ESG integration has been at the forefront of the changes in the investment landscape over the past decade, with these three factors being part of the criteria investors take into consideration when looking at a firm’s ethical impact and sustainable practices.
Hermes’ third edition of its biennial ESG report, ESG Investing: A Social Uprising, which looks at the development and impact that ESG integration has had on companies over the last two years, suggests that as a growing number of investors take into account the transition to a low-carbon economy, companies have started implementing sustainable practices to meet the demand.
Even though attractive environmental characteristics have a very small percentual significance for companies (less than 0.1%), the Hermes report shows that such features are the ones differentiating companies between the top decile and the lowest decile.
Specifically, companies with better environmental characteristics have outperformed those in the lowest decile for the last seven years (by calendar year). Similarly, environmental factors seem more effective during down markets than bull markets, recording a 19bps difference.
According to the report, the social factor is the most relevant one. It has a statistical significance (with the average monthly dispersion between companies in the lowest decile reaching above 0.3% in 2009 and 2012) and research showed that companies with poor or worsening social practices have underperformed by 15bps each month since 2009.
However, the social aspect has a varied geographical relevance. For instance, it is very effective in Japan, mostly effective in Asia and Europe, and has made little difference in North America.
Up until 2017, corporate governance was one of the most effective indicators – well-governed companies were very likely to be the ones in the top decile. However, in the last year poorly governed companies appear to have performed better than well-governed ones.
The report attributes this change to the leadership that Faangs (Facebook, Amazon, Apple, Netflix and Google) have had in the US stock market. Defining them as “hyper-growth companies”, the report suggests that, although Faangs are facing rocket-high growth rates, they are often “young, disruptive companies” that do not meet traditional ESG standards.
Consequently, the report differentiated between hyper-growth and non-hyper-growth companies, with the results backing up previous claim that good governance results in better performance. For hyper-growth companies the average monthly dispersion for bad governance was -0.05%, while non-hyper-growth ones recorded -0.25%.
“These hyper-growth companies – businesses typically at an early stage of their lifecycle and experiencing stellar growth rates but often trading at high multiples – have delivered incredible returns, propelling the market to record highs despite already lofty valuations,” said Geir Lode, head of global equities at Hermes Investment Management.
“As relatively young disruptive companies, these often do not meet traditional ESG standards and score quite poorly on governance factors. Indeed, three of the five Faangs ranked in the lowest decile of governance in the six months to April 2018. This finding suggests that the Faangs disrupted the performance of the governance factor significantly during the six-month time period.
“Since our first study in 2014, ESG integration has evolved as an investment concept across the industry and environmental and governance issues have never been in doubt. It is therefore encouraging to see the rise of social. E, S and G matter to companies and investors. It is time this was recognised.”
In the US
Similar results were found by the US Forum for Sustainable and Responsible Investment (US SIF). In their Biennial US Sustainable, Responsible and Impact Investing Trends, the US SIF found that, since 2016, there has been a 38% increase in investors considering ESG factors, now amounting to $12trn (£9.3trn, €10.6trn) of professionally managed assets.
Source:Last Word Research
Dublin-based institutional asset manager KBI Global Investors welcomed the US SIF findings.
Noel O’Halloran, chief investment officer at KBI Global, said: “We can see that investors, in increasing numbers, are rejecting the long-held fallacy that there is some sort of trade-off between investment performance and investing responsibly.
“The ESG performance of a company directly influences whether (and if so, how much) we will invest in that company, across all our portfolios; they see that as a source of competitive advantage that is increasingly attractive to many investors, as evidenced by the results of this latest US SIF Report.”