There is some evidence that ESG alpha does exist in certain pockets of portfolio management, but whether managers can consistently deliver such alpha remains to be proved, according to recent research papers.
“In isolation, (environmental, social and corporate governance factors) are not going to dramatically improve returns,” said Andrew Howard, London-based head of the GS Sustain research team within the Global Research division of Goldman Sachs Group Inc. “But if you combine (the data on) how these signals can have a significant effect on financial results with other factors on how the company's financial results are achieved, then yes, I think ESG can be an important element in long-term outperformance.”
The GS Sustain focus list is Goldman Sach's concentrated global equity strategy that uses ESG factors along with other drivers to obtain outperformance.
“ESG is an ingredient in the recipe to identify future leaders” in a particular sector or market, Mr. Howard said. “If the sole selection criteria is ESG, then the strategy is not going to generate outperformance.”
However, opinions vary widely when it comes to isolating that ingredient and replicating the recipe. Chris McKnett, vice president and head of ESG Investing at State Street Global Advisors based in Boston, said while it is accepted that ESG factors can add alpha, “there's still a need for proof.”
Much of the available research has not been able “to conclusively establish a link between a company's ESG profile and stock price,” according to a recent State Street paper titled “Sustainable Investing: Positioning for Long-Term Success,” which was co-authored by Mr. McKnett. But as the quantity and quality of ESG data improve, Mr. McKnett believes the understanding of the link between ESG and performance can only strengthen. State Street's own research shows that share price might be correlated to ESG factors, but the degree of correlation varies across different countries and sectors. In additional research due to be published early this year, there is some preliminary evidence that companies with better ESG ratings offered some downside protection during the financial crisis, Mr. McKnett added. “These companies offered more stability during the worst period of the bear market in 2008,” he said.
Good governance, for example, may offer more downside protection by better aligning investor interest with that of the company's.
Lawrence E. Kochard, new CEO of the University of Virginia Investment Management Co. — which manages the $4.6 endowment fund, said he sees opportunities to unlock company value through collaborative, active engagement. The university endowment portfolio does include a portion dedicated to active engagement in which money managers work with public companies to exploit inefficiencies that will maximize value. Mr. Kochard, who started as CEO on Jan. 1, declined to specify the amount and the managers of the endowment's strategy. (He was previously CIO at Georgetown University's $1 billion endowment, where he also had invested in active engagement strategies.)
“This is an approach in which I have a lot of conviction,” Mr. Kochard said. “The challenge is finding managers who are good investors. They have to firstly be good investors in addition to being capable of effecting (corporate governance) changes in a non-hostile way.”