ESG demand grows despite performance doubt

“I’ve seen a number of reports and there is no hard evidence that you either give up or gain any performance [from ESG investing],” US-based Biggers told FSA on a recent trip to Hong Kong.

“One school of thought is that incorporating environmental, social and governance factors will improve the selection of sound investments, while another school considers weighing such factors as a diminution of pure investment conviction.”

Biggers himself believes that “over the long run, it might not create outperformance, but it can keep you out of underperformance”.

The rationale is that although ESG screening might hold investors back from investing in certain companies that could generate high dividends or good performances, an ESG-fitted company is healthy over the long run and should perform better, he explained.

Biggers said Franklin Templeton is relying on external ratings from ESG service providers including MSCI and Bloomberg, which rate individual companies. The analysts can refer to the ratings when they research a company. 

Still, “complex organisations have many dimensions and an ESG rating will not perfectly characterise a company’s total social impact”, he noted.

ESG and the VW debacle

One notable example is Volkswagen. The German carmaker was removed from MSCI ACWI ESG Index due to governance issues in May 2015, four months before the scandal of VW cheating on US carbon emission tests. But it had been on other ESG-focus indices such as Dow Jones Sustainability index, and FTSE4Good index.

“VW has a very low ESG rating due to actions that have come to light around emissions testing. But in the past, before such revelations, it had a positive ESG profile,” Biggers said.

The Volkswagen scandal is also an example of an ESG screening failure. The company failed in corporate governance and as a result it could take decades to rebuild its brand name.

Governance may be the strongest component of ESG, according to a recent study from Hermes Investment Management. The study found that high scores on environmental and social factors do not result in meaningful performance improvement, but companies with the strongest governance significantly outperformed peers with lower governance ratings.

The ratings game

Templeton added that ESG ratings are just one input for ESG analysis that should be challenged. The ratings should only provide some degree of benchmarking. “Understanding the material metrics and key performance indicators below the headline ratings (in the context of the business’ operations) is more beneficial.”

The ESG is also less restrictive than socially responsible investing (SRI), which excludes certain industries such as tobacco, weapons or gambling industries, said Biggers. 

Credit is given to an individual company which makes improvements, even if the industry is not necessarily environmental friendly, he explained. “If you are a coal company, you will probably get a low score in ESG. But if you are a coal company improving [ESG practices], you can also get a good rating within the category.”

Hence, if VW shows an improvement in governance, the firm could gain back a positive ESG rating in the future, he noted.

Demand for ESG investing is growing in Asia but mainly from Australia only, Biggers said. Australia, Northern Europe and continental Europe are big proponents of ESG investing in the institutional investor space, while the US and the rest of the world is lagging.

One growth driver for ESG investing comes from the millennials, who are “willing to look beyond performance and have a portfolio that they can be proud of”, he said. They weigh ESG considerations as a reflection of personal values on a voluntary basis.

“Institutional investors incorporate an ESG framework into investing at the discretion of the asset owner’s fiduciary oversight leadership. This would typically be the fund’s board or plan sponsor.”

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A comparison of the three-year performance between MSCI ACWI index, MSCI AC Asia index and their corresponding ESG index, according to data from FE Analytics.