May 24, 2011
ESG Yields Profits
By Ron Robins, Founder & Analyst
When I started my career as an
investment analyst in 1970, the idea that a company’s
environmental and social activities would be important
in helping predict its future financial and stock
performance was seen as largely irrelevant. Well, not
anymore!
Inclusive of governance issues and abbreviated as ESG
(environmental, social and governance), factors
pertaining to ESG are now included in mainstream
corporate stock and bond analysis in numerous investment
firms, funds and managers globally. Why? Because it
provides analysts better insight into companies and a
possibility of producing higher investment returns with
less risk.
ESG has its beginnings in ethical and socially
responsible investing (SRI), which have their roots in
some religious traditions. Now, with mounting
environmental and climate change concerns, ‘green’ or
sustainable investing has emerged. It was with these
asset classes that ESG issues first began to play a
pivotal role. However, ESG issues are now becoming a
significant factor in all asset classes.
Evidencing the enormous shift towards inclusion of ESG
issues in investment analysis among global financial
institutions, were the findings reported in a September
14, 2010, press release of the United Nations (UN)
Principles for Responsible Investment (PRI). The PRI is
a “ …framework to help investors achieve better
long-term investment returns and sustainable markets
through better analysis of environmental, social and
governance issues in investment process and the exercise
of responsible ownership practices.” Companies sign on
as signatories to the PRI framework.
In the PRI press release, Executive Director James
Gifford said, “every large, world-class listed company
is now monitoring and reporting on its ESG performance,
and so too are an increasing number of investors.” The
PRI reported that, “total [PRI] signatory numbers… has
jumped in the last year by more than 30 per cent… The
value of the assets under management of PRI signatories
now stands at $22 trillion, over 10 per cent of the
estimated total value of global capital markets…”
Continuing, “signatories are now drawn from 45
countries… Over 95 per cent of asset owners and 87 per
cent of investment managers have an overall investment
policy that addresses ESG issues... The percentage of
asset owners involved in dialogue with regulators on ESG
issues rose to 85 per cent.”
And governments and regulators everywhere are listening.
Countries that are taking big steps in promoting ESG
issues in corporate reports include the USA, the UK,
France and Sweden. Also, the European Union might soon
have a policy for all member countries on ESG corporate
reporting as well.
Even stock exchanges are becoming proactive on ESG
issues concerning their listed companies. For instance,
in South Africa, the Johannesburg Stock Exchange became
the first exchange to require all listed companies to
produce fully integrated financial and ESG reports. In
Malaysia, its major stock exchange, the Bursa Malaysia,
actively pursues ESG reporting among its listed
companies.
As a result of such interest, especially by global
investment institutions and individual investors, ESG
stock and bond indexes are becoming commonplace
everywhere. All the major stock/bond index producers—Dow
Jones, FTSE, MSCI, S&P etc.—have global, continental,
country and often even industry specific ESG stock
indexes.
Encouraging the ESG cause are studies demonstrating
improved financial, portfolio and stock performance
where ESG factors are analytically applied. One study,
published in March 2009 is by risklab, a division of
Allianz Global Investors. It is “… a landmark study
[that] strengthens the position of ESG advocates. The
results reveal that a focus on ESG (environmental,
social and corporate governance) factors can
significantly reduce portfolio risk or enhance returns.
The study… is the first systematic quantitative analysis
explicitly examining ESG risk in a portfolio context…
[it] concludes that investors ‘not only have a right to
feel good about promoting ESG, but that clear financial
benefits can be expected.”
Another study finds that, “… [ESG] improves portfolio
diversification through a reduction of the average
stock’s specific risk …ESG criteria probably leads
best-in-class ESG screened funds to be better
diversified than otherwise identical conventional funds…
pension funds should at least contemplate about the use
of ESG criteria, as an ignorance of ESG criteria could
violate their fiduciary risk management duties.” (From,
Portfolio Diversification and Environmental, Social or
Governance Criteria: Must Responsible Investments Really
Be Poorly Diversified? By Andreas G. F. Hoepner of the
University of St. Andrews, School of Management,
Principles for Responsible Investment, UN.)
And a third study also by risklab, reported in Global
Pensions on April 18 found that ESG can reduce the risk
of negative or ‘tail’ risk impacts on portfolios in
emerging as well as developed markets. “ … The tail risk
of an ESG risk neutral emerging market equity strategy
defined by the MSCI Emerging Markets Index can be
reduced from -64.5 per cent p.a. to -38.8 per cent. The
same is true for corporate bonds defined by the Merrill
Lynch Global Broad Market Corporate Index, it added,
where the tail risk—measured as conditional value at
risk (95 per cent) of the default strategy—can be
reduced from -8.1 per cent p.a. to -4.9 per cent... [and
for developed market equity, the] tail risk optimisation
potential of the ESG neutral default strategy defined by
the MSCI World Equity Index [went down] from -38.1 per
cent p.a. to -25.7 per cent.”
With increasing social, environmental and climate change
risks, it makes dollars and cents to now include ESG
issues in investment decisions. And that is why asset
managers and investors everywhere are adopting ESG
criteria in the selection of individual stocks and bonds
as well as aiding in their structuring of entire
portfolios.
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