Research Review | 3 August 2018 | Sustainable (ESG) Investing

Does ESG Matter for Asset Allocation?
Joachim Klement (Fidante Partners)
July 12, 2018
The integration of ESG [environmental, social and governance] factors into the investment process is increasingly becoming mainstream for institutional investors. However, investors struggle with how to incorporate ESG criteria into their top-down asset allocation decisions.
In this report we show how ESG criteria can be systematically and consistently integrated into the asset allocation process. Our approach can be used for almost any multi-asset portfolio without materially reducing return expectations or increasing portfolio risk.

Is ESG an Equity Factor or Just an Investment Guide?
André Breedt (Capital Fund Management), et al.
July 3, 2018
Environmental, Social and Governance (ESG) information demands attention within the asset management industry since it has become widely accepted that making an allowance for ESG criteria within an equity portfolio enhances returns. We test this proposition by incorporating ESG criteria into a worldwide market neutral portfolio using an ‘off-the-shelf’ third party database of individual securities’ ratings. Our results show that incorporating ESG information into a worldwide equity market neutral portfolio yields no additional return, as any benefits from tilting towards a better rated ESG portfolio is already wholly captured by other well-known equity factors. Doing so, however, does not hurt returns. We conclude that ESG should not be considered as a unique equity factor.

Money, Millennials and Human Rights: Sustaining ‘Sustainable Investing’
John Gerard Ruggie (Harvard University) and Emily Middleton
July 2, 2018
ESG investing takes into account companies’ environmental, social and governance performance. Also known as sustainable investing, it now accounts for some US $26 trillion, or more than one-quarter of all assets under professional management. Continued growth is is expected. However, one impediment is the mixed quality of information available to asset owners and asset managers. The S in ESG is by far the weakest link in the chain.The first part of this paper examines the rise and current state of ESG investing.The second addresses the conceptual and statistical weakness of the S domain. The third explains why and how drawing on internationally recognized human rights standards can strengthen the S and thereby improve the robustness and comparability of ESG aggregations. This should interest investors, issuers, and human rights advocates alike.

A New Book From The Capital Spectator:
Quantitative Investment Portfolio Analytics In R:
An Introduction To R For Modeling Portfolio Risk and Return

By James Picerno

Asset Managers’ ESG Strategy: Lifting the Veil
Stephanie Mooij (University of Oxford)
November 25, 2017
It appears that asset managers take widely different approaches when it comes to ESG integration. Previous research suggests that they may be receiving conflicting short-term signals from clients, which hinder the responsible investment efforts of asset managers. I investigate whether this is true and whether there are more obstacles. I also look at how asset managers make sense of responsible investment. Given the limited body of qualitative research, too little is known on how responsible investment is perceived, what triggers asset managers to initiate change and how is it integrated in practice. Finally, what differentiates a fully integrated asset manager from one who is not? To answer these questions, I interview 15 asset managers in the Netherlands, the UK and Germany. I find that, in some cases, asset managers decouple what they say from they are actually doing. ESG teams are sometimes used as boundary spanning units to shield the rest of the organization from changes they do not want to make.

Do Global Financial Markets Capitalise Sustainability? Evidence of a Quick Reversal
Fabio Moliterni (Fondazione Eni Enrico Mattei)
July 6, 2018
This study investigates the growing importance of sustainability in equity markets by estimating whether company commitment to sustainability matters in corporate valuation. The spreading concern for social and environmental issues, and especially for the material risks of climate change, induces policy to encourage companies to prioritise sustainability in their decision making. There is growing evidence that points to a rationale for a profit-driven response to social and environmental problems, uncovering the role of sustainability in investors’ decisions. Exploring a panel of 3,311 listed companies in 58 countries for the period 2010-2016, this study reveals that sustainability contributes to the creation of market value for listed companies, over the considered period. Furthermore, it investigates how this relationship changes according to environmental policy stringency and sector sensitivity to climate policies.

The Market of Environmental, Social, and Governance (ESG)
Ruoke Yang (Columbia University)
December 05, 2017
The incorporation of nonfinancial ESG objectives into financial decision-making has been on the rise of late. Yet, very little is known about the ESG ratings that numerous practitioners and academics rely on to form their investment decisions and inferences about the link between social responsibility and other characteristics of the economy. In this paper, I pose and address the fundamental question: do these ratings convey informative signals about important stakeholder outcomes? I discover the answer to be generally ‘no’ for a set of most broadly used ratings and find that these ratings offer no financial benefits either for socially conscious investors. I introduce a model for the problem of the ratings agency and explore its implications for firm managers and investors.

Exploring Social Origins in the Construction of ESG Measures
Robert G. Eccles and Judith C. Stroehle (University of Oxford)
July 12, 2018
As both demand and supply for information about companies’ sustainability performance continues to grow, many investors complain that the ESG data universe is getting too complex and confusing. Several studies have shown how rating agencies and data vendors display very little agreement on how to construct and use ESG measures. While commending these findings, we argue that only studying how data diverges is missing the insights of a more substantial question about the why of this divergence. Taking a lens of “social construction”, we thus set out to explore the differences between ESG measures as a function of (a) data vendors’ diverse social origins and (b) their necessity to create a unique profile in a maturing market. Examining five cases of eight interconnected ESG data vendors and rating agencies, we thus show how the origin of each company (their founding principles, legal status, purpose, etc.) strongly influences its conception of sustainability, definition of materiality, and by extension, the way ESG issues are measured and sold. We find that data vendors can be characterized into groups of value-vs values-based organizations, and that dynamics of consolidation on the ESG market and the mainstreaming of ESG data use are linked to a shift from values-to value-driven investors in the ESG space. Finally, the paper highlights pathways into a new ESG research agenda which explores the impact of the here examined origins of metrics.

Environmental, Social and Governance Reporting in Annual Reports: A Textual Analysis
Philipp Baier (Darmstadt University of Technology), et al.
24 Jul 2018
Purpose: Considering environmental, social, and governance (ESG) factors becomes increasingly important for companies. However, ESG is not clearly defined so far and, therefore, it is difficult to measure the ESG activity of companies. The increased attention of ESG among investors forces the question how companies deal with ESG topics.
Design: We analyze the extent and changes in 10-K reports and proxy statements on ESG, using a textual analysis and creating an ESG dictionary.
Findings: The results show an average of 4.0 % ESG words on total words in the reports. The main influence is exerted by the traditional category governance, but the emerging field of envi-ronmental issues increases. Proxy statements deal with ESG topics to a larger extent than 10-K reports. Moreover, we find significant differences across industries. Industries being critical to an ESG topic, such as energy, show a higher average share of ESG words.
Originality/value: The ESG word list with 482 items can be used to quantitatively examine the ex-tent of ESG reporting, which will be helpful especially for SRI investors. Our classification of 40 subcategories allows a highly granular analysis of different ESG related aspects. Moreover, indica-tions for a relation between changes in reporting and real events, especially negative media pres-ence, are detected. Regulatory bodies have to be aware of the use of such words and how they are used.