ESG AND CORPORATE FINANCIAL PERFORMANCE: A STUDY ON ...€¦ · ESG AND CORPORATE FINANCIAL...
Transcript of ESG AND CORPORATE FINANCIAL PERFORMANCE: A STUDY ON ...€¦ · ESG AND CORPORATE FINANCIAL...
Guido Giese
Melbourne, October 2018
ESG AND CORPORATE FINANCIAL PERFORMANCE:
A STUDY ON CORRELATION AND CAUSALITY
INTRODUCING MSCI ESG RESEARCH
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1 Source: MSCI ESG Research as of April 2018. Includes full time employees and allocated staff performing non-investment advisory tasks.2 Based on latest P&I AUM data and MSCI clients as of December 2017
Paris
London
Frankfurt
Geneva
Beijing
Hong Kong
Manila
SydneyCape Town
Mumbai
San Francisco
Boston
New York
Gaithersburg
Monterrey
Toronto Portland
Tokyo
185+ ESG analysts1
(325+ FTE)
1200+clients
46of 50Global asset managers2
TOP
900+ESG equity & fixed income indices use MSCI ESG Research
ratings and data
Stockholm
Chicago
Seoul
MSCI ESG RATING METHODOLOGY
3Sources: MSCI ESG Research
Identify leaders and laggards within each
industry
Industry-Relative ESG Ratings (AAA-CCC)
Focus on most relevant ESG factors by industry
Quantitative Approach + Annual Consultation
Focus on risk exposure not just disclosure
Scoring Models Assess Risk Exposure + Risk Management
Analysis begins with a deepgovernance assessment
Ownership, Board, Pay, Accounting, Corporate Behavior
MSCI ESG RATING MODEL
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ENVIRONMENT PILLAR
Climate Change
Carbon Emissions
Product Carbon Footprint
Financing Environmental
Impact
Climate Change Vulnerability
Natural Capital
Water Stress
Biodiversity & Land Use
Raw Material Sourcing
Pollution & Waste
Toxic Emissions & Waste
Packaging Material &
Waste
Electronic Waste
Env. Opportunities
Clean Tech
Green Building
Renewable Energy
SOCIAL PILLAR
Human Capital
Labor Management
Health & Safety
Human Capital Development
Supply Chain Labor Standards
Product Liability
Product Safety & Quality
Chemical Safety
Financial Product Safety
Privacy & Data Security
Responsible Investment
Insuring Health & Demographic
Risk
Stakeholder Opposition
Controversial Sourcing
Social Opportunities
Access to Communication
Access to Finance
Access to Health Care
Opportunities in Nutrition &
Health
GOVERNANCE PILLAR
Corporate Governance
Board
Pay
Ownership
Accounting
Corporate Behavior
Business Ethics
Anti-Competitive Practices
Corruption & Instability
Financial System Instability
Tax Transparency
Three-Step Process1) Identify Key Issues By Industry 2) Measure Risk Exposure for each Key Issue3) Measure Risk Management for each Key Issue
DISCLOSURE ISN'T EVERYTHING……. RISK EXPOSURE MATTERS
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COMPANY A✓ Policy: Child Labor✓ Policy: Wages & Hours✓ Compliance Audits Corrective Action Plan Engagement with NGOs
COMPANY B✓ Policy: Child Labor✓ Policy: Wages & Hours✓ Compliance Audits✓ Corrective Action Plan✓ Engagement with NGOs
1,500 Suppliers
Production in Bangladesh300,000 Units
$20bn Revenue at Risk
200 Suppliers
Production in Australia10,000 Units
$100m Revenue at Risk
FOUNDATIONS OF ESG - PART 1: WHY ESG MATTERS
Research objectives
Step 1:
Fundamental research
• Establish fundamental channels from ESG to financial values
• Elaborate what dependencies we can expect
• Mitigate risk of ‘correlation mining’
Step 2:
Empirical validation
• Validate dependencies using empirical analysis for each channel
• Differentiate between correlation and causality
Step 3:
Conclusions for investors
• Highlight areas of asset management where ESG integration can add value
• Derive methodology recommendations for ESG integration
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RESEARCH METHODOLOGY
Understand channels from ESG to financial values
DCF Model frameworkESG ratings
Profitability Dividend yield
Incidents risksTail risks
VolatilityBeta
Valuation
Denominator: Required rate of returnSystematic risks
Numerator: Expected cash-flows
Cash-flow channel
Valuation channel
Stock-specific risk channel
Stock-specific opportunities
Stock-specific risks
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STOCK-SPECIFIC CHANNELS
Cash-flow channel
Strong ESG profile1. More
competitive2. Higher
profitability3. Higher dividends
Economic rationale:
1. More competitive due to more efficient use of resources & human capital development & better innovation management.
2. Generate abnormal returns, which ultimately leads to higher profitability.
3. Higher profitability results in higher dividends.
Profitability of ESG quintiles
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STOCK-SPECIFIC CHANNELS
Stock-specific risk channel
Strong ESG profile1. Better Risk Management
2. Lower risk of severe incidents
3. Lower tail risk
Economic rationale:
1. Better risk management and corporate governance standards.
2. Less frequent incidents such as fraud, embezzlement, corruption or litigation cases etc.
3. Lower tail risk in the company’s stock price.
Incident Frequency of Top and Bottom ESG Quintile
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SELECTED INCIDENTS AND PERFORMANCE IMPACT
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Firm Benchmark Incident date 1 year active performance after incident
Weight in benchmark (%, as of incident date)
BP MSCI World April 1, 2010 0.31% 0.80
VW MSCI World September 21,2015 0.02% 0.09
Equifax MSCI World September 11, 2017 0.01% 0.04
Petrobras MSCI ACWI May 27, 2014 0.09% 0.15
Petrobras MSCI EM May 27, 2014 0.73% 1.39
Wells Fargo MSCI World September 12, 2016 0.07% 0.71
Facebook MSCI World March 17, 2018 0.10% 1.08
SYSTEMATIC CHANNEL
Valuation channel
Strong ESG profile1. Low
systematic risk2. Low cost of
capital3. High
valuation
Economic rationale:
1. High ESG rating companies are less vulnerable to systematic market risks such as commodity prices or changes in regulation.
2. Lower systematic risk means investors demand a lower required rate of return = cost of capital.
3. Lower cost of capital leads to higher valuation.
Systematic volatility of ESG quintiles
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DERIVED CHANNEL: ESG MOMENTUM
From the static relationship
We derive the dynamic relationship
ESG Momentum ( = change in ESG rating)• Was verified by empirical analysis• Is an indication for causality in the three transmission channels• Was found to be a performance driver in empirical analysis
ESG ratings 3 channelsProfitability
RiskValuation
Change in ESG rating
3 channels
Change in Profitability
RiskValuation
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DERIVED CHANNEL: ESG MOMENTUM
Financial performance of ESG momentum: Top versus bottom quintile
Cumulative performance differential of the top ESG Momentum quintile versus the bottom ESG Momentum quintile. ESG Momentum is defined as the 12 month change in ESG score.13
-2%
0%
2%
4%
6%
8%
10%
12%
14%
16%
17-May-09 29-Sep-10 11-Feb-12 25-Jun-13 7-Nov-14 21-Mar-16 3-Aug-17
Cu
mu
lati
ve p
erf
orm
ance
Developed Markets
Emerging Markets
CASE STUDY:MSCI EMERGING MARKETSESG LEADERS INDEX
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ESG LEADERS INDEX METHODOLOGY
ACWI
All
LIQ
UID
an
d IN
VES
TAB
LE
GO
OD
ESG
P
ERFO
RM
ERS
PO
OR
ESG
P
ERFO
RM
ERS
ACWI ESG LEADERS
Worst offenders
AAA
CCC
50%
Incentive to improve through reweight 50% Selection Best-in-class
(Selection per region and GICS sector to avoid biases)
Minimum ESG standards
Avoid most-problematic companies
BB
NO ESG BUILT-IN ESG INTEGRATION
PERFORMANCE IN LIVE TRACK (MAY 2013 – MARCH 2018)
16*See https://www.unpri.org
Key Metrics
MSCI EM (Emerging
Markets) Index
MSCI EM (Emerging
Markets) ESG
Leaders Index
Total Return* (%) 5.9 9.0
Total Risk (%) 15.2 14.5
Return/Risk 0.39 0.62
Sharpe Ratio 0.36 0.59
Active Return (%) 0.0 3.1
Tracking Error (%) 0.0 2.8
Information Ratio NaN 1.10
Historical Beta 1.00 0.94
No of Stocks*** 833 373
Turnover** (%) 4.9 7.1
Price To Book*** 1.5 1.9
Price to Earnings*** 13.6 15.5
Dividend Yield*** (%) 2.6 2.5
Period: 31-May-2013 to 30-Mar-2018
* Gross returns annualized in USD
** Annualized one-way index turnover over index reviews
*** Monthly averages
The definitions of all statistical parameters are available in the Appendix
MSCI EMERGING MARKETS ESG LEADERS ALLOCATION
Index: MSCI EM (Emerging Markets) ESG Leaders Index
Period: 31-May-2013 to 30-Mar-2018
Return (%)
Risk (% Std Dev)
0.13
0.02 0.02 0.02 0.05 0.08 0.05 0.07 0.12
Growth Liquidity
-0.01 0.01 0.02 0.04 0.05 -0.01 0.09
Leverage Earn. Qlty Inv. Qlty Profitability Earn. Var. Div. Yield
0.28 0.110.16 0.13 0.13 0.10 0.03 0.31
-0.22 0.09-0.14 -0.04 0.06 -0.04 -0.02 0.23
Beta Res. Vol.BtoP Earn. Yield LT Reversal Size Mid Cap Momentum
2.15
0 0.71 0.00 0.98 0.73 0.75 1.51
0 0.33 0.00 -0.12 0.47 0.25
Risk Indices Asset
Currency Currency Equity Selection
Explicit Implicit World Countries Industries
0.33 0 2.75 N/A N/A
0.71 0 2.53 N/A N/A
Active Trading Transaction
Selection Equity Equity Cost
5.94 3.09
15.17 2.80
Currency Cash
Annualized Gross Returns
Total
9.03
14.46
Benchmark Active
Performance attribution for MSCI Emerging Markets ESG Leaders Index (live track, May 2013 till March 2018)
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CONCLUSIONS FOR INVESTORS
1. MSCI ESG Ratings and MSCI ESG ratings trend (ESG momentum) have shown a financially significant impact on valuation, profitability and risk and therefore may be used in financial analysis as well as portfolio construction.
2. ESG integration into portfolio management requires a long-term horizon.
3. Stock selection based on MSCI ESG Ratings has shown a positive impact on performance and risk in life history for global MSCI ESG equity indexes.
4. Bloomberg Barclays MSCI ESG indexes for corporate bonds have shown risk reduction and slightly better performance compared to benchmark.
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Risk & Performance
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