This belief is supported by a growing body of evidence. A good example of a meta-study on the relationship between ESG and performance is the 2015 paper entitled ‘From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance’ by Oxford University and Arabesque Partners.1
This paper examined more than 200 sources – including academic research, industry reports, newspaper articles and books – and concluded that “80% of the reviewed studies demonstrate that prudent sustainability practices have a positive influence on investment performance”.
A separate survey later that year by Deutsche Bank’s Asset and Wealth Management division in conjunction with the University of Hamburg went even further. This research looked at the entire universe of 2,250 academic studies published on the subject since 1970, using data spanning four decades until 2014. It concluded that ESG made a positive contribution to corporate financial performance in 62.6% of meta-studies and produced negative results in only 10% of cases (the remainder were neutral).2
There are several studies that examine the contribution of ESG to corporate performance. One of the first and most famous was that of Paul Gompers of the Harvard Business School in 2003, which found a strong positive link between good corporate governance and results. More specifically, it found that companies with stronger shareholder rights enjoyed higher values, profits and sales growth, had lower capital expenditures, and made fewer acquisitions.3
There is also significant evidence of a link between good human capital management and performance. A study by Alex Edmans of the University of Pennsylvania found that companies listed on Fortune’s 100 Best Companies to Work For (i.e. have satisfied employees) outperform the average company in terms of stock returns.4 In 2005, a study by Jeroen Derwall of Erasmus University noted that companies with a high eco-efficiency outperform their counterparts.5
Why are some still skeptical?
Unfortunately, some of the negative studies are the ones that tend to be the best known by the general public, such as those on the so-called sin stocks, while current discussions still focus predominantly on whether sustainability actually adds value. So why do people’s perceptions of the benefits of sustainability investing differ so widely?
One of the main reasons is that the concept of sustainable investing is very broad. We have identified three different objectives for doing it. First, some investors simply wish to avoid certain companies because their business activities do not match their beliefs. Much of the early academic work, including a paper on sin stocks by Harrison Hong of Princeton University and Marcin Kacperczyk of New York University, focused on these values-based exclusion policies.6
Second, some investors want to create a positive impact by allocating capital to specific companies or sectors that offer solutions to global issues. Although it makes sense to invest in companies that play into specific sustainability trends, financial motives can differ per investor. Sometimes the main driver is the desire to have a positive impact on society. Third, investors increasingly want to exploit the growing amount of data and knowledge on sustainable business models as a way to improve their financial returns.
Different objectives, different outcomes
Distinguishing between sustainable investors’ different objectives makes it easier to separate fact from fiction and say something meaningful about expected financial performance. If investors do not have any financial motives for taking certain steps – such as by excluding particular companies – it is not uncommon to find that investing has no overall impact, or even a negative impact, on returns.
For fundamentally managed equity strategies, excluding stocks need not matter too much, as such portfolios are typically already concentrated. For quantitatively managed strategies, however, restrictions usually tend to limit the power of the model, and therefore its expected performance. Historical tests show that if the number of excluded stocks is modest, the universe is still large enough to retain most or all of its factor exposure.
Financial materiality matters
Most of the studies documenting a positive contribution from sustainability considerations focus on financially material factors. An example is the 2015 research ‘Corporate Sustainability: First Evidence on Materiality’ by Mozaffar Khan of Harvard University. It showed that investments in material sustainability issues can be value-enhancing for shareholders, while investing in immaterial sustainability issues has little impact on returns.7
When investigating the link between sustainability and future investment returns, people have traditionally looked at the link between a firm’s current sustainability profile and its future investment returns. Lately we have also seen studies examining the link between changes in a firm’s sustainability profile and its future performance. Their central hypothesis is that the best time to invest for those seeking to benefit from improvements in firms’ ESG standards is before the improvement is widely recognized – and rewarded – by the market.8
Another interesting stream of research focuses on the financial pay-off of engagements by investors. A 2015 study led by Elroy Dimson of the London Business School documented engagements at 613 US public firms between 1999 and 2009. It showed that after successful engagement, firms’ investment returns were on average higher than would have been expected without the engagement. It also found that after successful engagement, companies experienced improvements in their operating performance, profitability and governance. 9
In conclusion, while we believe strongly in the financial materiality of integrating sustainability into the investment process, and have done so since 2010, it is not an exact science, and does still face difficulties with data availability and interpretation. So, we will continue to research ESG factors to ensure that this information is implemented in our portfolios in the best way possible, and in line with our firm belief that its use in investment processes adds value to our strategies.
1 Clark, G.L., Feiner, A. & Viehs, M., ‘From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance’, 5 March 2015. Available at SSRN
2 Deutsche Asset and Wealth Management, ‘ESG and Corporate Financial Performance: Mapping the global landscape’, December 2015
3 Gompers, P.A., Ishii, J.L. & Metrick, A., ‘Corporate Governance and Equity Prices’, Quarterly Journal of Economics, Vol. 118. No. 1, pp. 107-155, February 2003
4 Edmans, A., ‘Does the stock market fully value intangibles? Employee satisfaction and equity prices’, Journal of Financial Economics 101
5 Derwall, J., Guenster, N., Bauer, R., & Koedijk, K., ‘The Eco-Efficiency Premium Puzzle’, Financial Analyst Journal, pp. 61-2
6 Harrison, H. & Kacperczyk, M., ‘The price of sin: The effects of social norms on markets’, Journal of Financial Economics, pp. 93-1
7 'Corporate Sustainability: First Evidence on Materiality', The Accounting Review 91-6
8 ‘The materiality of ESG factors for equity investment decisions: academic evidence’, NN Investment Partners and ECCE report, 2016
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