Is ESG a Self-fulfilling Prophecy?


New research from Amundi suggests that ESG considerations have started to improve portfolio performance, but caveats remain.

Stockholm (NordSIP) – As ESG considerations continue to gain popularity within the asset management community, the issue of performance is still at the forefront of the investors’ mind. Driven by concerns that past studies may be tainted by the poor quality of the data that dominated the early years of this investment trend, researchers at Amundi have used a more recent and proprietary dataset that excludes the pre-financial crisis period to investigate this matter. Their results suggest that ESG may indeed have a positive effect on performance. However, the difficulty researchers encountered when identifying whether performance is determined by actual profitability or by herding should be a cause for pause for investors looking to base their sustainable investment decisions on past outperformance alone.

The research, led by Thierry Roncalli, Head of Quantitative Research at Amundi, was based on a dataset of 1700 companies between 2010 and 2017 covered in the North America, EMU, Europe-ex EMU, Japan and World MSCI indices. The companies are ranked according to their ESG scores and divided into five quintile portfolios from best-ranked to worst-ranked. Finally, the authors also considered the different impact of active and passive investment strategies.

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Although the research suggests that ESG is of little consequence on drawdowns and volatility screening seems to be significant for portfolio returns, the direction of this effect appears to be dependent on the period under consideration. Overall, the research showed that ESG-screening was beneficial to stock performance only after 2014 but that it hurt returns from 2010 to 2013 regardless of whether an active or a passive strategy was followed. Performance varied across regions, but the message was relatively consistent. “Buying the 20% best ESG-ranked stocks and selling the 20% worst ESG-ranked stocks would have generated an annualised return of 3.3% in North America and 6.6% in the Eurozone during the 2014-2017 period, while these figures were respectively -2.70% and -1.20% between 2010 and 2013”, according to the report.

Different factors also weighted differently across different geographies. In North America, the environmental component of ESG seems to have been the most important guide for performance whereas in the Eurozone the same was true of the governance aspect.
One caveat that should be taken into account is that a self-reinforcing mechanism may be at work. According to the report, “currently, ESG investment flows are driven by demand, and we have reason to believe that the demand pressure will continue over the coming years. (…) [this] clearly operates in favour of ESG investors.” This implies that a driving element in the improved performance of the best-in-class stocks in the second half of the sample was the very ESG appeal which the study is trying to measure. As ESG considerations gained momentum in the second half of the sample period, the returns of the 20% best-ranked stocks may have improved because investors bought those stocks mainly based on their ESG appeal, and not necessarily on the profitability or health of the businesses themselves. Conversely, as investors sought to divest from worst-in-class stocks, returns may have decreased at the opposite end for that reason.

It may be challenging to distinguish the reason for stock out- or under-performance based on ESG criteria over such a short period. Perhaps indeed, the return differential is at least partly explained by investors’ shifts in preferences. However, the very principle of sustainable investing suggests that stock selection should take into account more long-term term considerations and see beyond the effects of a company’s decision on its short-term profits. Showing the effects of sustainable investing from a pure business performance perspective may, therefore, require a study on a much longer time horizon.

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