The finding is the result of research Hermes has done into the question whether ESG investing does actually enhance returns. The study found that high scores on environmental and social factors do not significantly improve performance. But, echoing similar findings from a study conducted earlier this year by NN Investment Partners, it concludes that the ‘G’ in ESG is the most lucrative letter of the acronym.
Companies with good or improving scores on issues such as board independence, remuneration, business ethics and risk management outperform companies with poor or worsening governance by 30 basis points a month on average. This performance gap is largely driven by companies with the lowest-ranking severely underperforming the average.
Companies within the lowest governance decile underperform the MSCI World more than two thirds of the time (see graph below), suggesting (bad) governance is indeed a powerful performance predictor.
Japan lags behind
Hermes also looked at ESG performance across the different equity markets. It found that European companies score best on environmental and social factors, while US companies have the best corporate governance policies. Perhaps this is a coincidence, but US stocks have outperformed other equity markets over the research period.
Japanese companies are serious laggards when it comes to corporate governance. Japanese companies’ average Governance scores are more than 20% lower than those of their peers in Europe, the US and the Asia Pacific ex-Japan regions. “This is not surprising given the country’s historic business culture, which placed little importance on independent representation at board level, had almost no focus on diversity and a general lack of transparency for shareholders,” the authors note.