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A Comprehensive Analysis of the Relationship between ESG Rankings and Investment Returns
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A Comprehensive Analysis of the Relationship between ESG Rankings and Investment Returns


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K. Stuart Peskin CFA, Vice President - State Street Global Advisors (Japan) Co., Ltd. - Japan.

K. Stuart Peskin CFA, Vice President - State Street Global Advisors (Japan) Co., Ltd. - Japan.

Published in: Economy & Finance, Business

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    • 1. TBLI Conference Asia 2009 A Comprehensive Analysis of the Relationship Between ESG and Investment Returns K. Stuart Peskin, CFA May 27, 2009
    • 2. Presentation Overview
      • Rationale for study
      • Examination of the study results
      • The way forward
      A Need to Know – Has ESG investment been rewarded historically?
    • 3. Rationale for Study
      • Many believe that a logical link between ESG ratings and future investment returns exists
      • Key relationships have not definitely been answered by existing industry studies
      • Prior internal SSgA studies were not sufficiently broad or conclusive
      • External expectations for an asset manager to understand how ESG factors impact performance have increased
      A Need to Know – Has ESG investment been rewarded historically?
    • 4. Study Overview
      • Scope: broad study conducted on all world markets
        • 10 datasets analyzed: seven Environmental, five Social and eight Governance
        • Analysis period begins in 2003 due to paucity of earlier data
        • Developed market focus due to paucity of Emerging market data
      • Methodology
        • Tested all individual datasets
        • Combined like datasets into blended environmental, social and governance “superfactors”
        • Aggregated all data sets into single superset to produce a generalized ESG superfactor
      Global quantitative examination of the relationship between ESG ratings and investment returns
    • 5. Key ESG Findings
      • Highly ranked ESG companies do not outperform poorly ranked ESG companies
      • However, selective application of ESG factors can add value
      • ESG payoff can be swamped in the short run by macro drivers of share prices
      • ESG factors can sometimes act as good stock selectors within an industry
      The relationship between ESG performance in share price is variable yet there are pockets of alpha power Source: SSgA, Advanced Research Center, September 2008
    • 6. Global ESG Factor
      • A simple measurement of super ESG ratings across global equity markets shows that companies with good ESG ratings were not rewarded with good share performance
        • US and Canadian companies had the poorest relationship
        • European companies had a weaker relationship
        • Asia Pacific companies were close to indifferent
      • Companies with very high ESG rankings outperform average companies but so do those firms with very poor ESG rankings
      ESG appears to have promise as a means to differentiate within sector
    • 7. Global ESG Factor (Cont’d)
      • Using ESG performance as a discriminator between companies within the same sector works in 8 of 10 sectors analyzed
        • Materials consistently negative Utilities consistently positive
      Source: SSgA, Advanced Research Center, September 2008
    • 8. Global Environmental Factor
      • Companies with poor environmental polices have been rewarded for polluting and the largest emitters have had the best returns
        • This relationship is very strong in Australia
        • Japan is the only country where we find that clean companies were rewarded
      • Compared to the average company low polluters outperformed but high polluters outperformed by an even greater margin
      Findings follow historical logic but logic similarly dictates that past performance is no guarantee of future results
    • 9. Global Environmental Factor (Cont’d)
      • At the sector level we find only one sector that persistently rewarded high polluters and one that rewarded low polluters
        • Materials rewarded large polluters Utilities rewarded low polluters
      Source: SSgA, Advanced Research Center, September 2008
    • 10. Global Social Responsibility Factor
      • Globally, the investment performance of a company bears little relationship to its level of social responsibility
        • More recently in Asia Pacific, and particularly in Japan, companies with good social ratings demonstrate superior performance
        • United States companies are weakly penalized for being socially responsible
      Socially responsible companies not historically rewarded but some evidence of change over time
    • 11. Global Social Responsibility Factor (Cont’d)
      • At the sector level, the relationship between like companies with varying levels of social responsibility is also weak
        • Industrials and Utilities show a positive relationship between good social behavior and performance
        • Materials consistently negative but strengthening over time
      Source: SSgA, Advanced Research Center, September 2008
    • 12. Global Governance Factor
      • Well-governed companies underperformed in the US yet outperformed in Canada and Asia Pacific
      • Poorly-governed companies in Australia, Japan and Canada have on average had very poor investment performance but the best governed companies are not found to outperform the average company
      • In the UK, the best-governed firms outperform average the average company with the poorest governed firms also occasionally outperforming
      Causal relationship between quality of governance and stock return remains unclear
    • 13. Global Governance Factor (Cont’d)
      • At the sector level, well-governed firms outperform in 3 out of 10 sectors
        • Consumer Staples, Telecommunication Services and Utilities outperform
        • Consumer Discretionary and Financials underperform
      Source: SSgA, Advanced Research Center, September 2008
    • 14. Summary of ESG Factor Power
      • The observed relationships between ESG exposures and future stock returns are weak relative to primary drivers of market returns
        • Macroeconomic environment can swamp the ESG effect
      • ESG power may still be harnessed to improve expected returns
        • Macro effects can be neutralized by making comparisons within sector
        • ESG factors can applied selectively to market segments that have high ESG exposures
      • The expected payoff for ESG factors is over a longer horizon
        • Longer run statistics should be observed when analyzing results
        • Broad portfolios with ESG tilts stand the best chance of succeeding
    • 15. Issues to Consider
      • While the linkages discovered exhibit generally good statistical significance, there is more work to be done on understanding the financial logic of the empirical relationships
      • The effect of the macro environment may overwhelm the effect of ESG in the short run
      • A degree of judgment is required in determining which ESG relationships discovered will have relevance in the future
        • The future environment for ESG influence on corporate profitability may change and in the case of carbon, is expected to change
    • 16. Conclusion
      • There are enough promising pockets of ESG based outperformance in our analysis to warrant further investigation
      • A forward view of how things will change is required to justify good expected returns
      • Periodic updates as more information becomes available and conditions change will be required
      • SSgA is investigating the logical arguments for fit with statistical results
      • We anticipate that with selected ESG tilts or careful application of ESG Alpha factors, it may be possible to produce ESG friendly portfolios and simultaneously retain or enhance return expectations
      A good beginning yet more work remains
    • 17. This document is prepared / provided for the purpose of explaining about investment performance analysis and is not intended to solicit investment into a specific financial product. No part of this material may be copied or duplicated in any form or redistributed without SSgA’s prior written consent. The document may include materials prepared by State Street Global Advisors (Boston). The data are sourced from presumably reliable sources but the accuracy / completeness is not guaranteed. Past performance and simulated results are not guarantees of actual future performance results. Information in this document is as of May 2009 and subject to change without notice. State Street Global Advisors (Japan) Co., Ltd. Financial Instruments Firm Registration Number   Director of Kanto Local Finance Bureau (Kinsho) No.345 Member of Japan Securities Investment Advisers Association Member of The Investment Trusts Association, Japan Member of Japan Securities Dealers Association