The Economic Value of ESG/SRI
The Norwegian Business School – November 15, 2012
Lars G Hassel
Program Director
Mistra
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 increase
First 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
SmB
HmL
MOM
Market Risk
Small Firm
Price/book
Momentum
β
Risk
Risk
Effect
R2
Best-in-Class
Portfolio
4.15**
0.92***
-0.19***
0.02
-0.09***
0.88
Worst-inClass
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
Derwall et al. (2005)
1995-2003
Innovest
Kempf &Osthoff (2007)
1991-2004
Statman & Glushkov
(2007)
Edmans (2009)
Derwall et al. (2011)
Borgers et al.(2012)
Alpha highranked
portfolio
Alpha lowranked
portfolio
Eco-Efficiency
4.15% *
-1.81%
KLD
Environmental performance
3.60% *
0.59%
1992-2007
KLD
Employee relations
3.73% *
n/a
1984-2005
Fortune
Best Companies to work for
4.08%*
n/a
1992-2004
1992-2008
1992-2004
2004-2009
Portfolio selection criterion
KLD
Employee relations
KLD
Stakeholder Index
5.62
2.81
3.52*
-2.80
n/a
n/a
Gompers et al. (2003)
1990-1999
IRCC
Corporate governance
8.5%*
n/a
Bebchuck et al (2011)
1990-1999
2000-2004
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 stocks
Controversial stocks continue to outperform their peers!
An unintended consequence of RI
Study
Hong and Kacperzyk (2009)
Kempf and Osthoff (2007)
Statman and Glushkov (2009)
Salaber (2007)
Fabozzi et al. (2009)
Derwall et al. (2011)
Region and
Period
U.S.
1926-2006
U.S.
1991-2004
U.S.
1992-2007
Europe
1975-2006
21 countries
1970-2007
U.S.
1992-2002
1992-2008
Tobac.
Alc.
Game
Weap.
Nuke
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
Biotech
Adult
Alpha
Positive
Positive
(non-significant)
Positive
(non-significant)
Positive
X
X
Positive
2.86*
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 riskadjusted returns of portfolios
SIRP is funded by Mistra, the foundation for strategic environmental research
Sustainable Investment Opportunities
INclude
Product
Strategic
Best
Practices
Product
Innovations
Sustainable
Ventures
Sustainable
Products
Best
CSR
Practice
Compliance
with legislation
and norms
Mature
Unsustainable loosers
EXclude
Worst
Practices
Emerging
Momentum
Established
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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SIRP is funded by Mistra, the foundation for strategic environmental research