Kroll analyzed data on over 13K companies across industries and found that those with better ESG ratings outperformed their peers with lower ratings; globally, ESG leaders had annual returns of 12.9% vs 8.6% for laggards.
A new study by Kroll, a leading independent provider of global risk and financial advisory solutions, examines the relationship between historical returns of publicly traded companies and their ESG ratings globally.
The ESG and Global Investor Returns Study analyzed data on over 13,000 companies across a variety of industries around the globe and found that companies with better ESG ratings outperformed their peers with lower ratings.
“The future of ESG and sustainability investing will depend on investor confidence in the reliability of ESG ratings and ESG disclosures, and their relevance as an indicator of public company performance,” stated Carla Nunes, Managing Director and Global Leader of the Valuation Digital Services Group at Kroll. “Quantitative analysis of the relationship between ESG ratings and equity returns is a critical component for evaluating ESG-based investment decisions. Increased regulation around ESG ratings is likely to bring some uniformity to the field.”
As new global regulatory and financial reporting standards are set, ESG investing will likely remain an important driver of investment decisions for management teams, investment firms, regulators and standard setters. A strong ESG materiality framework for identifying and assessing dynamic ESG factors is critical for effective reporting. Because the concept of materiality differs between ESG disclosure standards and proposals, there will be an increased need for complex data-gathering processes, which will require technology solutions and close attention to internal controls.
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“The demand for ESG disclosure attestation and assurance services will also increase dramatically, allowing investors to place greater reliance on ESG data for their investment-decision making,” Nunes added.
The ESG and Global Investor Returns Study examines the relationship between a company’s total stock returns (dividends plus capital appreciation) over the 2013-2021 period as compared with ESG company ratings published by MSCI to ascertain if an investment strategy focused on companies with a better rating would result in a superior return performance. The study is unique due to its scope: The relationship between company ESG ratings and returns was covers four geographic regions (World, North America, Western Europe and Asia), 12 countries/markets (Australia, Brazil, Canada, China, France, Germany, (Hong Kong SAR), India, Japan, South Korea, the UK and the US) and 11 industries.
Globally, ESG leaders earned an average annual return of 12.9 percent, compared to an average 8.6 percent annual return earned by laggard companies. This represents an approximately 50 percent premium in terms of relative performance by top-rated ESG companies.
In the United States, the country with the largest number of rated companies, the ESG leaders earned an average annual return of 20.3 percent, compared to a 13.9 percent average annual return earned by laggard companies. Similar to the findings globally, the relative performance by top-rated ESG companies was nearly 50 percent stronger than their lower-rated counterparts.
The positive relative performance of ESG leaders vs laggards was generally consistent across all major geographic regions and for most industries, with some exceptions.
European companies are further along in their ESG journey, according to MSCI. For example, in December 2021, nearly a third of Western European companies were rated as ESG leaders. In contrast, only 10 percent of North America and 6 percent of Asia companies had a leader rating.
Globally, leaders outperformed laggards in all industries analyzed, except for Consumer Staples and Health Care. This contradicts the claim by some market analysts that the outperformance of ESG investments (when present) is attributable to the overweighting of IT stocks.
Global performance of ESG ratings portfolios: Cumulative return in 2013-2021 horizon
Kroll noted that the need for a better understanding of the correlation between ESG ratings and investment performance was being driven by the growing volume of sustainable investments globally. In 2020, more than one-third of investment assets in developed markets was defined as “sustainable” — reaching a total of US$35.3 trillion globally and US$17.1 trillion in the US alone, according to the Global Sustainable Investment Alliance.
However, accusations of greenwashing and anti-ESG backlash in the US have led to significant pushback on what is characterized as “sustainable” investing, spurring regulatory enforcement actions, increased litigation, and a flurry of proposed and/or finalized new standards focused on ESG and sustainability disclosures around the globe. As a result, many investment funds have changed their naming or classification and no longer label themselves as sustainability focused — making it very difficult to compare sustainable investing trends between 2021 and 2022. In addition, according to a recent BCG analysis, global overall assets under management declined by 9.5 percent — from US$108.6 trillion in 2021 to US$98.3 trillion in 2022 — making comparisons even more complicated.
As regulatory and reporting standards gel and give companies firmer footing when it comes to ESG investing, studies such as Kroll’s — as well as the ability to quantify the impacts of their investments — will be critical in continuing to illustrate the business case of putting your money where your values are.