Companies with good, or improving track records on social and governance factors tend to outperform those with static or worsening track records, according to research by Hermes Investment Management.
This is the first time that this research has found a statistical link between a company’s track record on social issues and the returns to shareholders.
In contrast there was a little difference when looking at a company’s environmental track record.
Overall Hermes looked at the impact of ESG factors on equity returns in the MSCI World Index over the past 10 years.
It found that good governance had the most positive impact on returns.Here companies with good or improving governance have tended to outperform lower performing peers by 24 basis points per month on average.
This though was less than the average monthly outperformance (of 30 basis points) detected in a previous study.
Companies with good or improving social characteristics have tended to outperform their lower-ranked peers by an average of 15bps per month.
Meanwhile there was no evidence of either outperformance or underperformance when looking at companies with attractive environmental characteristics.
Hermes Investment Management head of global equities Geir Lode says: “We have conducted this research twice before, in 2014 and 2016, and despite highlighting a link between corporate governance and returns, this is the first time we have seen a statistical link between social practices and a company’s performance.
“With the recent IPCC report on climate change and a slew of corporate governance scandals which have weighed heavily on share price performance, we have seen ESG investing accelerate from niche to norm.
“However, due to the intangible nature of social factors it has been harder for investors to quantify and understand this element and the importance placed upon it by investors has always lagged behind.”
The Hermes global equity team take a three-pronged approach to assessing social factors which takes into account the geographic location and the industry in which the company operates.
The research showed that while well-governed companies have outperformed over the longer term, this has not been the case in the last 12 months.
During this this period, poorly governed companies have tended to outperform well-governed companies.
Lode says: “These hyper-growth companies – businesses typically at an early stage of their life cycle and experiencing stellar growth rates but often trading at high multiples – have delivered incredible returns, propelling the market to record highs despite already lofty valuations.
“As relatively young disruptive companies, these often do not meet traditional ESG standards and score quite poorly on governance factors.”
He adds that I three of the five so-called FAANG stocks (Facebook, Amazon, Apple, Netflix and Google) ranked in the lowest decile of governance in the six months to April 2018. This suggests that the FAANGs disrupted the performance of the governance factor significantly during the six-month time period.