How do ESG proposals and engagements benefit shareholders?

Julie Gorte, Senior Vice President for Sustainable Investing, Impax Asset Management

The Department of Labor recently issued a new field assistance bulletin for ERISA plan fiduciaries (that means pension funds, for practical purposes) reminding those fiduciaries that the interests of the plan come before anything else. The world wasn’t breathlessly awaiting that news: we all already knew that. Then the bulletin noted two new things, which can be summarized in two sentences: 

  • Don’t invest in ESG funds that present lower returns or higher risks than non-ESG funds. 

  • Don’t spend too much money engaging with companies on these ESG issues. 

This erroneously presumes that including ESG factors in funds will lower the return or raise the risk. The evidence coming from people who rely on actual facts couldn’t be clearer: that’s not what usually happens. Sure, any fund can underperform, and every year, lots do—but the list of underperformers is not dominated by ESG funds. 

That may be why Bank of America noted that investors who factor ESG into investment decisions can avoid a lot of bankruptcies—like 90%. It’s why MSCI published a study showing that a group of 100 companies that had significantly outperformed their peers in terms of Return on Invested Capital, economic spread, margins and asset turnover ratios had higher ESG ratings than their less well-performing peers.

Bank of America Merrill Lynch’s second report on ESG highlights the risk-predictive value of ESG information. The report notes that ESG attributes are a better signal of future earnings volatility than any other measure the analysts had found, and states in the first paragraph that “ESG would have helped investors avoid 90% of bankruptcies” in the time frame examined. 

A new academic article explored the benefits of corporate social responsibility (CSR) to corporate bonds during the financial crisis, noting that firms with higher CSR benefited from lower bond spreads on secondary markets during the financial crisis, and were able to raise more debt capital on primary markets as well. 

Societé Générale just issued a new report noting that stocks rated in the top decile for ESG factors outperformed the Stoxx600 index by 28.6% over the last 4.5 years.

Governance. I’ve heard several times from people who know what ESG is that the G factor—governance—is the one least connected to either sustainability or performance. Two recent reports stand out for knitting sustainability and governance together in cogent, persuasive ways. 

An article from the National Association of Corporate Directors explored how boards cope with reputation risk, something that sounds like a soft factor to a lot of quantitatively-minded analysts, but can be a source of profound, even existential risk, especially these days, when intangibles account for 87% of market value for the S&P 500. Why? If the vast majority of your value is intangible, a reputational crisis can cost your company a lot of its value—just ask Volkswagen, BP, Equifax, and Chipotle—and there aren’t enough brick-and-mortar assets to make enough of a safety net to keep the company from becoming shark bait for hedge fund activists or takeover specialists. This paper explores how the impact of environmental and social factors are not on the radar of many boards, and that “[u]nfortunately, many ESG and CR [corporate responsibility] risks are unknown to the board until an incident happens and it goes public—and possibly viral.” The article goes on to show how boards can better identify and manage such risks—and capitalize on reputational opportunities as well.

Read the original article here.