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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
SIRP is funded by Mistra, the foundation for strategic environmental research
SIRP is funded by Mistra, the foundation for strategic environmental research
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 is funded by Mistra, the foundation for strategic environmental research
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.
SIRP is funded by Mistra, the foundation for strategic environmental research
…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)
SIRP is funded by Mistra, the foundation for strategic environmental research
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
SIRP is funded by Mistra, the foundation for strategic environmental research
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)
SIRP is funded by Mistra, the foundation for strategic environmental research
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
SIRP is funded by Mistra, the foundation for strategic environmental research
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
SIRP is funded by Mistra, the foundation for strategic environmental research
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
SIRP is funded by Mistra, the foundation for strategic environmental research
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
SIRP is funded by Mistra, the foundation for strategic environmental research
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)
SIRP is funded by Mistra, the foundation for strategic environmental research
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*
SIRP is funded by Mistra, the foundation for strategic environmental research
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
SIRP is funded by Mistra, the foundation for strategic environmental research
Sustainable Investment Opportunities
WorstPractices
BestPractices
ProductStrategic
Emerging Momentum Established
SustainableProducts
BestCSR
Practice
Unsustainable loosersEXclude
ProductInnovations
Compliancewith legislation
and norms
Mature
INclude
SustainableVentures
SIRP is funded by Mistra, the foundation for strategic environmental research
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)
SIRP is funded by Mistra, the foundation for strategic environmental research
THANK YOU!
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