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Research Review | 8 February 2019 | ESG Investing

Summary:
Can Sustainable Investment Yield Better Financial Returns: A Comparative Study of ESG Indices and MSCI IndicesMansi Jain (Guru Gobind Singh Indraprastha University), et al. 2 February 2019‘Sustainable investment’ includes a variety of asset classes selected while caring for the causes of environmental, social, and governance (ESG). It is an investment strategy that seeks to combine social and/or environmental benefits with financial returns, thus linking investor’s social, ethical, ecological and economic concerns… The purpose of this paper is to study whether the sustainable investment alternatives offer better financial returns than the conventional indices from both developed and emerging markets… The results indicate that there is no significant difference in the performance

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Can Sustainable Investment Yield Better Financial Returns:
A Comparative Study of ESG Indices and MSCI Indices

Mansi Jain (Guru Gobind Singh Indraprastha University), et al.
2 February 2019
‘Sustainable investment’ includes a variety of asset classes selected while caring for the causes of environmental, social, and governance (ESG). It is an investment strategy that seeks to combine social and/or environmental benefits with financial returns, thus linking investor’s social, ethical, ecological and economic concerns… The purpose of this paper is to study whether the sustainable investment alternatives offer better financial returns than the conventional indices from both developed and emerging markets… The results indicate that there is no significant difference in the performance between sustainable indices and the traditional conventional indices….

How ESG Investing Has Impacted the Asset Pricing in the Equity Market
Leila Bennani (Amundi Asset Management), et al.
November 2018
In this research, we analyze the relationship between ESG and performance in the recent years (2010 – 2017) since ESG was more an anecdotal and explanatory investment idea before the Global Financial Crisis. For that, we consider different regions (North America, Europe, Japan, World) and different investment styles (passive management, active management and factor investing). We show that ESG investing has been rewarded since 2014, but not before. Across the three ESG pillars, the Environment factor in North America and the Governance factor in the Eurozone performed the strongest. Overall, the study reveals that ESG does not impact all stocks, but tends to impact best-in-class and worst-in-class assets.
Contrary to common beliefs, we also observe that ESG had little impact on volatility and drawdown management during the 2010-2017 period. In the case of passive management, implementing an ESG strategy helps to improve the information ratio if the investor accepts to take a tracking error risk. Finally, we show that ESG investing is related to factor investing. In particular, we conclude that ESG investing remains an alpha strategy in North America, whereas it has become a beta strategy in the Eurozone.

Performance Assessment of Firms Following Sustainalytics ESG Principles
Aaron Filbeck (The Joseph Group Capital Management), et al.
January 1, 2019
Do highly rated ESG firms actually provide alpha opportunities for portfolios? This type of investing is not new, but has historically been a much more qualitative in nature. Sustainalytics, one of the largest agencies in the space, recently partnered with Morningstar Inc., which brought their proprietary rating system to the individual investor. We examines whether Sustainalytics ESG ratings (both the level and change) have an impact on future stock performance relative to a broad index like the S&P 500… Overall, our results indicate that firms following the ESG principles assessed by Sustainalytics do not hinder portfolio performance. In fact, on a raw return basis, the market tends to award higher returns, but these results appear to be driven by their relatively higher levels of alternative systematic risks. Thus, investors should note that if they feel passionate about ESG principles, they should, at worse, not underperform a broad market philosophy.

The Law and Economics of Environmental, Social, and Governance Investing by a Fiduciary
Max Schanzenbach (Northwestern U.) and R. H. Sitkoff (Harvard Law School)
September 5, 2018
The use of environmental, social, and governance (ESG) factors in investing is increasingly common and widely encouraged by investment professionals and non-government organizations. However, trustees and other fiduciary investors in the United States, who manage trillions of dollars, have raised concerns that using ESG factors violates the fiduciary duty of loyalty. Under the “sole interest rule” of trust fiduciary law, a trustee or other investment fiduciary must consider only the interests of the beneficiary. Accordingly, a fiduciary’s use of ESG factors, if motivated by the fiduciary’s own sense of ethics or to obtain collateral benefits for third parties, violates the duty of loyalty. On the other hand, some academics and investment professionals have argued that ESG investing can provide superior risk-adjusted returns. On this basis, some have even argued that ESG investing is required by the fiduciary duty of care. Against this backdrop of uncertainty, this paper examines the law and economics of ESG investing by a fiduciary. We differentiate “collateral benefits” ESG from “risk-return” ESG, and we provide a balanced assessment of the theory and evidence from financial economics about the possibility of persistent, enhanced returns from risk-return ESG.
We show that ESG investing is permissible under trust fiduciary law only if two conditions are satisfied: (1) the fiduciary believes in good faith that ESG investing will benefit the beneficiary directly by improving risk-adjusted return, and (2) the fiduciary’s exclusive motive for ESG investing is to obtain this direct benefit. We reject the claim that the law imposes any specific investment strategy on fiduciary investors, ESG or otherwise. We also consider how the law should assess ESG investing by a fiduciary if authorized by the terms of a trust or a beneficiary or if it would be consistent with a charity’s purpose, clarifying such cases by asking whether a distribution would have been permissible under similar circumstances.

CSR engagement and financial risk: A virtuous circle? International evidence
Pierre Chollet (Université de Montpellier) and Blaise W.Sandwidib UPEC)
November 2018
This paper investigates the complex relationship between the financial risk of firms and their engagement in corporate social responsibility (CSR), measured by Thomson Reuters ASSET4 environmental, social, and governance scores. Financial risk is estimated by the usual proxies: systematic, firm-specific, and total risks. Analyzing an international sample of 23,194 firm-year observations from 2003 to 2012 by using a panel vector autoregressive (VAR) model with generalized method of moments (GMM) estimations, we demonstrate a virtuous circle between corporate social performance (CSP) and risk (specific and total). More specifically, we show that a firm’s good social and governance performance reduces its financial risk and thereby reinforces its commitment to good governance and environmental practices.

Do Global Financial Markets Capitalise Sustainability? Evidence of a Quick Reversal
Fabio Moliterni (Fondazione Eni Enrico Mattei)
June 2018
This study investigates the growing importance of sustainability in equity markets by estimating whether company commitment to sustainability matters in corporate valuation. The spreading concern for social and environmental issues, and especially for the material risks of climate change, induces policy to encourage companies to prioritise sustainability in their decision making. There is growing evidence that points to a rationale for a profit-driven response to social and environmental problems, uncovering the role of sustainability in investors’ decisions. Exploring a panel of 3,311 listed companies in 58 countries for the period 2010-2016, this study reveals that sustainability contributes to the creation of market value for listed companies, over the considered period. Furthermore, it investigates how this relationship changes according to environmental policy stringency and sector sensitivity to climate policies.

Sovereign bond yield spreads and sustainability:
An empirical analysis of OECD countries

Gunther Capelle-Blancard (Universite Paris), et al.
January 2019
We study whether and how a country’s environmental, social, and governance (ESG) performance relates to its sovereign borrowing costs in international capital markets. We hypothesize that good ESG performance plays an economic role: It signals a country’s commitment to sustainability and long-term orientation and is a buffer against negative shocks, leading to lower sovereign bond yield spreads. Using a sample of 20 OECD countries over the period 1996–2012, we show that countries with good ESG performance are associated with lower default risk and lower sovereign bond yield spreads. Moreover, we show that the social and governance dimensions have a significant negative association with sovereign bond yield spreads, whereas the environmental dimension does not.

Equity SRI funds vacillate between ethics and money:
An analysis of the funds’ stock holding decisions

Robert Joliet and Yulia Titova (IESEG School of Management)
December 2018
We provide a detailed holdings-based analysis of investment decisions made by U.S. equity SRI funds. Besides incorporating conventional fundamental factors, such as earnings growth, leverage, dividend yield, stock return and volatility, SRI funds adjust portfolio weights by considering companies’ relative ESG performance. This holds for all categories of passively and actively managed funds, while for active funds ESG scores have a higher economic impact for value rather than growth funds. The timing of inclusion of companies in active SRI funds or their exclusion is driven primarily by fundamentals rather than by ESG performance. We find that both active SRI and matched conventional funds integrate ESG information as well as financial criteria in their investment decisions, but SRI portfolios exhibit higher average sustainability scores. Finally, we posit that SRI screening criteria effectively guide investment decisions, positive screening resulting in higher active portfolio weights of best performers in a corresponding ESG pillar.

James Picerno
James Picerno is a financial journalist who has been writing about finance and investment theory for more than twenty years. He writes for trade magazines read by financial professionals and financial advisers. Over the years, he’s written for the Wall Street Journal, Barron’s, Bloomberg Markets, Mutual Funds, Modern Maturity, Investment Advisor, Reuters, and his popular finance blog, The CapitalSpectator.

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