Positive ESG performance improves returns globally, research shows

By Cole Horton and Simon Jessop

NEW YORK (Reuters) – Stock funds outperformed across global markets over the last five years if they were weighted toward companies with positive environmental, social and governance (ESG) scores, research from sustainability data firm ESG Book shared exclusively with Reuters this month showed.

ESG Book’s analysis of model portfolios containing 60 to 85 stocks on average showed performance varied widely by individual ESG component. Companies with better governance scores outperformed more strongly than those with higher social scores, for example.

The analysis excluded companies with low market capitalisations and daily trade volumes to avoid distortion.

With trillions of dollars flowing into funds focused on ESG performance, whether and how much it impacts returns is increasingly a focus for investors.

A model portfolio of European stocks tilted toward ESG leaders was the best regional performer, with an annual average return 1.59% above its unweighted benchmark from January 2017 through April 2022, according to the firm.

A similarly constructed portfolio of companies in Asia-Pacific (APAC) was close behind, beating its benchmark by an average of 1.02% annually, while North American and global portfolios marginally outperformed, with excess returns of 0.17% and 0.13%, respectively.

ESG-positive portfolios vs. benchmarks: https://graphics.reuters.com/GLOBAL-FUNDS/ESGBOOK/movanaadjpa/chart.png

Backed by groups including HSBC, Deutsche Bank and Swiss Re, ESG Book launched in December 2021 to make corporate sustainability data more transparent and comparable.

Sustainable investors have been tested this year by a slump in tech stocks and a rally in their energy peers, which has caused many ESG equity funds to underperform, but ESG Book’s research adds to a growing body of evidence that ESG can still drive outperformance across extended periods.

“Over a long-term horizon, regardless of region, there are benefits and better risk-return profiles,” said Todd Bridges, head of ESG research and sustainable investing at ESG Book.

At the same time, ESG Book uncovered wide performance disparities when model portfolios were built around individual environmental, social and governance components.

Portfolios tilted toward companies with strong corporate governance metrics, for example, beat their benchmarks across the four regions ESG Book analyzed, with average annual outperformance as high as 2.17% in Europe.

“It’s a very uniform signal that markets understand the importance of governance and have been seeing it as a value creator,” said Bridges.

Governance-positive portfolios vs. benchmarks: https://graphics.reuters.com/GLOBAL-FUNDS/ESGBOOK/lgvdwzzggpo/chart.png

By contrast, a bias toward companies with high social scores led to underperformance in the North American and global portfolios, but outperformance in the Asia-Pacific region and Europe.

“The markets are confused as to what it is, how to measure it and how to determine performance implications,” Bridges added.

Social-positive portfolios vs. benchmarks: https://graphics.reuters.com/GLOBAL-FUNDS/ESGBOOK/gdpzylljdvw/chart.png

There is slightly more consensus around the value of environmental factors, as companies seek to measure and cut their climate-related risks, said ESG Book Chief Executive Daniel Klier.

Companies that ESG Book scored highly on environmental metrics contributed to outperformance in all but the global portfolio, where performance was dragged lower by its exposure to emerging markets, lagging its benchmark by 0.82% a year, on average.

Environmental-positive portfolios vs. benchmarks: https://graphics.reuters.com/GLOBAL-FUNDS/ESGBOOK/klvykyyjrvg/chart.png

This variability in performance shows why singular ESG ratings that blend all three elements into one score can be “meaningless” to investors, according to Klier.

“Unless you unpack a single score into the drivers, you will never get to the bottom of what’s driving performance,” he said.

(Reporting by Cole Horton in New York; editing by Simon Jessop in London and Josie Kao)