What if we told you how to avoid stocks that go bankrupt?
We think you would listen. Environmental, Social & Governance (ESG) factors are too critical to ignore, in our view. In our earlier report ESG: good companies can make good stocks, we found that ESG-based investing would have offered long-term equity investors substantial benefits in mitigating price risk, earnings risk and even existential risk for US stocks — ESG would have helped investors avoid 90% of bankruptcies in the time frame we examined. Our findings were encouraging enough to warrant a closer look. We here assess how US corporations, regulators and investors are positioned for ESG, and how the market is responding.
ESG is the best signal we have found for future risk
Prior to our work on ESG, we found scant evidence of fundamental measures reliably predicting earnings quality. If anything, high quality stocks based on measures like Return on Equity (ROE) or earnings stability tended to deteriorate in quality, and low quality stocks tended to improve just on the principle of mean reversion. But ESG appears to isolate non-fundamental attributes that have real earnings impact: these attributes have been a better signal of future earnings volatility than any other measure we have found.
US corporates may be behind the curve . . .
Despite empirical evidence of its efficacy, ESG is not drawing much enthusiasm from US corporates. Among companies participating in our survey at our March 2017 BofAML US Investor Relations conference, almost half of the survey respondents indicated they have no resources dedicated to ESG initiatives, and no intentions of implementation. Globally, the theme is burgeoning: ESG-related regulations have doubled since 2015; over 6,000 EU member state companies will be required to publish disclosures; and 12 global stock exchanges require written ESG guidance – but not one is in the US!
. . . but investors are ahead of it & PE multiples are responding
In our May survey of BofAML institutional clients, 20% cited using ESG, well above the estimated 5% of float that corporations believe is held by ESG-oriented investors. In another investor survey, 66% raised issues on sustainability disclosures, and 85% called for improved disclosure in filings. And the investment industry is changing to accommodate governance: for the first time ever, FTSE Russell ruled out the addition of zero voting rights stocks, citing “concerns raised by shareholders.” The market is listening: shareholder-friendly companies have seen significant multiple expansion — and we see strong signs that this re-rating continues.
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