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 ofglobal risk and financial advisory solutions, examines the relationship betweenhistorical returns of publicly traded companies and their ESG ratings globally.
The ESG and Global Investor Returns Study analyzeddata on over 13,000 companies across a variety of industries around the globeand found that companies with better ESG ratings outperformed their peers withlower ratings.
“The future of ESG and sustainability investing will depend on investorconfidence in the reliability of ESG ratings and ESG disclosures, and theirrelevance as an indicator of public company performance,” stated CarlaNunes, Managing Director and GlobalLeader of the Valuation Digital Services Group at Kroll. “Quantitative analysisof the relationship between ESG ratings and equity returns is a criticalcomponent for evaluating ESG-based investment decisions. Increased regulationaround ESG ratings is likely to bring some uniformity to the field.”
As new global regulatory and financial reporting standards are set, ESGinvesting will likely remain an important driver of investment decisions formanagement teams, investment firms, regulators and standard setters. A strongESG materialityframeworkfor identifying and assessing dynamic ESG factors is critical for effectivereporting. Because the concept of materiality differs between ESG disclosurestandards and proposals, there will be an increased need for complexdata-gathering processes, which will require technology solutions and closeattention to internal controls.
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“The demand for ESG disclosure attestation and assurance services will alsoincrease dramatically, allowing investors to place greater reliance on ESG datafor their investment-decision making,” Nunes added.
Methodology
The ESG and Global Investor Returns Study examines the relationship between acompany’s total stock returns (dividends plus capital appreciation) over the2013-2021 period as compared with ESG company ratings published by MSCI toascertain if an investment strategy focused on companies with a better ratingwould result in a superior return performance. The study is unique due to itsscope: The relationship between company ESG ratings and returns was covers fourgeographic regions (World, North America, Western Europe andAsia), 12 countries/markets (Australia, Brazil, Canada,China, France, Germany, (Hong KongSAR), India,Japan, South Korea, the UK and the US) and 11 industries.
Key findings
Globally, ESG leaders earned an average annual return of 12.9 percent,compared to an average 8.6 percent annual return earned by laggardcompanies. This represents an approximately 50 percent premium in terms ofrelative performance by top-rated ESG companies.
In the United States, the country with the largest number of ratedcompanies, the ESG leaders earned an average annual return of 20.3 percent,compared to a 13.9 percent average annual return earned by laggardcompanies. Similar to the findings globally, the relative performance bytop-rated ESG companies was nearly 50 percent stronger than theirlower-rated counterparts.
The positive relative performance of ESG leaders vs laggards was generallyconsistent across all major geographic regions and for most industries, withsome exceptions.
European companies are further along in their ESG journey, according toMSCI. For example, in December 2021, nearly a third of Western Europeancompanies were rated as ESG leaders. In contrast, only 10 percent of NorthAmerica and 6 percent of Asia companies had a leader rating.
Globally, leaders outperformed laggards in all industries analyzed, exceptfor Consumer Staples and Health Care. This contradicts the claim bysome market analysts that the outperformance of ESG investments (whenpresent) 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 betweenESG ratings and investment performance was being driven by the growing volume ofsustainable investments globally. In 2020, more than one-third of investmentassets in developed markets was defined as “sustainable” — reaching a total ofUS$35.3 trillion globally and US$17.1 trillion in the US alone, according tothe Global Sustainable InvestmentAlliance.
However, accusations ofgreenwashingand anti-ESGbacklashin the US have led to significant pushback on what is characterized as“sustainable” investing, spurringregulatory enforcement actions, increased litigation, and a flurry of proposedand/or finalized new standards focused on ESG and sustainability disclosuresaround the globe. As a result, many investment funds have changed their namingor classification and no longer label themselves as sustainability focused —making it very difficult to compare sustainable investing trends between 2021and 2022. In addition, according to a recent BCGanalysis,global overall assets under management declined by 9.5 percent — from US$108.6trillion in 2021 to US$98.3 trillion in 2022 — making comparisons even morecomplicated.
As regulatory and reporting standards gel and give companies firmer footing whenit comes to ESG investing, studies such as Kroll’s — as well as the ability toquantify the impacts of theirinvestments— will be critical in continuing to illustrate the business case of putting yourmoney where your values are.
