ESG Strategies for the Sustainable Investors - BI Norwegian

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					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              R2
                                     Market Risk   Small Firm   Price/book      Momentum
                                         β           Risk         Risk             Effect



       Best-in-Class     4.15**      0.92***       -0.19***       0.02           -0.09***          0.88
       Portfolio


       Worst-in-         -1.81       1.03***         0.04       0.23***          -0.08***          0.86
       Class
       Portfolio


       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    Portfolio selection criterion               Alpha high-         Alpha low-
                                                                                              ranked              ranked
                                                                                              portfolio           portfolio

  Derwall et al. (2005)   1995-2003   Innovest   Eco-Efficiency                                  4.15% *              -1.81%

  Kempf &Osthoff (2007)   1991-2004     KLD      Environmental performance                       3.60% *              0.59%
  Statman & Glushkov
                          1992-2007     KLD      Employee relations                              3.73% *                n/a
  (2007)
  Edmans (2009)           1984-2005    Fortune   Best Companies to work for                       4.08%*                n/a
                          1992-2004                                                                 5.62
  Derwall et al. (2011)                 KLD      Employee relations                                                     n/a
                          1992-2008                                                                 2.81
                          1992-2004                                                                3.52*
  Borgers et al.(2012)                  KLD      Stakeholder Index                                                      n/a
                          2004-2009                                                                -2.80
  Gompers et al. (2003)   1990-1999     IRCC     Corporate governance                              8.5%*                n/a

                          1990-1999                                                          5.88* to 14.76*
  Bebchuck et al (2011)                 IRCC     Corporate governance                                                   n/a
                          2000-2004                                                           -3.60* to 4.2*




                                                                  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                         Region and     Tobac.   Alc.   Game       Weap.        Nuke      Biotech      Adult           Alpha
                                 Period
                                  U.S.
Hong and Kacperzyk (2009)                      X       X      X            X                                               Positive
                               1926-2006
                                  U.S.                                                                                    Positive
Kempf and Osthoff (2007)                       X       X      X            X           X
                               1991-2004                                                                              (non-significant)
                                  U.S.                                                                                    Positive
Statman and Glushkov (2009)                    X       X      X            X           X
                               1992-2007                                                                              (non-significant)
                                Europe
Salaber (2007)                                 X       X      X                                                            Positive
                               1975-2006
                              21 countries
Fabozzi et al. (2009)                          X       X      X            X           X           X          X            Positive
                               1970-2007
                                  U.S.
                                                                                                                            2.86*
Derwall et al. (2011)          1992-2002       X       X      X            X           X
                                                                                                                            2.64*
                               1992-2008




                                                                  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 risk-
  adjusted returns of portfolios


                                SIRP is funded by Mistra, the foundation for strategic environmental research
            Sustainable Investment Opportunities
                                       INclude


                                    Sustainable
 Product            Product                                           Compliance
 Strategic                           Products
                  Innovations                                        with legislation
                                                                       and norms
                                       Best
                                       CSR
  Best            Sustainable                                                Mature
Practices                             Practice
                   Ventures

                                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!




WWW.SIRP.SE
              SIRP is funded by Mistra, the foundation for strategic environmental research

				
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