While price momentum is a stable part of financial markets, ESG scores are emerging more and more. However, there is an ongoing debate on the social responsibility of firms and the relationship with the performance. Literature offers mixed results whether the ESG enhances the performance of a stock, does not influence performance at all or even hampers the performance. In this paper, the pure price momentum is 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.
Padyšák, Matúš and Padyšák, Matúš, ESG Scores and Price Momentum Are More Than Compatible (July 13, 2020). Available at SSRN: https://ssrn.com/abstract=3650163 or http://dx.doi.org/10.2139/ssrn.3650163