Foundations of ESG Investing – Part 1: How ESG Affects Equity Valuation, Risk and Performance

categories: Indexes, ESG Products & Services, Portfolio Management Analytics, Americas, EMEAI, Risk Management Analytics, Asset Allocation and Asset Liability Management, Factor and Risk Modeling, Investing (Investment Management), Portfolio Construction and Optimization, Responsible Investing, Risk Management, Asia Pacific, Asset Owners, Hedge Funds, Equities, Asset Pricing and Valuation, MELAS Dimitris, NAGY Zoltan, Asset Managers (Quant or Fundamental), NISHIKAWA Laura, LEE Linda-Eling, GIESE Guido

Many studies have focused on the relationship between companies with strong ESG characteristics and corporate financial performance.  However, these have often struggled to show that positive correlations — when produced — can in fact explain the behavior. This paper provides a  link between ESG information and the valuation and performance of companies, both through their systematic risk profile (lower costs of capital and higher valuations) and their idiosyncratic risk profile (higher profitability and lower exposures to tail risk). The research suggests that changes in a company’s ESG characteristics may be a useful financial indicator. ESG ratings may also be suitable for integration into policy benchmarks and financial analyses.

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