Volume 16, No. 1, First Quarter 2018

Environmental, Social and Governance Exposures (ESG)

• Article

  Assessing Risk Through Environmental, Social and Governance Exposures

  by: Jeff Dunn, Shaun Fitzgibbons and Lukasz Pomorski

  We discuss risk and return implications of incorporating environmental, social and governance (ESG) considerations in an investment strategy and argue that ESG exposures may be informative about the risks of individual firms. We show empirically that stocks with worst ESG exposures have volatility that is up to 15% higher, and betas up to 3% higher, than stocks with the best ESG exposures. We also find that ESG scores may help forecast future changes to risk estimates from a traditional risk model. Controlling for the contemporaneous risk model estimates, we show that poor ESG exposures predict increased future statistical risks.

• Article

  Environmental, Social, and Governance Criteria: Why Investors Should Care

  by: Ravi Jagannathan, Ashwin Ravikumar and Marco Sammon

  We argue that even money managers who care only about risks and returns are likely to benefit from incorporating Environmental, Social, and Governance (ESG) criteria into their investment process. ESG-related issues can cause sudden regulatory changes and shifts in consumer tastes, resulting in large asset price swings which leave investors
  limited time to react. By incorporating ESG criteria into their investment strategy, money managers can tilt their holdings towards firms which are well prepared to deal with these changes, thereby managing exposure to these rare but potentially large risks.

• Article

  Establishing ESG as Risk Premia

  by: Julia L. Pollard, Matthew W. Sherwood and Ryan Grad Klobus

  This seminal research provides statistically significant evidence for the empirical identification of Environmental, Social and Governance (ESG) as a factor of risk premium when integrated within an equity portfolio. This study purposes to establish that the conceptual development, adoption and population of ESG research-based strategies are leading to the documentation and acceptance of ESG risk premium as an intuitively and measurably independent risk premia. This study has demonstrated empirically, through a cross-sectional analysis of increasingly developed ESG research, that ESG premia geographically and longitudinally provides excess returns. Furthermore, this study presents the potential for ESG premia to take its place alongside other well-documented risk premia such as momentum, volatility, carry, size, value, and liquidity across asset classes.

• Article

  A Blueprint for Integrating ESG into Equity Portfolios

  by: Jennifer Bender, Todd Bridges, Chen He, Anna Lester and Xiaole Sun

  Environmental, social and governance (ESG) offers a source of new and potentially valuable information for investors, impacting both potential returns and risk. Growing data availability has created the opportunity to integrate ESG into equity portfolios for a variety of investment processes, for both indexing and active management. In this paper, we provide an overview of the current data landscape and several popular methods for integrating ESG. A main challenge is that ESG data collection and aggregation methods can vary significantly across providers, leading to very different ratings for the same company. If the data issues are properly addressed, integrating ESG has important potential benefits for investors. Our “blueprint” lays out a path for any investment manager seeking to understand how ESG fits into their investment process.

• Article

  Carbon Footprint and Productivity: Does the “E” in ESG Capture Efficiency

  by: Gerald T. Garvey, Mohanaraman Iyer and Joanna Nash

  This paper analyses the now-popular carbon ratio (emissions relative to sales) as a way to select stocks. We document that reduced carbon ratios are associated with stronger future profitability and positive stock returns in a global universe of stocks. But why? The prevailing view is that lower emissions reduces a firm’s exposure to future greenhouse gas regulations or taxes, and the market is slow to appreciate this. However, we find strong effects in industries such as internet and commercial services where carbon taxes would have little direct effect. We show that there is a more fundamental connection between carbon emissions and overall productive efficiency. Most of a firm’s activities, or inputs, result in some form of carbon emission due to direct energy consumption or indirect emissions (e.g., travel). We first show evidence that carbon emission works like an input to production along with the more traditional capital and labour. More importantly, firms that produce more than expected given their inputs tend to outperform in the future both in profitability and returns.

• Book Review

  Portfolio Construction, Measurement, and Efficiency Essays in Honor of Jack Treynor

  by: John B. Guerard • reviewed by: Savannah Smith

  “Book Reviews” identifies important, and often popular, new books from a wide range of investment topics. Beyond providing a summary and review of the content and style of the books, “Book Reviews” seeks to contribute to a conscious, critical, and informed approach to investment literature.

• Practitioner's Digest

  Practitioner’s Digest • Vol. 16, No. 1

  The “Practitioners Digest” emphasizes the practical significance of manuscripts featured in the “Insights” and “Articles” sections of the journal. Readers who are interested in extracting the practical value of an article, or who are simply looking for a summary, may look to this section.