How ESG engagement creates value for investors
ESG engagement boosts returns
There is a solid body of evidence that ESG engagements conducted by investors help improve financial performance, in addition to sustainability performance. Investors see engagement as a way to uncover new signals and alternative data points that help them better understand the risk and return profile of their investments, in addition to a mechanism to deliver on sustainability goals.
A landmark academic study on ESG engagements with US publicly-listed companies between 1999 and 2009 found that successful engagements are followed by positive abnormal returns. The graph on the right shows the cumulative monthly abnormal returns (CARs) for target companies engaged by investors from one month before the engagement, to eighteen months after. The average one-year size-adjusted abnormal return after initial engagement is +7.1% for successful engagements, demonstrating that ESG improvements increase the market value of engaged companies. The positive abnormal returns are most pronounced for engagements on the themes of corporate governance and climate change.
Source: Dimson, Karakas, & Li (2015) Active Ownership
Source: Fidelity International (2020) Outrunning a Crisis
A 2020 analysis by Fidelity International further exemplifies how ESG engagement can contribute to market outperformance, even in the midst of a crisis. The authors looked at Fidelity’s ESG ratings for 2,689 companies in the context of the Covid-19 induced market downturn. They found that in the 36 days between 19 Feb and 26 March, the S&P 500 fell 26.9 per cent, while the price of a share in companies with a high (A or B) Fidelity ESG rating dropped less than that on average. On average, each ESG rating level was worth 2.8 percentage points of stock performance versus the index during that period of volatility.
Engagement Helps Asset Managers Meet Growing Expectations
Investor engagement on ESG is a key mechanism to meet the evolving requirements of sustainable finance regulations and stewardship codes, as well as fulfilling responsible investing commitments. Below are three examples where engagement can help asset managers to meet expectations:
EU Shareholder Rights Directive (SRD) II: According to the legislation, “institutional investors and asset managers shall develop and publicly disclose an engagement policy that describes how they integrate shareholder engagement in their investment strategy. The policy shall describe how they monitor investee companies on relevant matters, including strategy, financial and non-financial performance and risk, capital structure, social and environmental impact and corporate governance, conduct dialogues with investee companies, exercise voting rights and other rights attached to shares, cooperate with other shareholders, communicate with relevant stakeholders of the investee companies and manage actual and potential conflicts of interests in relation to their engagement.”
UK Stewardship Code: Principle 7 of the Code is “signatories systematically integrate stewardship and investment, including material environmental, social and governance issues, and climate change, to fulfil their responsibilities”. Principle 9 of the Code is “signatories engage with issuers to maintain or enhance the value of assets”, and signatories are encouraged to describe the outcomes of engagements performed annually.
Principles for Responsible Investment (PRI): Principle 2 is “we will be active owners and incorporate ESG issues into our ownership policies and practices”, with possible actions to implement this principle including: developing an engagement capability, engaging with companies on ESG issues, and participating in collaborative engagement initiatives.