New research has found that institutional investors overreact to bad ESG news, causing “wild fluctuations to the share market”.
Researchers from Monash University found that investors “collectively overreact” when companies are the subject of bad ESG news, leading to share prices falls greater than justified.
“Our prediction was grounded in salience theory, which holds that when the attention of decision-makers is disproportionately directed to one or a few factors – in this case, environmental, social, and governance issues – those factors will receive disproportionate weighting in subsequent judgements,’’ the researchers wrote.
“Thus, when institutional investors observe a negative shock to the ESG attributes of a stock, it is expected that they will overestimate the probability of further shocks, resulting in a stronger tendency to sell, and a larger fall in the stock price than might be justified by fundamental considerations.”
The researchers analysed more than 331,000 ESG news events between January 2000 and December 2019 and found that investors are better off waiting up for bad news to pass before making trade decisions.
“The research findings show traders have an opportunity to buy these stocks at a discount and then sell at a profit,” said Dr Bei Cui, one of the researchers.
“It also suggests that investors wishing to reduce exposure following bad ESG news can sometimes be better off waiting, in some cases up to 90 days after the announcement – to execute the necessary trades at a better price… There is also considerable evidence that the advanced leaking of information ahead of bad news events, as cumulative abnormal returns began occurring several days before this news was announced.”
Between 2016 and 2018 the total value of sustainable and responsible investment assets in the five major markets surged by 34 per cent to $30.7 trillion. In Australia and New Zealand, 63.2 per cent of total managed assets are invested using ESG frameworks.
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