Stockholm (NordSIP) – “Companies and investors simply cannot afford not to care,” is the main conclusion in the Nordic Ideas report from the Nordea Equity Research team, which was published this week. Among other things, the report finds a growing interest in ESG among asset managers, the public and regulators, that ESG screening is a worthwhile tool, and that ESG screening contributes to risk mitigation and, as such, has become a justified component in company valuation.
The focus on ESG integration is highest in the Nordics, according to the report, with a higher valuation premium in the Nordic region and Europe generally than in North America. The Nordic region also stands out as a top performer in ESG ratings. Nordea Equity Research argues that his could lead to more ESG investments from companies as they see increased customer demand, which could allow pricing to compensate for ESG-related costs. ESG investments also tend to pay off in terms of higher returns in higher ESG ratings categories, so while greater ESG may lead to short-term pain, the longer-term gain can be substantial.
While a strong ESG performance contributes to risk mitigation, the report finds, it is also an indicator of strong operational and share price performance. Nordea’s analysts also found, to their surprise, that ESG factors added alpha to already proven quant factors despite a lack of correlation between these, making it a valuable addition to quant analysis. Finally, ESG ratings can be a leading indicator of future earnings stability and a predictor of share price volatility.
Among the key findings of the report:
- Interest in ESG among corporates, the public and regulators is growing, especially in the Nordics;
- ESG-related risks can translate into poor operational performance for companies, and impact flows for asset managers;
- Companies that invest in ESG are generally of higher quality;
- 2012 is when ESG really started to matter as a quant factor;
- ESG factors are likely to become more important in the future;
- Investing in ESG strategies in Europe has worked well since the beginning of 2013;
- Performance divergence is most visible in the worst performers and in the top two ratings;
- High ESG-rated companies score better on many fundamental metrics;
- ESG ratings a re a good proxy for future operational performance;
- Highly rated ESG companies are valued at a premium – justified by lower cost of capital and superior returns;
- The premium is higher in Europe and the highest in the Nordics, where the focus on these factors is the greatest;
- ESG screening by asset managers can impact flows into ESG-rated companies, impacting cost of capital and with it valuations;
- Asset managers are becoming increasingly sophisticated in their approach to ESG;
- 2011-2013 marked a grand increase in ESG-related investment strategies;
- Exclusions remain the dominant strategy, at more than EUR 10 trillion, covering 48% of professionally managed assets in Europe;
- Since 2012, a combination strategy of quality and ESG has generated considerable alpha;
- ESG combined with value has added to upside and limited downside since 2012;
- ESG as a leading indicator helps explain its incremental alpha versus a ‘plain vanilla’ quality strategy
Read the report here.
Image: (c) Andrey Yurlov – shutterstock