Is it Time to Drop the ‘ES’ from ESG?

(May 23, 2014) — The environmental and social parts of the ESG acronym do not contribute to positive returns for investors, research from Hermes has shown.

By using the most comprehensive data set available, gathered from its in-house advisory Equity Ownership Services, Hermes found while investing in companies with good—and improving—governance made good returns, selecting companies based on an environmental or social basis had a negligible or even negative effect.

Using the MSCI World Index, Hermes scored companies on a scale of one to 1,000 and selected only the best companies scoring highly on these ESG criteria.

“Selecting companies using the governance criteria added up to 30 basis points a month,” said Hermes Senior Portfolio Manager Lewis Grant. “This equates to 3% a year, which is significant.”

However, using environmental selection criteria actually pulled down performance by 10 basis points a month—based on a back test run between December 2008 and December 2013—while sustainable criteria boosted returns by just one basis point a month.

“It makes sense that the best run companies, or those which are actively improving their governance structures, make the best returns,” said Grant. “Governance is the ‘added value’.”

Investors should not completely abandon a penchant for environmental and social causes, however.

“The ‘E’ and ‘S’ part do no harm,” said Grant, adding that the numbers were too volatile to count the 10 basis point reduction as anything either constant or significant. “There were some months over the five year back test that these factors worked well and these points will be important, they are just not there yet. People will focus on them in time, but these things are very slow moving.”

Several large investors have dropped investments that are against their environmental moral code in recent years, including large endowments, pensions, and sovereign wealth funds around the world.