The latest data shows that stocks and indices with higher ESG ratings have continued to outperform non-ESG counterparts, across different markets and timescales.
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Speaking at Corporate Adviser’s ESG Forum, Kristina Rüter, executive director, global head of ESG methodology, ISS pointed to a meta study recently published by New York University, which reviewed more than 1,000 individual papers on this issue and 27 existing meta studies published between 2015 an 2020. They found that higher ESG scores consistently correlate with better performance.
Rüter says that ISS’s own in-house research back this up. She says that from 2006 to the end of 2020 the ISS Prime Portfolio – which consists of large cap stocks with higher ESG ratings – achieve continuous outperformance, with the exception of just two months in 2009.
“On an aggregated basis the prime portfolio achieve a cumulative return on investment of 258 per cent, compared to 213 per cent for the conventional benchmark.”
She adds: “I think these results show ESG investment actually pays off not only in terms of positive impact but also in terms of returns on investment.”
Jas Duhra, head of EMEA ESG Indices, S&P Dow Jones Indices says it has been widely reported that ESG indices and funds have outperformed during the pandemic in 2020.
“Sometimes people assume this outperformance has been driven by being overweight in financial and technology stocks. But this in not the case with many of our indices which are designed to mirror parents indices in terms of sector weightings.”
She says this outperformance is driven by the fact that the companies selected for their higher ESG credential across different sectors have also tended to have better financial performance, which has driven this outperformance.
Both delegates agreed with earlier assessment by the pension minister Guy Opperman that the UK had a ‘first mover advantage’ when it came to ESG issues, particularly when it came to legislation regarding the move towards net zero goals.
However they also emphasised the role the EU had to play in devising standard which are likely to be used globally on this issue.
Rüter says: “I still think the EU had a really important part to play. I genuinely though think the UK can say it is leading edge in certain ways.
“It is interesting the conversation that we’re having with clients in the UK. They ‘re more concerned with transition generally and moving towards a net zero economy. There’s probably more of a focus in European market on regulation.”
Both delegates discussed how agencies like ISS score individual companies and how the range of data that is produced is then used by companies like S&P Down Jones to devise tailor-made indices.
Rüter says there are a range of different approaches and methodologies, which can result in diverging scores. Some for example limit evaluation to risk management, while others integrate opportunities and impact perspectives. She points out that one major difference can be how forward-looking this scoring is, or whether it adopts a more backward-orientated approach. This latter approach may exclude emerging and evolving material topics such as cybersecurity, and supply chain issues she says.
Rüter adds: “Ratings agencies have been criticised in some cases for only looking at the how a company operates and not what they actually do. A striking example illustrating this is the diverging ratings for a UK tobacco company.”
She says some scoring systems may apply a ‘relative approach’ scoring a company on how it compares to others in it sectors on a range of key metrics (such as managing supply chains, carbon emissions, etc). Others though may take a more holistic approach and integrate both the positive and negative impact of the company’s business model into the rating assessment, so while it might be outperforming sector peers on issues like deforestation, its score will be affected if it is not adequately addressing the negative impacts of its products on public health.
Duhra says there are a range of different ESG indices designed to meet clients different investment objectives. Some will aim to mirror a parent index, but with the higher ESG scores. Others are “high conviction” options where the focus is narrowed down “to include only the top 25 per cent of companies in each sector,” she says.
There was agreement that there were areas that were increasingly being included as standard exclusions on ESG funds. For example there is now widespread exclusion for cluster bombs and companies that fail to comply with UN Global Compact covering human and labour rights.
Both speakers agreed that there has been a lot more recent focus on coal as a general exclusion.
Rüter says: “The next thing is of course coal, followed by other fossil fuels including non-conventional fossil fuels of oil sands and gas obtained through hydraulic fracturing, but then also followed by conventional oil.”
Social issues – the ’S’ in the ESG are also coming to the fore. Duhra says this has been driven by a new focus on racial inequality in the US following the death of George Floyd.
However they both agreed there was often a lack of comprehensive data, and disclosure of key information of some of the social issues can be poor.