Socially Responsible Investing: Combining ESG Ratings with News Sentiment Generates Alpha

ESG ratings as a stock screener for downside protection can be significantly improved when combined with sentiment indicators derived from news and social media. Following a statistical approach, consisting in evaluating thousands of long-only monthly-rebalanced random portfolios, we find supporting evidence that: (1) ESG ratings used for portfolio screening provide downside risk mitigation and a positive, albeit modest, increase in performance with respect to fully random portfolios. (2) The performance and downside protection of ESG-screened portfolios can be enhanced by adding a sentiment overlay. (3) The price reaction of ESG-related negative events leads to fast momentum signals followed by slow reversal signals. (4) A double overlay of broad sentiment and ESG reversal signals improves alpha generation by up to 300 basis points and reduces the maximum drawdown by a factor of 2 compared to the random market portfolio.