Companies with poor corporate governance tend to underperform well governed companies by an average of 30bps per month according to new research by Hermes Investment Management, the £26 billion manager focused on delivering superior, sustainable, risk adjusted returns to its clients – responsibly.
The report from the firm’s Global Equities team entitled, ESG Investing: It still makes you feel good, it still makes you money, follows on from an earlier study conducted by the team in 2014 and examines the impact of environmental, social and governance (ESG) factors on equity returns from 2009-2016.
Geir Lode, Head of Global Equities, Hermes Investment Management said: “Two years on from our original study, which also showed a discrepancy of 30bps per month between well and poorly governed companies, this research highlights that the ‘governance premium’ is well and truly entrenched. Furthermore, our latest study demonstrates that the premium holds true across different geographies and sectors – albeit with a few caveats – proving the almost universal power of effective corporate governance.”
The research found Japan’s ESG scores to be lagging behind the three other major developed regions analysed: Asia Pacific ex Japan, Europe and North America. While North American companies scored highest on corporate governance, environmental and social scores trailed. The research also highlighted a negative relation between governance scores and shareholder returns for IT firms.
Lode explained: “The IT sector can be dominated by start-up companies which rapidly grow from micro-to-mega-cap businesses, often driven by a strong dominant founder. From a governance perspective, these companies can look weak – dictatorships are not the ideal corporate governance structure – but the returns achieved can be exceptional. Once these companies mature they tend to implement better standards of governance.”
However, the research did not prove that a statistically significant relationship between outperformance and environmental or social metrics exists. Nevertheless, it did confirm that favouring companies that are better at managing environmental and social risks (relative to their peers) does not tend to lead to underperformance.
Lode concluded: “2016 really was the year that responsible investing came of age. From Mark Carney, Governor of the Bank of England, highlighting the risk that climate change poses to financial stability through to the increased adoption of ESG market indices, it seems that the investment world has accepted that factors beyond traditional financial metrics can be material.”
To download the research report in full click here.
The Hermes Global Equities team has built a bespoke quantitative scoring methodology, which considers environmental, social and governance matters, evaluating each company’s current ESG characteristics and identifying positive change. The score combines data from Hermes EOS, CDP, Sustainalytics, Trucost, FactSet and Bloomberg.
The assessment methodology was applied to the constituents of the MSCI World index. There was sufficient data coverage for this index since 31 December 2007, allowing for scores to be created since 31 December 2008 (to allow for one year of data to measure changes in ESG practice). The test was conducted using monthly rebalancing, to match the greatest frequency at which the data set is updated.
Companies are assessed relative to their sector and geographic peers to remove any biases in the results.
Since our 2014 paper, we have improved the methodology used to create the scores. These changes have been driven by the availability of new data sources, allowing us to increase our focus on forward looking metrics, particularly regarding environmental and social risks. These new metrics assist in identifying which companies are setting robust programmes to reduce emissions, are better managing their supply chain risks and have a favourable outlook regarding any historic controversies impacting their business.
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