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The Economic Value of ESG/SRI

The Economic Value of ESG/SRI. Lars G Hassel Program Director Mistra. The Norwegian Business School – November 15, 2012. Programme objective 2006.

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The Economic Value of ESG/SRI

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  1. The Economic Value of ESG/SRI Lars G Hassel ProgramDirector Mistra The Norwegian Business School – November 15, 2012

  2. Programmeobjective 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

  3. SIRP vision • Investors expecttocreatevalueaddedby exploitingsustainableinvestments by asset management • …buttherearebarriersbecauseofuncertaintyoffinancialoutcomes and the strictfinancial focus offiduciaryduty • …institutionalinvestorshave the strengthtoimprove the market mechanismtodrive companiestowards a moresustainabledevelopment.

  4. …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)

  5. ESG and EconomicValue – FirmLevel • Is there a correlation? • Innovestecoefficiencyratingsof U.S. firmspositivelyassociated with firmvalue and operating performance(Guenster et al. 2011) • GES environmentalratingsof Swedishlarge-capfirmspositivelyassociated with firmvalue 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 practicesaddeconomicvalueto assets! Costs of practices drop (learning and scale) and future benefits increase First mover advantage

  6. SRI Risk/Returns • Is there an alpha? • SRI fundsand portfolios seemtoperformneutrally (Olsson, 2007; Derwall and Koedijk (2009); Herzel at al, 2012) • Performancecan be different in different SRI segments (Derwall et al 2011) • Values driven (exclusion) and profit-seeking (alpha) segments • ESG portolioshaveoutperformed in the past (e.g. Derwall et al 2005) • Investors aremoresophisticated and havelearned. • Canmis-pricingoflarge-capfirmscontinue? (Borgers et al 2012)

  7. 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

  8. Empirical Research Twomainstrategies have been studied: • ESG opportunity (select best-in-class) • ESG risk management (excludesin stocks) • Portfolio construction: • Top: leading best performers on E, S, or G • Bottom: lagging worst performers on E, S, or G • Abnormalreturns or “Risk-adjusted” returns • Different risk-factors (4 factor model) accountedfor

  9. Derwall et al (FAJ 2005): RISK- AND STYLE-ADJUSTED PORTFOLIO RETURNS (ALPHA) BASED ON INNOVEST ECO-EFFICIENCY RATINGS (U.S companies 1995-2003) Abnormal Return! Mispricing or another risk factor? Liquidity; downside risk, takeover factors

  10. ESG opportunity portfolios in the U.S.Best-in-classoutperformancefadesout over timewheninvestorslearn!

  11. ESG Risk Management • Controversialstocks/industriesareexcludedbased on norms • The Price of Sin…(Hong and Kacperczyk JFE 2009) • Lowerinstitutionalownership and lessanalysts’ coverage • Price/bookratios for sinstockslower • Superiorreturns 1926-64; 1965-2003 (4 factor α) • KLD controversials • Shunnedstocksoutperformpeers (Kempf & Osthoff EFM 2007; Statman & Glushkov FAJ 2009) • EuropeanSample • Sinstocksoutperformpeers, especiallyunderhighlitigationrisk and protestantfaith (Salaber 2007)

  12. Performance of controversial stocksControversialstocks continue tooutperformtheirpeers!An unintendedconsequence of RI

  13. SRI/ESG- whathavewelearned? • Sustainable business practicesaddeconomicvalueto assets • Costsof the practicesdropbecauseoflearning and economicsofscale • Expectedbenefitsof the practiceswillincrease • As sustainabilitycreateseconomicvalue, thisvalue is priced, and does not necessarilyresult in higher risk-adjustedreturnsof portfolios

  14. SustainableInvestmentOpportunities INclude Product Innovations Sustainable Products Compliance with legislation and norms Mature Product Strategic Best CSR Practice Sustainable Ventures Best Practices Unsustainable loosers EXclude Worst Practices Emerging Momentum Established

  15. Benchmarking • ESG ratings and rankings haveimproved the transparency and market efficiency for largecaps and returnopportunities come now from • Engagement • ESG rising stars (timing) • Benchmarking needed on • Small-capfirms • Private equity – venture capital • Global Real EstateSustainability Benchmark (GRESB)

  16. THANK YOU! WWW.SIRP.SE

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