Lars G. Hassel
The Economic Value of ESG/SRI
EAPSPI Conference on Sustainable Investments
October 24, 2014
Hotel Kristina
Outline for an Academic Approach
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Sustainable and Responsible Investment strategies
SRI value creation in financial markets
ESG metrics in research papers
Errors in investors’ expectations and learning
– The alpha puzzle and market efficiency
– Learning and Disappearing Association between Governance and
Returns (Bebchuk et al., JFE 2013)
– Stakeholder Relations and Stock Returns: On Errors in Investors’
Expectations and Learning (Borgers et al., JEF 2013)
• Evidence from academic studies on portfolio analysis, event
studies around earnings announcements, analysis of errors
in analysts’ forecasts, and firm value studies
• Conclusions with implications
Sustainable and Responsible
Investment Strategies
European SRI Study 2014
SRI in Europe - Eurosif
Key Features of the European Market
35
CHARACTERISTICS OF INVESTORS
ASSET ALLOCATION
The impressive growth of SRI in Europe can, just as in previous years’ reports, be a ributed to institutional investors.
The overall split between retail assets and institutional assets has tilted further in favour of the la er, and now stands
at 96.6% institutional. Part of this growth can be a ributed
to the addition of Finland, Norway and Sweden to this data
for 2013, but even correcting for this shows minimal growth
for retail assets on aggregate. Figure 13 provides the evolution of the European market breakdown of retail vs. institutional since 2009, while Figure 14 illustrates the differences
across the European countries.
Figure 15 details SRI asset allocations by country and provides an asset-weighted European average. At European
level, equities represented about 50% of the SRI assets in
December 2013. This compares with 33% for both 2011and
2009, thus representing a signifi cant increase. By contrast,
the allocation to bonds fell from 53% and 51% in 2009 and
2011respectively to 40.0% in 2013. The allocation to money
markets also f ell sharply from 6.9% in 2011to 1% last y ear.
FIGURE 13: Institutional vs. Retail Europe 2009 – 2013 (%)
This year, for the fi rst time, Eurosif broke down the allocation to bonds. In 2013, 21.3% of SRI bond assets were invest ed in corporate bonds, 16.6% in sovereign bonds and 1.4% in
supra-national bonds (Figure 16).
Allocation to so-called alternative assets remained relatively fl at between 2009 (9.3%) and 2013 (9.1%), but fell compared to 2009 (12%). However, real estate and commodities
recorded signifi cant growth between 2011 and 2013, while
the allocation to hedge funds decreased.
FIGURE 15: SRI Asset Allocation by Country (2013)
Source : Eurosif
31
SRI – by Country
ESG Value Creation in Financial
Markets
• When benefits to
ESG materialize,
SRI investor enjoys
positive earnings
“surprise”?
• ESG at firm level
associated with
productivity,
efficiency, and
hence, cash flow
Alpha
ESG drives
future cash
flows
Errors in Impact on
consensus company
expectations valuation
• The market
overlooks the
benefits of ESG?
• How does market
price ESG ? Extrafinancial value
ESG Metrics - dimensions
Thomson Reuters
(ASSET4)
MSCI ESG Research
(KLD Research and Analytics)
Global Engagement Services
Semenova and Hassel: On the Validity of Environmental Performance Metrics, JBE 2014
ESG and Stock Return – Alpha Puzzle
Institutions often justify their responsible practices
using the argument that ESG factors generate
positive investment returns (alpha).
Investors (and companies) that exploit this
market inefficiency will benefit from an
early mover advantage that can last
decades before risk-return equilibrium is
established (2012)
ESG and Stock Return – Alpha Puzzle
Abnormal return!
Derwall et al (FAJ, 2005): The high-ranked portfolio based on Innovest ecoefficiency ratings provided substantially higher average returns than its lowranked counterpart over the 1995-2003 period.
ESG and Stock Return – Positive Alpha
Factors: market, small-large, valuegrowth, momentum
Abnormal Return - Mispricing?
Stock market anomalies
• Classical EMT suggests that trading strategy
based on public information cannot produce
abnormal returns (Fama, 1970).
• Adaptive EMT suggests that the ability of trading
strategy to generate abnormal returns will
disappear over time (Daniel and Titman, 1999).
• Errors in expectations and Learning – evidence
from SRI studies (Bebchuck and Borgers studies,
2013)
Errors in Investors’ Expectations and Learning
 Intangible nature of ESG
 Mispriced information eventually disappears
when investors learn about the anomaly
 Increased integration of ESG factors
 Media and research attention
 More shareholder proposals on ESG issues
 Positive risk-adjusted returns on portfolios of
high-ranked ESG stocks will disappear
 ESG earnings surprises will disappear
 Positive association with firm value (Tobin’s Q)
will persist
Governance and stock returns
• Learning and disappearing association between governance
and returns by Bebchuk, Cohen, Wang (JFE, 2013)
• Investor Responsibility Research Center (IRRC) Corporate
Governance data on S&P 500
– Democracy firms (Good G) and Dictatorship forms (Bad G) based on
• G-Index (24 IRRC provisions; such as voting rights, CEO
protection, tactics for delaying hostile bidders, other takeover
defences)
• E-Index (limited to 6 IRRC provisions)
– High G-Index and E-Index (protection) = poor Governance
– Periods: 1990-2008; 1990-1999 and 2000-2008
Good Governance Effect
• The disappearance of the governance-return correlation was
associated with an increase in the attention to governance by a
wide range of market participants;
• Until the beginning of the 2000s, stock market reactions to earning
announcements reflected the market’s being more positively
surprised by the earning announcements of good-governance firms
than by those of poor-governance firms;
• Stock analysts were also more positively surprised by the earning
announcements of good-governance firms than by those of poorgovernance firms until the beginning of the 2000s but not
afterwards;
• While the G-Index and E-Index could no longer generate abnormal
returns in the 2000s, their negative association with Tobin’s Q and
operating performance persisted (good-governance firms higher
market value).
Attention paid to G by media and
institutional investors increased
from 2000
Structural break in abnormal G returns occurred in November 2000
Critical learning point occurred in October 2001
Governance indices and abnormal stock returns
Abnormal returns fade out over time
Governance indices and operating performance
and Tobin’s Q
Association between governance indices and operating performance
and Q persist during both 1990-2001 and 2002-2008
Environmental and Social information and
stock returns
• Stakeholder relations and stock returns: On errors
in investors’ expectations and learning (Borgers et
al, JEF 2013)
• Stakeholder-relations index, SI
– (KLD ES ratings: emissions and pollution prevention,
environmental management systems, community
involvement, diversity, employee relations, product
quality, human rights)
• High SI = high ES ratings
• U.S large cap 1000-3000 firms (1992-2009; 19922004 and 2004-2009)
ES mispricing is eliminated
• Provide evidence that the Stakeholder-relations Index (SI)
explained errors in investors' expectations about firms' future
earnings 1992–2004.
– SI was positively associated with long-term risk-adjusted
returns,
– Earnings announcement returns, and
– Errors in analysts' earnings forecasts over the period
• When attention for stakeholder issues became more
widespread, these relationships diminished considerably.
• The results are consistent with the idea that increased
investor attention for stakeholder issues eliminates
mispricing.
Number of shareholder proposals
CSR in the news
Number of occurrences for CSR in the newspapers, including the
Wall Street Journal, the Financial Times (Capelle-Blancard and Petit,
2011)
Learning effect: time variation in abnormal
returns top-minus-bottom ES ranked portfolios
Critical learning point occurred in April 2004
ES and risk-adjusted returns
ES and earnings announcement returns
Subsample 2: April 2004 – December 2009
1992-2004: higher abnormal returns around earnings announcements
2004-2009: earnings surprises disappear
Errors in analysts’ forecasts
Error: actual EPS minus consensus analyst longterms forecast from I/B/E/S
Positive Errors 1992-2004
Zero Errors 2004-2009
ES and Operating Income
Performance of shunned-stocks and high employee
relations portfolios 1992-2008 (Derwall et al., 2011)
Shunned stocks: KLD Controversials (tobacco, alcohol, gaming,
nuclear, firearms)
Values-driven v. profit-seeking SRI
Performance of controversial stocks
Study
Hong and Kacperzyk (2009)
Kempf and Osthoff (2007)
Statman and Glushkov (2009)
Salaber (2007)
Fabozzi et al. (2009)
Visaltanachoti et al. (2009)
Region and
Period
U.S.
1926-2006
U.S.
1991-2004
U.S.
1992-2007
Europe
1975-2006
21 countries
1970-2007
China
1975-2006
Tobac.
Alc.
Game
Weap.
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
Controversial stocks outperform!
Nuke
Biotech
Adult
Alpha
Positive
Positive
(non-significant)
Positive
(non-significant)
Positive
X
X
X
X
Positive
Positive
Conclusions and Implications
• Mispriced ESG information has generated in the past
superior risk-adjusted returns in the short run
• Increased attention for ESG issues has eliminated errors in
investors expectations in the long run (learning effect)
– Correlation between G and abnormal returns disappears from
2000
– Correlation between ES and abnormal returns disappears from
2004
• Public ESG information used by researchers is not able to
provide a basis for profitable trading strategy.
• Positive association with operating performance and
market value persists in the long run
• ESG becomes more significant in the market and to be
taken into account by investors
Doing well while doing good!