Does ESG performance bear out over the long term? It depends

Study indicates link to financial performance may depend on specific ESG focus as well as sectoral differences

Does ESG performance bear out over the long term? It depends

One commonly held belief about ESG-oriented companies is that the influence of their ethical and sustainable focus will only become clear in the long run. But as with practically all things ESG, the truth may not be so black and white.

In a newly released research paper, MSCI analysts Guido Giese, Zoltan Nagy, Linda-Eling Lee sought to deconstruct the impact of ESG ratings on financial valuations based on differences in individual “pillar scores” – assessments of Environmental, Social, or Governance factors – as well as varying emphasis on specific ESG Key Issues and sector exposures.

“We found that ESG pillars and ESG Key Issues, which underpin MSCI ESG Ratings, related differently to companies’ financial performance,” the researchers said.

Focusing on the three main ESG pillars, they found that Governance pillar scores, which encompass corporate governance and corporate behaviour, tended to have a more significant on profitability, idiosyncratic risk, and systematic risk than Environmental and Social pillars over relatively short periods of one year or so. In contrast, Environmental and Social pillars had more bearing over longer periods, particularly with respect to stock-price performance.

“For example, carbon emissions and labour management showed no or minimal significance on profitability, idiosyncratic risk and systematic risk in the short term,” the researchers said, referring to key issues under the Environmental and Social umbrellas, respectively. Among all key issues, carbon emissions exhibited the most significant stock-performance impact over the full study period of 2013-2019.

They also found that Governance scores tended to have the most significant variation in stock-specific risk, as governance factors typically exert an immediate impact on stock prices through specific events such as ethics breaches. Environmental and Social pillar scores, meanwhile, are influenced by a mix of both event risks and risks linked to issues that exert an impact over longer periods through regulatory and other industry-level sea changes.

The analysis also revealed that the different ESG pillars can have an outsized impact depending on the industry a particular company is in. While Governance was particularly germane in financials and consumer-discretionary sectors, the Environmental pillar was most significant in the materials and energy sectors. The Social pillar, meanwhile, had the greatest bearing in the consumer discretionary space.

“Sectoral differences reflected industry-specific ESG Key Issues underlying the Environmental and Social pillars,” the researchers said.


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