Duration Considerations in ESG Performance

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    Stockholm (NordSIP) – As ESG integration and its effects on investment performance continue to generate significant interest among institutional and retail investors, the body of research in this field continues to grow. In this spirit, MSCI recently chose to highlight the contributions of Guido Giese, Zoltán Nagy and Abhishek Srivastav, in an article published in the May/June 2022 edition of the journal Investments & Wealth Monitor.

    The article discusses the significance of the time horizons relevant to investors when analysing ESG risks. In so doing, it distinguishes between short-term event-related risks, such as fraud, corruption or accidents, and longer-term erosion risks, such as carbon emissions.

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    The article also considers the relationship between ESG risks and specific factors used in the calculation of ESG ratings finding that specific risks can be matched with each of the sustainability factors.

    “For example, short-term event-driven risks, such as fraud or corruption, are frequently tied to the G pillar. Others, such as accidents, strikes or oil spills, may be tied to E and S scores. In contrast, erosion risk represents a long-term risk, often reflecting environmental and social issues’ contributions to stock-price performance.”

    The authors argue that their results are meaningful for the integration of ESG factors into investment portfolios. “Investors building concentrated portfolios with relatively high turnover may want to focus on identifying and mitigating short-term event risks. Such investors may find erosion risks to be less relevant given their tendency to unfold over longer time horizons.”

    Diversified long-term investors, such as indexed or buy-and-hold investors, may care more about long-term erosion risks in their choice of ESG criteria and integration while aiming to mitigate event risks through diversification.

    The authors also argue that the manner through which ESG pillars are aggregated matters. “Our findings suggest that an approach to constructing ratings that adjusts industry-relevant issues and weighs annually can make a difference to financial performance over time compared with an approach that E, S and G components arbitrarily or based chiefly on historical data.”

    Last but not least, the article includes a small section discussing how Russia’s invasion of Ukraine could raise climate transition risks for investors. The argument the authors make is that in the course of the war, European nations imposing bans on Russian gas are having to swap that fossil fuel for the use of relatively more polluting coal. This represents a short-term delay in the transition pathway of European nations which will have to be compensated by an accelerated pace of decreased greenhouse gas (GHG) emissions later on.

    The authors highlight the energy and materials sectors, as well as the communications services, consumer staples and consumer discretionary sectors as being the most exposed to the increased net transition risk posed by this delay.

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