Sustainability and Financial Markets Lars Hassel Aronia seminar - - PowerPoint PPT Presentation

Sustainability and Financial Markets

Lars Hassel Aronia seminar 16.09.2010

Sustainable Investments Research Program

• Vision

– Institutional Investors can take a leading role in promoting Sustainable Development (SD) by changing the behaviour

• f companies in which they invest.
• Objective

– Find out how Sustainable Investment (SI) practices can create added value for institutional investors and identify barriers to mainstreaming such practices among asset

• wners and managers

– SI have to go beyond the business case and aspire to make a contribution to SD

Research Agenda

• SI and Fiduciary Responsibility

– ESG in conflict with interpretation of fiduciary duty? – Balance between short term gains and long term values

• The Investment Case

– Evaluate SI strategies in different asset classes

• How sustainable can SI be?
• Company Behaviour

– Explain mechanisms through which SI can influence company behaviour towards SD

• How sustainable can companies become?

Conflicting Evidence of Risk‐Adjusted SRI Returns?

• Derwall et al, FAJ 2005 ´The eco‐

efficiency premium puzzle’

• No difference in risk adjusted returns

between ethical and conventional mutual funds or back‐tested portfolios

• Demystifying RI… (Mercer 2007)
• Shedding light on RI… (Mercer 2009)
• Hong & Kacperczyk, JFE 2009, The price of

sin: The effects of social norms on markets

• Statman & Glushkow, FAJ 2009 ’The

wages of social responsibility’

Best-in-class Superior returns Conventional risk/return trade-off ’No Harm’ Sin or shunned stocks Superior returns

Neutral Returns on SRI Funds?

• SRI mutual funds

– Conventional wisdom; SRI and conventional mutual funds produce similar risk adjusted returns ; 4‐factor α, (Bauer et al JB&F 2005) – Applies also to fixed‐income SRI funds (Derwall and Koedijk JBF&A 2009) – Volatility of flows and sensitivity to past returns generally lower in SRI funds (Bollen, JF&QA 2007) – Willingness to accept losses applies to negative SRI screens (Renneboog et al 2009) – Different SRI retail market segments found in Swedish survey (Nilsson, IJBM 2009) – SRI investors have different motives

SRI Strategy – Negative Screens and Exclusion

• Shunned Stock Hypothesis
• Sin stocks in conflict with societal norms (norms‐constrained investor)
• Shunned stocks trade at discount and have a higher expected return
• The Price of Sin…(Hong & Kacperczyk JFE 2009)

– Lower institutional ownership and less analysts’ coverage – Price/book ratios for sin stocks lower – Superior returns 1926‐64; 1965‐2003 (4 factor α)

• KLD controversials

– Shunned stocks outperform peers (Kempf & Osthoff EFM 2007; Statman & Glushkov FAJ 2009)

• European Sample

– Sin stocks outperform peers, especially under high litigation risk and protestant faith (Salaber 2007)

Fabozzi et al (JPM 2008): Sin Stock Returns

SIN Funds

SRI Strategy: Positive Selection of Best‐in‐ Class

• Errors‐in‐expectations hypothesis

– CSR information value relevant but not well understood by market – Abnormal risk‐adjusted returns only when investors underestimate CSR as a driver of future expected cash‐flows.

• Innovest eco‐efficient portfolios

– U.S. Portfolio outperformed industry peers (Derwall et al FAJ 2005).

• KLD social investment indicators

– High‐ranked portfolios outperform lowest‐ ranked portolios (Kempf & Osthoff EFM 2007; Statman & Glushkow FAJ 2009.

• Employee satisfaction as an intangible

– Fortune’s classification provided abnormal returns (Edmans, 2009)

19

Derwall et al (FAJ 2005): RISK‐ AND STYLE‐ADJUSTED PORTFOLIO RETURNS (ALPHA) BASED ON INNOVEST ECO‐EFFICIENCY RATINGS (U.S companies 1995‐2003)

alpha % Rm-Rf

Market Risk β

SmB

Small Firm Risk

HmL

Price/book Risk

MOM

Momentum Effect

R2 Best-in-Class Portfolio 4.15** 0.92***

• 0.19***

0.02

• 0.09***

0.88 Worst-in- Class Portfolio

• 1.81

1.03*** 0.04 0.23***

• 0.08***

0.86 Difference 5.96**

• 0.12***
• 0.23***
• 0.22***
• 0.01

0.17

Abnormal Return! Mispricing or another risk factor?

Concluding Studies on SRI Portfolio Strategies

• SRI markets serve different motives and SRI has become a

multidimensional concept (Derwall et al 2010)

• Back‐testing based on ESG ratings suggests

– Values driven investors shun controversial stocks at the expense of financial returns – Profit seeking investors hunt best‐in‐class stocks

• The abnormal returns have faded out in recent years

when E & G (S) risks and opportunities are priced

• The value relevance of ESG increases over time

21

Social and Financial Performance on Firm Level

• Environmental

‐ Social ‐Governance ‐ratings

Economic Value: Operating profit Market value and Cost of Equity Capital

+/-

Doing good while doing well – win‐win situation

22

ESG and Extra‐Financial Value – Firm Level

• Back‐testing confirms E and G (S) factors bring added value

– ESG metrics and financial measures (MSCI: U.S.)

– ROI (+/‐) – Market premium, Tobin’s Q (+) – Cost of Equity Capital (‐)

• Innovest eco‐efficiency rating (Guenster et al, 2006)
• GES environmental index (Semenova &Hassel SD 2008)
• KLD ESG sub‐dimensions (Derwall & Verwijmeren, 2008)
• Commercial property and housing markets

– Green office buildings U.S (Eichholtz et el AER 2009) – Energy efficient housing NL (Brounen & Kook 2009)

Market Value = Tangible Information + Intangible Information

Market Value

Past performance Earnings and Book Value Cash Flows/Reputation Environmental and Social Performance

Value relevant?

Semenova, Hassel & Nilsson (2010): The Value Relevance of Environmental and Social Performance for Swedish SIX 300 Companies

Sample: SIX 300 Companies Classified by Sectors and Market Capitalization

Environmental and Social Performance for SIX 300 Companies 2005‐2008 (U.S. Companies)

ES Data Provider: GES - Investment Services

Environmental Performance Value Relevant for Large and Mid Cap (not Small Cap) on OMX Stockholm 2005‐2008

Random Effects

Market Value

• f Equity/Total

Assets =

Net Income/TA Book Value of Equity/TA Environmental performance Social performance Sales Growth Firm Age Industry dummies Year dummies

Concluding Studies on ESG and Firm Value

• An upward market price correction of environmental leaders
• ver time – MSCI U.S
• Market assigns more value relevance to environmental

information in Large Cap firms

• Companies with potential to improve ESG can provide excess

returns

• ESG in Small Cap companies is not priced

– lower disclosure and transparency – less analysts’ coverage – small firm ESG risk

Thank You !