The cost of ignoring ESGArian Neiron, Managing Director11 October 2018
New VanEck research Sustainable Investing: The case for taking a sustainable approach, provides analysis of why investing in companies with high ESG ratings can improve returns for investors.
Companies with strong ESG profiles typically enjoy enhanced corporate performance and financial returns – and targeting those companies can boost portfolio performance by reducing the risks which companies, and therefore investors, face.
On the other hand, not adhering to ESG factors can greatly cost companies and raise the risks of poor performance. The recent high profile examples mentioned below highlight where a company’s revenue has been lost due and share price has collapsed due to its misconduct and poor ESG governance.
For investors, adopting ESG guidelines in a portfolio can improve performance by helping to minimise exposure to companies with poor ESG performance and thus reduce the risk of their investment. This has been unfolding recently in real time.
Link between ESG and risk mitigation
Investors around the globe have witnessed a barrage of corporate disasters and bad management this year causing shareholders to lose billions of dollars. Locally, just think what the Hayne Royal Commission has meant for Australian financial institutions. Globally, we’ve witnessed the Facebook/Cambridge Analytica scandals and Atlantia’s poorly maintained bridge in Genoa which collapsed in August.
Research from academics, asset managers and index providers has found a link between good ESG governance and improved financial performance, largely through risk reduction. Targeting high ESG performers can therefore pay real dividends to investors by avoiding companies like Atlantia or Volkswagen, which is still giving its shareholders heartburn.
Indeed, the evidence is mounting that not investing in companies with good EGS ratings can ‘cost’ investors. For Australian banks, the reputational damage from the Hayne Royal Commission is still mounting and their share prices are well down from their highs back in 2015.
In Italy, one of the worst performers on the Milan stock exchange this year has been Atlantia, which owns Autostrada per Italia, the owner of the poorly maintained bridge in Genoa which collapsed in August killing 43 people. The company has been highly criticised in the global media for not properly maintaining its bridges. The company has lost around one third of its value following the disaster.
In Germany, Volkswagen’s share price has never recovered from its 2015 plunge following the diesel emissions scandal. The company faces ongoing class actions and more potential payouts to aggrieved investors after it rigged diesel emissions test results.
Lesser known but as shocking are details that it investigated the harmful effects of diesel exhaust on monkeys placed in airtight chambers, watching cartoons for entertainment as they inhaled fumes from a diesel Volkswagen Beetle.
In another big scandal, Facebook’s shares have dropped this year by almost 16% after revelations it failed to properly protect the privacy of users’ data after Cambridge Analytica harvested the personal data of millions of people's Facebook profiles without their consent and used it for political purposes.
In contrast, its peers have done much better, with Apple up 30%, Google-owner Alphabet up 8% and Microsoft up 29%. Facebook has a relatively low ESG rating from index provider MSCI of ‘BBB’, compared to Microsoft’s ‘AAA’ rating and Alphabet and Apple’s ‘A’ ratings. MSCI assesses all of the stocks in its global universe on a 'AAA' to 'CCC' scale according to their exposure to industry specific ESG risks and their ability to manage those risks relative to peers.
These three examples highlight the loss that can result in shareholder value due to poor corporate governance. They also raise questions for the general population – would you want to be invested in companies that carry out such activities or didn’t act as they should have to protect lives? For many, the answer would be no.
The way forward
Interest in investing according to ESG guidelines has grown considerably over the past few years. Now that research is finding that ESG factors may add to investment returns by reducing the risks which investors face. Investors can have more confidence that their choices can improve their portfolio returns, as well as align their investments to their personal values. On the other hand, ignoring ESG factors can cost investors real dollars, not just missed opportunities as the many recent corporate scandals highlight at home and abroad.
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 As at 9 October 2018.