Winners vs. Losers: Momentum-based Strategies with Intertemporal Choice for ESG Portfolios

TL;DR

This paper develops a dynamic, regime-aware momentum strategy incorporating ESG sentiment and tail-risk metrics, revealing that ESG-loser portfolios outperform winners in pro-ESG regimes due to market overreactions.

Contribution

It introduces a novel state-dependent momentum framework integrating ESG regimes with tail-risk-adjusted metrics, enhancing portfolio performance in turbulent markets.

Findings

ESG-loser portfolios outperform winners in pro-ESG regimes.

Market overreaction to ESG sentiment causes short-term inefficiencies.

Framework is effective across equities and cryptocurrencies.

Abstract

This paper introduces a state-dependent momentum framework that integrates ESG regime switching with tail-risk-aware reward-risk metrics. Using a dynamic programming approach and solving a finite-horizon Bellman equation, we construct long-short momentum portfolios that adjust to changing ESG sentiment regimes. Unlike traditional momentum strategies based on historical returns, our approach incorporates the Stable Tail Adjusted Return ratio and Rachev ratio to better capture downside risk in turbulent markets. We apply this framework across three asset classes, Russell 3000 equities, Dow Jones~30 stocks, and cryptocurrencies, under both pro- and anti-ESG market regimes. We find that ESG-loser portfolios significantly outperform ESG-winner portfolios in pro-ESG regimes, a counterintuitive result suggesting that market overreaction to ESG sentiment creates short-term pricing inefficiencies. This pattern is robust across tail-sensitive performance metrics and is most pronounced under a two-week formation and holding period. Our framework highlights how ESG considerations and sentiment regimes alter return dynamics, offering practical guidance for investors seeking to implement responsive momentum strategies under sustainability constraints. These findings challenge conventional assumptions about ESG investing and underscore the importance of dynamic, regime-aware portfolio construction in environments shaped by regulatory signals, investor flows, and behavioral biases.