Practical Applications of ESG Controversies and Their Impact on Performance

Practical Applications Summary

In ESG Controversies and Their Impact on Performance, in the December 2019 issue of The Journal of Investing, Carmine de Franco of Ossiam analyzes how controversies over environmental, social, and governance (ESG) issues affect stock performance. De Franco derives an aggregated controversy indicator from a subset of ESG markers, then uses it to categorize stocks as no, low, moderate, or high controversy. He constructs stock portfolios with equivalent controversy levels for Western Europe, the United States, and the Asia-Pacific region. His research reveals that in Europe and the United States, stocks of highly controversial companies significantly underperform both selected benchmarks and stocks of companies with little or no ESG-related controversy. In Asia-Pacific, however, stock markets appear to be less sensitive to such controversy.

To probe this geographical divergence, De Franco plots performance along a “controversy effect curve” (CEC) to estimate average excess return of those stocks whose controversy levels change. Some pronounced patterns emerge. In Western Europe, unexpected deterioration in controversy levels is associated with negative returns. In the United States, regular downgrades of a company’s ESG profile degrade stock performance. Asia-Pacific is again an outlier, with no clear pattern between changes in ESG controversy levels and stock performance.

TOPICS: Portfolio theory, portfolio construction, ESG investing