Companies with good or improving social characteristics have tended to outperform their lower-ranked peers on average by 15bps per month, according to new research from the Global Equities team at Hermes Investment Management.
ESG Investing: A Social Uprising, examines the impact of environmental, social and governance (ESG) factors on equity returns in the MSCI World Index from 31 December 2008 to 30 June 2018. The study found that:
Geir Lode, Head of Global Equities, Hermes Investment Management, said: “We have conducted this research twice before, in 2014 and 2016, and despite highlighting a link between corporate governance and returns, this is the first time we have seen a statistical link between social practices and a company’s performance.
“With the recent IPCC report on climate change and a slew of corporate governance scandals which have weighed heavily on share price performance, we have seen ESG investing accelerate from niche to norm. However, due to the intangible nature of social factors it has been harder for investors to quantify and understand this element and the importance placed upon it by investors has always lagged behind.”
The Hermes Global Equities team take a three-pronged approach to assessing social factors which takes into account the geographic location and the industry in which the company operates:
As concluded in the 2014 and 2016 research, the governance indicator has also been shown to be effective: well-governed companies have tended to outperform poorly governed companies since the start of 2009. And while this latest research reaffirms this, it also shows that the governance factor has been particularly ineffective in the past 12 months: during this period, poorly governed companies have tended to outperform well-governed companies. The research found that prior to November 2017, the longest period during which poorly governed stocks outperformed well-governed companies was three months in 2013. But in the six consecutive months to April 2018, poorly governed companies outperformed their well-governed peers.
Geir Lode explains: “These hyper-growth companies – businesses typically at an early stage of their life cycle 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. 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.”
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 score is built to use the data available at the historic point in time, adopting new sources as they became available to. In order to ensure sufficient historic data, the team limited the universe of companies to the MSCI World Index from 31 December 2008 to 30 June 2018.
The historic scores are used to create sector-neutralised rankings of companies based on the E, S and G scores. The team subsequently form region-neutralised portfolios of companies with the highest E, S and G rankings and those with low rankings. This methodology ensures they are comparing like-for-like companies and eliminating sector or regional biases from our portfolios.