. Lastly, the most important tuning parameter is the temperature decrease (the probability of accepting a new solution is falling with the rising number of iterations).

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What will happen if we mix ESG scoring with price momentum? Can we improve simple ESG investing strategy?

The pure price momentum can be combined with ESG scores using a Knapsack algorithm. Knapsack algorithm is a well-known mathematical problem of optimization, and in the case of momentum and ESG, can be used to make the momentum portfolios significantly more responsible, with lower volatility and better risk-adjusted return. The second option is to make the ESG portfolio substantially more profitable by using Knapsack algorithm to construct high ESG portfolio with large momentum. The approach resulted in a strategy with high ESG score and compared to pure momentum or momentum-ESG strategy, with significantly reduced volatility. Therefore, the ESG-momentum strategy has the best risk-adjusted return, the lowest drawdown, the lowest volatility and the most consistent returns.