Well-governed companies have outperformed poorly-governed counterparts by an average of over 30 basis points per month since the beginning of 2009, research1 from Hermes Fund Managers has found.
The report, entitled ESG Investing - Does it make you feel good, or is it actually good for your portfolio? examines the impact of environmental, social and governance (ESG) factors on equity returns. On average, companies rated in the top decile in terms of governance have outperformed those rated in the bottom decile by over 30bps per month. The research also highlights that it is the companies with the lowest-ranked governance scores which have tended to underperform the average, rather than the higher-scoring companies outperforming the average.
Geir Lode, Head of Hermes Quantitative Equities, said: u201cOur results suggest that it is poor governance that leads to underperformance, rather than good governance leading to outperformance. Furthermore, our research shows that companies with a poor standard of corporate governance underperformed in 61% of the months during the time periodu201d.
In terms of sectors and regions, using governance as an indicator of shareholder returns is more useful in Asia and Europe. North American markets are subject to more robust regulation and companies are at higher risk of litigation, which has led to a generally better standard of governance across companies making the measure less effective in North America.
Lode continued: u201cThis distortion in returns is also apparent by sector. If we turn to IT companies, there appears to be a negative relationship between governance scores and shareholder returns. The IT sector is dominated by a small number of companies whose performance over the past five years has been stellar despite a lower focus on their governance structureu201d.
However, despite the positive impact of companies with strong ESG characteristics, the impact of environmental and social factors was negligible. Despite increasing suggestions that companies seeking to tackle environmental and social challenges are more likely to achieve a lower cost of capital, better risk-adjusted returns and are therefore more resistant to share price volatility, there was no evidence to support this assertion over the same time period.
Lode concluded: u201cOverall, we found a strong link between underperforming companies and poor corporate governance. Yet, we did not see either a statistically significant relationship between shareholder return and environmental or social metrics. As more data becomes available, and more asset owners focus on environmental or social considerations, this may change. For now, we conclude that favouring well-governed companies can enhance the return of equity strategiesu201d.
1: Hermes used internal sources as well as external providers such as Trucost, Sustainalytics, Bloomberg and FactSet. We analysed companies in the MSCI World index from the end of2008 to end of November 2013.u00a0
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