Academic researchers warn investors that outperformance in the environmental, social, and governance (ESG) arena could end, as the industry reaches maturity and begins to see trend-chasing investors begin to pull back.
Abraham Lioui, professor of finance at Edhec Business School and an expert in the strategy of investing according to good ESG principles, argued that he and his co-authors found indications that the ESG market is hitting maturity and that the segment’s outperformances will peter out, the Financial Times reports.
“We are going to the zone where the positive impact of the ESG buzz on prices is coming to the end of its cycle,” Lioui told the Financial Times. “Soon we will be at the stage where the relationship between ESG and performance will be negative as it [logically] should be.”
The rising popularity around the ESG theme has fueled exponential growth in ESG and impact investing, which may be partially attributed to a surge in passive investments that has been supported by evidence that a corporate focus on material ESG issues could help generate improved returns. According to NYU Stern, of the almost 250 studies published between 2016 and 2020, only 8% revealed a negative correlation between ESG and financial performance at a corporate level.
Lioui and his fellow academics also noted that the accumulated alpha, or outperformance, for the environmental and social aspects of ESG was above 1 percentage point per year, which supported claims that companies can do well by doing good. “However, we identify a downward sloping pattern in this outperformance,” according to a the recent research paper.
“It should not be a surprise if, in the long term, ESG investing does come at some cost to investors,” Greg Davies, head of behavioural science at Oxford Risk, told the Financial Times.
Davies argued that over time, companies will likely incur costs by trying to improve environmental and social scores, which will lead to less profitability over the long haul.
“The results of the paper suggest that as assets have piled into stocks with the strongest ESG credentials, the expected outperformance of these stocks have dwindled away in recent years,” Kenneth Lamont, senior fund analyst for passive fund research at Morningstar Europe, told the Financial Times. “To many in the financial industry this news won’t come as a surprise, as an ESG label doesn’t exempt stocks from the fundamental laws of the market.”
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