July 10, 2017

10 studies that show how and why ESG investing works

by TruValue Labs

Earlier this year, we laid out the top 10 reasons Wealth Advisers and Managers are following investor demand to ESG.

The next question: how do ESG, or environment, social, and governance investments, perform? When do these strategies work, and why?

Here’s a look at the circumstances under which ESG-related investing works the best, across different asset classes such as stocks and bonds.

10. First, there’s the elephant in the ESG research room: Friede, Busch, and Bassen’s landmark metastudy that reviewed the results of 2,200+ studies from 1970 through 2014.

It’s one of the most comprehensive, authoritative looks at the subject, and you can see the results at the top of this page: corporate financial performance is positively linked most of the time with ESG factors individually, and taken in combination.

“The results show that the business case for ESG investing is empirically very well founded,” the authors write. “Roughly 90% of studies find a nonnegative ESG–CFP (corporate financial performance) relation. More importantly, the large majority of studies reports positive findings.”

9. How do intangibles contribute to financial performance? One specific example comes from a paper titled “Does the stock market fully value intangibles? Employee satisfaction and equity prices,” published in the Journal of Financial Economics.

The study found that firms with above-average employee satisfaction showed abnormal positive returns and earnings surprises:

“The stock market does not fully value intangibles, even when independently verified by a highly public survey on large firms … certain socially responsible investing (SRI) screens may improve investment returns.”

8. … That strategy has been employed by San Francisco-based Parnassus, whose fund Parnassus Endeavor has beat the S&P 500 by nearly four percentage points since its inception in 2005.

As Fortune reports, “Overall, Parnassus Endeavor is not only the top performer among so-called sustainable and responsible funds, but it’s №1 among all large-cap growth stock funds over every long-term period measured by research firm Morningstar, from one year to 10 years.”

7. What about the ESG relationship with corporate credit? That’s what analysts at Hermes Credit set out to find in a study published early this year.

The results: using proprietary ESG scores, Hermes found higher spreads for lower-decile ESG performers, as shown in the chart above.

The analysis covered companies in four CDS indices — the CDX High Yield, CDX Investment Grade, iTraxx Europe, and iTraxx Crossover — from 2012 to 2016.
Hermes found that:

• “issuers with the lowest QESG Scores tended to have the highest median CDS spreads…”
• “the distribution of observed annual average CDS spreads was also widest among the lowest QESG deciles….”
• “This implies that firms with lower ESG scores produce more unpredictable investment returns. Conversely, issuers with the highest QESG Scores tend to have the lowest CDS spreads and the narrowest distribution of spreads, which should result in a more stable return profile.”
• “…companies with higher QESG Scores tend to have lower CDS spreads.”

6. More to support the credit connection: A study by MIT and Breckenridge Capital found correlations between ESG factors and a variety of credit metrics:
“We found significant quantitative evidence that ESG scores are positively correlated with small, stable spreads in corporate debt markets. This relationship also applies to other financial metrics such as ROA and leverage ratios. Furthermore, these relationships appear to strengthen during periods of market turmoil, and persist throughout market recoveries.”

To get the details on the metrics studied, including Option Adjusted Spread and others, you can find the paper at this link.

5. Last November in Denver, SRI held its 27th annual conference. At the breakout session “Performance Methodology: Are We Asking the Right Questions?” the discussion centered on the influence of ESG analysis on portfolio risks and returns. Thanks go to the First Affirmative Financial Network blog, which wrote about the event in a blog.

Per First Affirmative, Stephen Freedman, PhD, the head of Thematic and Sustainable Investing Strategy for UBS Wealth Management Americas, discussed a meta-analysis he performed on 51 independent studies.

“Freedman concluded that there is a ‘statistically significant positive correlation’ between a fund being labeled as SRI and its financial returns. Whether it is a large firm like UBS, or a smaller one, most everyone now agrees that SRI has a neutral to positive affect on financial performance of investment portfolios.”

UBS is taking actions to back up the talk — it’s in the process of educating its 7,000 financial advisors in the U.S. on how to incorporate sustainable investing practices.

4. A 2012 review by Deutsche Bank Group (chart above) found that 89% of studies on ESG show companies with high ESG ratings show market-based outperformance, while 85% of the studies show accounting-based outperformance.

3. A study of Thomson Reuters ESG dataset by Bank of America Merrill Lynch found that ESG integration can protect investors from bankruptcies, volatility, price declines, and earnings risk.

A study of Thomson Reuters ESG dataset by Bank of America Merrill Lynch found that ESG integration can protect investors from bankruptcies, volatility, price declines, and earnings risk.

More details can be found at the study link, or in the excerpt below.

Materiality means examining a company’s ESG performance in areas that matter for financial performance for that industry. A framework for materiality is currently being finalized by the Sustainability Accounting Standards Board, or SASB.

The emerging best-practice of materiality analysis was used in this study by Khan, Serafeim, and Yoon, who found that:

“…firms with good ratings on material sustainability issues significantly outperform firms with poor ratings on these issues. In contrast, firms with good ratings on immaterial sustainability issues do not significantly outperform firms with poor ratings on the same issues.”

1. Momentum matters: The most recent evidence in this area comes from NN Investment Partners in London, which studied ESG momentum — positive and negative changes in ESG score, and how it relates to financial performance.

“…The research demonstrated a clear positive relationship between incremental changes — or momentum — in a company’s ESG scores and investment performance,” authors of the study write. “Stocks with positive momentum in ESG scores outperformed those with negative momentum, with the strongest positive performance effect found by companies with medium ESG scores.”

So, how can you examine ESG performance in ways that let you put these powerful relationships with financial performance to work?

  • For momentum, you’ll want an ESG solution with timely data.
  • For materiality, and individualized E, S, and G scores, you’ll want granular category performance
  • For intangibles, you’ll want to track the latest events and reactions from consumers.

These are all investment needs that TruValue Labs’ app on Thomson Reuters Eikon, Insight360 SASB on Eikon™ was built to satisfy.

Timely ESG insights with annual company-reported data all filtered by SASB materiality standards. Available in the Eikon App Studio for subscribers.

TruValue Labs sells subscription licenses to financial professionals for our SaaS-based Insight360 application, both directly and in the Thomson Reuters Eikon App Store. 


Request a free trial of Eikon today.

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