While ESG considerations are now undoubtedly on the minds of all fiduciary investors, in Australia and New Zealand at least, the main body of research on the subject has delivered mixed results in quantifying the relationship with investment performance.
Jonathan Treussard, the head of product management for Research Affiliates, told the firm’s seminars in Australia last week (see other report this edition) that empirical results from studies of performance data were mixed. The results tended to be limited by a lack of consistent long-term data and lack of international standards for ESG reporting. This latter limitation might lead to a positivity bias, where companies only report what looks good for them.
“All the data in the world might not yield empirical certainty, Treussard said. “The future may well look very different from the past” Investors and analysts had to accept that some ESG investing came down to beliefs. “Be critical without being cynical,” he said.
He listed four important papers which found return deterioration for portfolios with ESG principles, four papers which were ‘neutral’, and three which found return improvement. There were also three papers which found that ESG investing lowered risk.
To bridge the gap, if one exists, between investor preferences and performance requirements, Treussard suggested investors could leverage return drivers which were wholly consistent with ESG investing. This could be done by:
. studying the “financial discipline” of companies, which has historically led to better company performance
. look to generate sustainable long-term performance rather than making decisions to benefit managers in the short run, and
. look at the four measures of financial discipline which are aligned with long-term value creation and sustainable growth. They are: high profitability, low investment, low issuance and dilution and low accounting accruals.
But investing in companies which were considered “good” by generic ESG standards was not enough, he said. You should target low turnover and therefore low transaction costs, set a long time horizon to fully capture return potential, monitor capacity and potential for strategies to become crowded or expensive and take not of fees.
– G.B.
