Download - SIRP is funded by Mistra, the foundation for strategic environmental research The Economic Value of ESG/SRI Lars G Hassel Program Director Mistra The Norwegian

SIRP is funded by Mistra, the foundation for strategic environmental research

The Economic Value of ESG/SRI

Lars G Hassel

Program Director

Mistra

The Norwegian Business School – November 15, 2012


Programme objective 2006

• Find out how sustainable investment practices can create added value for institutional investors and identify barriers to mainstreaming such practices

• Research on:– Economic value of ESG/SRI – Sustainable value and reporting– Incentive Systems– Fiduciary duty


SIRP vision

• Investors expect to create value added by exploiting sustainable investments by asset management

• …but there are barriers because of uncertainty of financial outcomes and the strict financial focus of fiduciary duty

• …institutional investors have the strength to improve the market mechanism to drive companies towards a more sustainable development.


…the evidence suggests that there does not appear to be a performance penalty from taking ESG factors into account in the portfolio management process (2007)

Academic research continues to support the hypothesis that specific environmental, social and corporate governance (ESG) factors can make a positive contribution to investment performance (2009)


ESG and Economic Value – Firm Level

• Is there a correlation?– Innovest eco efficiency ratings of U.S. firms positively associated with firm

value and operating performance (Guenster et al. 2011)– GES environmental ratings of Swedish large-cap firms positively associated

with firm value and operating performance (Semenova and Hassel, 2011)– Green buildings in U.S. with a LEED or Energy Star certificate have higher

rental rates (Eicholtz et al 2010)– Environmental performance associated with higher credit ratings and lower

cost of debt of U.S. firms (Hahn and Bauer, 2010)

• Sustainable business practices add economic value to assets!Costs of practices drop (learning and scale) and future benefits increaseFirst mover advantage


SRI Risk/Returns

• Is there an alpha?• SRI funds and portfolios seem to perform neutrally (Olsson, 2007; Derwall

and Koedijk (2009); Herzel at al, 2012)

• Performance can be different in different SRI segments (Derwall et al 2011)– Values driven (exclusion) and profit-seeking (alpha) segments

• ESG portolios have outperformed in the past (e.g. Derwall et al 2005)– Investors are more sophisticated and have learned. – Can mis-pricing of large-cap firms continue? (Borgers et al 2012)


SRI- a theoretical perspective

• Efficient Market Hypothesis: Prices reflect all publicly available information and prices instantaneously adjust to reflect any new public information

• If all information is incorporated in prices– No predictive power for future returns– It is not possible to use ESG information to earn abnormal

returns (as long as this information is available to more investors)

• SRI restrictions– Restricting the universe worsens portfolio’s risk-return tradeoff– SRI portfolios underperform


Empirical Research

Two main strategies have been studied:

1. ESG opportunity (select best-in-class)

2. ESG risk management (exclude sin stocks)

• Portfolio construction:• Top: leading best performers on E, S, or G• Bottom: lagging worst performers on E, S, or G

• Abnormal returns or “Risk-adjusted” returns• Different risk-factors (4 factor model) accounted for


Derwall et al (FAJ 2005): RISK- AND STYLE-ADJUSTED PORTFOLIO RETURNS (ALPHA) BASED ON INNOVEST ECO-EFFICIENCY RATINGS (U.S companies 1995-2003)

alpha % Rm-Rf

Market Risk

β

SmBSmall Firm

Risk

HmLPrice/book

Risk

MOMMomentum

Effect

R2

Best-in-Class Portfolio

4.15** 0.92*** -0.19*** 0.02 -0.09*** 0.88

Worst-in-Class Portfolio

-1.81 1.03*** 0.04 0.23*** -0.08*** 0.86

Difference 5.96** -0.12*** -0.23*** -0.22*** -0.01 0.17

Abnormal Return! Mispricing or another risk factor?

Liquidity; downside risk, takeover factors


ESG opportunity portfolios in the U.S.Best-in-class outperformance fades out over time when investors learn!

Study Period CSR data Portfolio selection criterion Alpha high-ranked portfolio

Alpha low-ranked portfolio

Derwall et al. (2005) 1995-2003 Innovest Eco-Efficiency 4.15% * -1.81%

Kempf &Osthoff (2007) 1991-2004 KLD Environmental performance 3.60% * 0.59%

Statman & Glushkov (2007) 1992-2007 KLD Employee relations 3.73% * n/a

Edmans (2009) 1984-2005 Fortune Best Companies to work for 4.08%* n/a

Derwall et al. (2011) 1992-20041992-2008 KLD Employee relations 5.62

2.81 n/a

Borgers et al.(2012) 1992-20042004-2009 KLD Stakeholder Index 3.52*

-2.80 n/a

Gompers et al. (2003) 1990-1999 IRCC Corporate governance 8.5%* n/a

Bebchuck et al (2011) 1990-19992000-2004 IRCC Corporate governance 5.88* to 14.76*

-3.60* to 4.2* n/a


ESG Risk Management• Controversial stocks/industries are excluded based on norms • The Price of Sin…(Hong and Kacperczyk JFE 2009)

– Lower institutional ownership and less analysts’ coverage– Price/book ratios for sin stocks lower– Superior returns 1926-64; 1965-2003 (4 factor α)

• KLD controversials– Shunned stocks outperform peers (Kempf & Osthoff EFM 2007;

Statman & Glushkov FAJ 2009)• European Sample

– Sin stocks outperform peers, especially under high litigation risk and protestant faith (Salaber 2007)


Performance of controversial stocksControversial stocks continue to outperform their peers!

An unintended consequence of RI

Study Region and Period

Tobac. Alc. Game Weap. Nuke Biotech Adult Alpha

Hong and Kacperzyk (2009)U.S.

1926-2006 X X X X Positive

Kempf and Osthoff (2007)U.S.

1991-2004 X X X X X Positive(non-significant)

Statman and Glushkov (2009)U.S.

1992-2007 X X X X X Positive(non-significant)

Salaber (2007)Europe

1975-2006 X X X Positive

Fabozzi et al. (2009)21 countries1970-2007 X X X X X X X Positive

Derwall et al. (2011)U.S.

1992-20021992-2008

X X X X X2.86*2.64*


SRI/ESG- what have we learned?

• Sustainable business practices add economic value to assets– Costs of the practices drop because of learning and

economics of scale– Expected benefits of the practices will increase

• As sustainability creates economic value, this value is priced, and does not necessarily result in higher risk-adjusted returns of portfolios


Sustainable Investment Opportunities

WorstPractices

BestPractices

ProductStrategic

Emerging Momentum Established

SustainableProducts

BestCSR

Practice

Unsustainable loosersEXclude

ProductInnovations

Compliancewith legislation

and norms

Mature

INclude

SustainableVentures


Benchmarking

• ESG ratings and rankings have improved the transparency and market efficiency for large caps and return opportunities come now from– Engagement– ESG rising stars (timing)

• Benchmarking needed on– Small-cap firms – Private equity – venture capital

• Global Real Estate Sustainability Benchmark (GRESB)


THANK YOU!

WWW.SIRP.SE

http://WWW.SIRP.SE/

Download - SIRP is funded by Mistra, the foundation for strategic environmental research The Economic Value of ESG/SRI Lars G Hassel Program Director Mistra The Norwegian

Top Related