Factor exposures of environmental, social, and governance (ESG) indexes

We examine the factor exposures of Environmental, Social, and Governance (ESG) indexes used as benchmarks by the largest ETFs with social responsibility (SR) focus. Our sample includes 31 ESG/SR indexes benchmarked by ESG/SR ETFs with the largest assets under management (AUM) as of January 31, 2020. We pay special attention to quality factors and use robustness of operating profitability and investment characteristics as proxies. Our findings indicate these indexes mostly act as expected in terms of size and value factors. Momentum factor, for the most part, is not significant. About half (14/31) exhibit a statistically significant positive quality tilt. However, there are some statistically significant negative tilts on proxies used for quality that can be explained by index composition. We also attempt to isolate the factor exposures due to the specific characteristics of the ESG indexes by pooling the individual ESG indexes by their segment benchmarks and analyzing ESG index returns in excess of non-ESG segment benchmark returns. Most exposures stay intact, though some reverse. However, the positive quality tilts persist. As the move from active to passive investment accelerates in the ESG space, understanding the factor exposures of these indexes is essential for investors, financial advisors, and fund managers.