The Journal of Impact & ESG Investing

Climate Alpha with Predictors also Improving Firm Efficiency

Viktoria-Sophie Wendt — 2022-02-08

Characteristics of companies associated with climate change predict excess equity returns. We show that firms with lower carbon emission intensities—with carbon emissions being a key component of the Paris Accord—have high excess returns. We present evidence that firms with lower carbon emissions have higher productivity, and that the lower carbon intensities may reflect greater firm efficiencies. A portfolio of firms with a higher proportion of LEED certified buildings also exhibits high excess returns. Such companies also contemporaneously exhibit higher return on assets. Portfolios constructed with the carbon emission intensities and the LEED certified buildings signals are only weakly correlated to a traditional quality factor. We discuss how climate change themed measures of firm efficiency may drive value for sustainably focused investors.

How ESG Affected Corporate Credit Risk and Performance

Reginald Laing — 2022-02-08

We extend our research on how environmental, social, and governance-related (ESG) characteristics have affected equity investing to corporate bonds. Unlike with equities — where MSCI’s previous research shows that MSCI ESG Ratings had positive effects on stocks’ risk and return characteristics — we find that a corporate bondholder’s main ESG focus could be mitigating downside risk, rather than capturing upside. We also examine whether ESG added value beyond credit ratings — a significant point of interest for bondholders. In short, ESG complemented credit ratings. ESG ratings had characteristics distinct from credit ratings and delivered additional insights into risk and performance. ESG was in general more financially relevant in high-yield (HY) than in investment-grade (IG) bonds and more relevant in IG bonds with longer, rather than shorter, maturities. Higher-ESG-rated issuers tended to have stronger cash-flow metrics, lower levels of ex-ante risk, and less frequent severe incidents than lower-rated ESG issuers.

The Evolving Landscape of Big Data Analytics and ESG Materiality Mapping

Sucharita Gopal — 2022-02-08

Raging hurricanes, devastating floods, sea-level rise, heatwaves, and other extreme weather conditions are now attributed to climate change. Climate risk poses a significant investment risk in terms of economic losses and societal disruptions such as migration, infectious diseases, and increasing vulnerability of exposure to more frequently reoccurring weather events. Countries around the world signed to Paris agreement in 2015 to keep global warming “well below 2° C above pre-industrial levels”. This entails a transition to low carbon or a decarbonized future. In this paper we propose a Climate Risk IQ framework utilizing “big data”, and data analytics coupled with AI to assess the materiality of the risks. We illustrate our approach in two use cases to highlight how businesses and municipalities can benchmark their exposure, risk, and vulnerabilities. We also consider long-term trends heading to a decarbonized future. “Is our future a panacea or a pipedream?”

Sustainable Consumption and Production, Climate Change, and Firm Performance

Maretno Agus Harjoto — 2022-02-08

As ESG investing is gaining its momentum, this study examines whether ESG scores are positively (aligned) or negatively related (misaligned) with firms’ sustainable consumption, production and firms’ ability to minimize climate change. Using Trucost environmental and Paris alignment data, we find that firms’ overall ESG score is aligned with firms’ sustainable consumption, production, and climate change. The environmental score is aligned while social and governance scores are not aligned with firms’ sustainable consumption, production and climate action. We find evidence that firms’ sustainable consumption, production, and climate action offer 0.3% to 0.8% annualized excess stock returns and 12.5% to 20% higher return on assets (ROA) for a 1% increase in firms’ ability to meet these goals. This study provides insights for asset managers who rely on ESG for their investment selection and corporate managers who attempt to improve firms’ ESG on how firms’ sustainable consumption, production and climate action goals are related to ESG components, stock returns and firm performance.

IMPACT OF ENVIRONMENTAL, SOCIAL & GOVERNANCE (ESG) FACTORS ON STOCK RETURNS OF EMERGING MARKETS

DINABANDHU BAG — 2022-02-08

Empirical evidence indicates that environmental social and governance (ESG) practices are associated with firm financial performance, but little is covered about investors’ attention towards stock performance. In this paper, we conduct a test of the relationship between ESG performance disclosures and the firm’s financial or capital market performance. We choose a stratified sample of large-cap firms across 8 sectors drawn from the S & P 100 during the period 2016 to 2021. The changes in ratings, namely, governance, environment, exhibit a small but significant impact on the stock’s performance during the periods. Our results show that few of the ESG disclosures are positively related and dominate over the usual firm-level determinants of ROA (Return on Assets). We find governance practice is more significant than climate disclosures. These outcomes are robustly demonstrated on use cases of top stocks with investor safety recommendations. The results could have useful implications for investors, fund managers and regulators.

Tuning Trend Following Strategies with Macro ESG Data

Christian Morgenstern — 2022-02-08

Trend Following (TF) is a well-known and documented strategy which has been employed by practi- tioners since the 1980s. The focus so far has been on the alpha-generating potential of the strategies and in particular on extending the strategy to a broader range of asset markets. In this paper, we describe how to integrate sovereign Environmental, Social and Governance (ESG) information into a macro TF strategy. Notably, we find that the ESG exposure of the macro portfolios can be substantially increased without any cost in performance.

Portfolio Construction and New Energy Infrastructure Investing

Christian Hans Andersson — 2022-02-08

In light of the increasingly severe consequences of climate change, an increasing number of institutional investors want their investments to replicate their ethical values. This article identifies the decarbonization of the global power generation as an opportunity for those investors requiring sustainable impact while enhancing the risk-adjusted returns for and future-proofing of their portfolios. After analyzing the worsening state of financial markets, with high equity valuations and record-low bond yields, the authors demonstrate the added benefit of economic resilience of sustainable infrastructure assets. A move into sustainable infrastructure is bolstered by global political tailwinds earmarking fiscal stimulus to upgrade existing and new green infrastructure, as well as regulators increasingly enforcing disclosure of progress. Finally, by delving deeper into portfolio construction, the authors argue for the benefits of diversifying into the adjacent renewable energy technologies needed to sustain the forthcoming renewable power networks to optimize the risk and return profile of portfolios.