Companies with improving ESG credentials have on average outperformed by 14.4% in emerging markets and 5.2% in developed markets over five years, according to a new MSCI report.
The MSCI research into how valuations are impacted by ESG scores compares the financial performance of companies with strong positive ESG momentum versus companies with negative ESG momentum.
MSCI's ESG momentum measurement examines progress via year-on-year changes of MSCI Industry-adjusted ESG scores, thereby measuring how changes in companies' ESG profiles impact performance.
The research suggests MSCI ESG score upgrades led to higher valuations, while downgrades led to lower valuations.
According to MSCI, the research found: "A change in a company's ESG profile has had an impact on valuation levels and stock prices that is not explained by the general market or other factors.
"Thus, ESG momentum may offer important new insights into how global markets price stocks."
The trend was evident across both emerging and developed markets, with companies demonstrating good ESG momentum outperforming by about 14% cumulatively in emerging markets from June 2013 to February 2018. Developed market companies with strong ESG momentum have outperformed by 5.2% over the same period and 12% from May 2009 to February 2018.
The findings also suggest equity markets reacted most sensitively to ESG information for companies that do not have extreme ESG scores - neither very low nor very high - and showed a stronger reaction to improvements in ESG characteristics than to declines in ESG performance.
Social begins to impact performance
A separate report, published by Hermes Investment Management's global equities team on Monday (12 November), found companies with good or improving social characteristics have tended to outperform their lower-ranked peers on average by 15bps per month.
ESG Investing: A Social Uprising, examines the impact of environmental, social and governance (ESG) factors on equity returns in the MSCI World Index from 31 December 2008 to 30 June 2018, revealed a strong social focus impacted valuations for the first time, having failed to make a difference in 2014 or 2016 studies.
It also found companies with good or improving corporate governance have tended to outperform companies with poor or worsening governance by 24bps per month on average, but this is down from a monthly average of 30bps in previous studies.
In addition, the study found no evidence that companies with attractive environmental characteristics have underperformed.
Head of global equities at Hermes Geir Lode said: "This is the first time we have seen a statistical link between social practices and a company's performance.
"With the recent IPCC report on climate change and a slew of corporate governance scandals that have weighed heavily on share price performance, we have seen ESG investing accelerate from niche to norm.
"However, due to the intangible nature of social factors it has been harder for investors to quantify and understand this element and the importance placed upon it by investors has always lagged behind."