Does Responsible Investment Drive Long Term Returns?

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Does Responsible Investment Drive Long Term Returns?

  • Does Responsible Investment Drive Long Term Returns? This article sheds light on proof that responsible investment is not to the detriment of returns, but in fact one which creates long-term financial returns for investors.
  • Date: Jan 31, 2018
  • Category: Responsible Investment

Since the 1970’s there has been an abundance of research into the correlation between Environmental, Social and Governance (ESG) integrated investing and portfolio performance. Despite this plethora of research and the growing traction that responsible investment has gained, investors have been reluctant to shake the belief that responsible investing comes with a performance trade-off. This article includes a summary of the most important research that proves responsible investment is not to the detriment of returns, but that it in-fact creates and sustains long-term financial value for investors.

1

Deutsche Bank

Aggregated evidence from over 2000 empirical studies investigates whether integrating ESG into the investment process has a positive effect on corporate financial performance.

2

Arabesque

Meta-study analysing 200 sources aims to provide concrete evidence about the relationship between corporate sustainability and operational and financial performance.

3

McKinsey

Discussion paper delving into the effects of short and long-termism on financial performance by comparing the success of 615 companies over a 14 year period.

4

NN Investments

Empirical study evaluates the specific ESG factors affecting share price performance of emerging market equity portfolios.

5

MSCI

Research comparing the long-term performance of two ESG investment strategies against a global benchmark.

1. ESG and Financial Performance: Aggregated Evidence From More than 2000 Empirical Studies.

Deutsche Bank and University of Hamburg, October 2015

The aim of this report was to determine tothe results of 2,200 past ESG studies in order to aggregate evidence for the correlation between ESG and corporate financial performance (CFP).

The results of the meta-study revealed that the majority of studies found a positive ESG-CFP correlation. There were some differences between asset classes, with a 52.2% positive correlation for equities, which rose to 63.9% for bonds and 71.4% for real estate. Alongside differences in asset classes, the study also identified that no single ESG criterion has a "dominating effect on CFP”. Finally, the study found a number of regional biases. Emerging markets exhibited the highest share of positive results (65.4%). In developed Asia/Australia, 33.3% of research showed positive results; however the region also possessed the largest share contradictory ESG-CFP negative correlations, at 14.3%. The smallest share of positive results were seen in develop European markets, where only 26.1% of studies showed a positive ESG-CFP correlation.

2. From the Stockholder to the Stakeholder – How Sustainability can Drive Financial Performance.

Arabesque Asset Management Ltd and University of Oxford, March 2015

This meta-study provides an in-depth overview of ESG research, based on the findings of more than 200 academic studies as well as industry reports, articles and books. The aim of the report was to provide concrete evidence about the relationship between corporate sustainability and company performance.

The report unveils a clear link between ESG and company performance. An overwhelming majority (88%) of sources found that companies with well-developed sustainability practices demonstrate better operational performance. These sustainability practices include: the board assuming responsibility of company-wide sustainability goals, broader stakeholder-orientation and a structure that incentivises employees to innovate. Alongside operational performance, 80% of studies found that prudent sustainability practices also have a positive influence on a company’s shares. Specifically, the research finds that good corporate governance, eco-efficiency and employee satisfaction contribute to better stock market performance.

3. Measuring the Economic Impact of Short-Termism

McKinsey & Company, February 2017

The discussion paper aimed to provide a factual base to settle the ongoing debate about the effects of short and long-termism on financial performance. The researchers undertook a systematic measurement of 615 publicly listed US long and short-term oriented companies. This approach, termed the “Corporate Horizon Index” (CHI) is based on patterns of investment, growth, earnings quality, and earnings management.

McKinsey found that, over a period of 14 years, long-term companies significantly outperformed short-term companies with higher, less volatile revenue growth. Furthermore, long-term companies generated 81% higher annual economic profit than short-term companies. Alongside economic success, the researchers demonstrated that long-term companies deliver greater total returns to shareholders than other companies. Astoundingly, the market capitalisation of long-term companies over the time period grew $7 billion more than their short-term peers, despite experiencing exaggerated market capitalisation declines during the financial crisis. The research concludes that companies classified as long-term outperform their shorter-term peers on a range of key economic and financial metrics.

4. The Materiality of ESG Factors for Emerging Markets Equity Investment Decisions: Academic Evidence

NN Investment Partners and European Centre for Corporate Engagement, January 2017

This empirical study evaluates the performance of emerging market equity portfolios that are formed using ESG criteria. Utilising ESG data and ratings of 751 MSCI Emerging Markets Index listed companies, the study looked at the performance of high ESG-rated companies relative to low ESG-rated companies. The metric used to evaluate the performance was the Sharpe ratio – a risk adjusted measure of the rate of return.

The results show that high ESG-rated companies have a higher Sharpe ratio than low-ESG rated companies. This higher ratio is derived from both better returns and lower volatility, suggesting that investors who select high-ESG rated shares can expect both outperformance and reduced risk. The study also finds that a high environmental score and concentration of ownership are two of the most positive influencers on a high Sharpe ratio. Moreover, the researchers argue that for emerging market investors, the ESG rating momentum has a large positive impact on the Sharpe ratio. Therefore, investors should seek to invest in companies that can demonstrate a meaningful, long-term effort to improve ESG credentials by considering both the level and changes in ESG scores.

5. Can ESG add Alpha? An Analysis of ESG Tilt and Momentum Strategies

MSCI, June 2015

The researchers set out to dispel the myth that responsible investing is to the detriment of financial performance. To do so, they analysed the financial returns of two investment strategies. The ‘ESG Tilt’ strategy overweights stocks with higher ESG ratings and the second strategy ‘ESG Momentum’ overweights stocks that have improved their ESG rating over recent time periods.

The results are impressive, with both strategies outperforming the MSCI World Index over an eight year period, with the ‘ESG Tilt’ strategy delivering a 12% outperformance against the benchmark. The ‘ESG Momentum’ strategy found that shares with increasing ESG rating over a 12 month period, tended to perform well in the next year, thereby proving that the momentum factor positively correlates to stock performance. These findings advocate for investors to employ systematic ESG strategies that not only improve a portfolio’s ESG performance but may also outperform a global benchmark.

Author

Esther Toth, Corporate Citizenship

Esther Toth is an Associate Director at Corporate Citizenship. Working with clients globally, she has developed an in-depth expertise in ESG ratings and reporting. She has a particular interest in measuring the impact of sustainable business practices, which in turn can drive scale and innovation. Esther advises multinational companies to adopt tailored strategies to engaging investors on ESG risks and opportunities.

  • Tags : Responsible Investment, ESG, Financial Performance, Stockholder, Stakeholder, Measuring, Economic, Short-Termism.

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