Environmental factors have become a statistically meaningful driver of shareholder returns over the past two years, according to controversial ESG investing champion Federated Hermes.
Avoiding the ‘ESG laggards’ and those whose standards are slipping is a crucial way to capture the ESG premium, the US firm’s global equities team has found. But real estate and energy companies are the exceptions; firms in these sectors with the worst or worsening environmental practices relative to peers tend to outperform.
The research follows the declaration by Federated Hermes last month that ‘responsible investing is not about promoting a specific political agenda’. The $669 bn global investment manager was responding to criticism from some investors that it is among the ‘gold sponsors’ of the Republican-leaning, climate change-skeptical non-profit State Financial Officers Foundation.
Federated Hermes’ inaugural ESG research, published in 2014, found the relationship between governance and shareholder returns to be ‘non-linear’. Companies with leading or improving corporate governance scores outperform peers with poor or worsening standards – but rather than performance deriving from the leaders outperforming, the governance premium is largely driven by the underperformance of the laggards. This same pattern exists for the social factor and for the environmental factor, the team claims.
The Covid-19 pandemic cemented the importance of social impact, with more socially responsible companies tending to outperform, says Federated Hermes. Previously there was weak evidence that environmental factors had similar properties, but the historic relationship was volatile and did not reach the necessary hurdle to be considered significant.
That has changed over the last two years, with environmental factors supporting performance on a par with social and governance. ‘This confirms that across the environmental, social and governance pillars, the link between ESG and performance is clearly in evidence,’ the firm says.
The latest Covid-19 Update report by IR Magazine shows more than six in 10 IROs and investors view the economy as having performed better than they considered it would at the onset of the pandemic.
Lewis Grant, senior global equities portfolio manager at Federated Hermes, says some investors simply avoid the entire real estate and energy sectors in the name of environmental considerations. ‘Does this exclusion by many sustainable investors result in the sector being more influenced by those less concerned by sustainability?’ he asks. ‘And if sustainability-focused investors are not acting as stewards of the energy sector, it may be asked: who is?’
Awareness of sustainability continues to grow across every sector, Federated Hermes says. Embracing sustainability in general is not just about avoiding risks, but also about finding business opportunities.
Grant adds: ‘We stand by the belief that sustainability requires a long-term focus and can deliver the opportunity for long-term results. In the developing environment, we believe businesses with the right longer-term focus will be the ones that thrive.’