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Companies with poor ESG practices underperform over long term

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3 minute read

The trend is consistent across sectors except for two notable exceptions.

Research by Federated Hermes on the link between environmental, social and governance (ESG) and company performance has found that those with poor practices have historically underperformed over the long term.

According to the firm, companies with leading or improving ESG scores perform better than their peers with poor or worsening standards largely due to the underperformance of the laggards rather than the outperformance of the leaders.

“For investors, avoiding the ESG laggards, and those whose standards are slipping, is a crucial way to capture the ESG premium,” suggested Federated Hermes senior global equities portfolio manager, Lewis Grant.

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The investment manager previously concluded that both social and governance factors have had a “meaningful impact” on shareholder returns but the relationship between environmental factors and performance was determined to be weak.

However, in the two years following its earlier research, Federated Hermes said it had observed a shift which has seen environmental factors supporting performance on par with social and governance.

This trend was found to be consistent across all sectors except real estate and energy, where companies with the worst or worsening environmental practices have typically outperformed. Mr Grant stated that this finding was concerning, particularly in regards to the energy sector.

“Some investors simply avoid the entire sector in the name of environmental considerations,” he said.

“Does this exclusion by many sustainable investors result in the sector being more influenced by those less concerned by sustainability? If sustainability-focused investors are not acting as stewards of the energy sector, it may be asked, who is?”

Federated Hermes also noted that awareness of sustainability was still growing across all sectors and added that embracing sustainability was not just about avoiding risks but also about finding business opportunities.

“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 who thrive,” said Mr Grant.

A study by Moody’s Analytics released earlier this year found that a company’s ESG performance has a strong impact on its market value.

As part of its analysis, Moody’s identified ESG-related controversies across more than 3,000 companies worldwide and determined their material effects. 

“We found that there is a meaningful benefit to a responsible ‘ESG risk management culture’ within a firm that can have a potentially material effect on equity returns,” Moody’s Analytics MD, Douglas Dwyer said.

“ESG controversies can inflict reputational damage with significant financial and legal repercussions. Firms that actively manage these risks do a better job of boosting shareholder value.”

Companies with poor ESG practices underperform over long term

The trend is consistent across sectors except for two notable exceptions.

Companies with poor ESG practices underperform over long term
Companies with poor ESG practices underperform over long term
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Jon Bragg

Jon Bragg

Jon Bragg is a journalist for Momentum Media's Investor Daily, nestegg and ifa. He enjoys writing about a wide variety of financial topics and issues and exploring the many implications they have on all aspects of life.

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