Increasing evidence of ESG awareness

According to the Global Sustainable Investment Review, by the beginning of 2020 the amount of assets allocated to global sustainable investment strategies had reached $US 35.3 trillion or 36% of total assets under management (AUM). This dollar amount had increased 55% in just a four year period and the surge in demand for sustainable strategies can be seen everywhere.

Sustainable investment as a percentage of total investment assets

Bauer, Ruof, and Smeets (2021) surveyed members of a pension fund that gives its members a vote on sustainable investment policy. They found that most survey respondents preferred their pension money to be invested sustainability, even if this resulted in lower returns.

This finding is consistent with Riedl and Smeets (2017), who find that socially responsible investors expect to earn lower returns and pay higher management fees.

Companies have also responded to the ESG concerns of investors. Chang, Chu, Tu, Zhang, and Zhou (2021) note that as of July 2020, 90% of the S&P 500 companies now publish annual ESG reports, a significant increase from a decade earlier.

Taken together, this all suggests that in the long run there will be an equilibrium where negative ESG companies have lower current prices and higher expected returns to compensate investors for the risks incurred in holding them.

Furthermore, positive ESG companies will have higher current prices and lower expected returns due to a segment of society investing in them for social rather than financial reasons.

While this long run equilibrium relationship appears relatively clear, there is more debate about the short run relationship.

If the repricing of companies based on ESG characteristics has already fully occurred then the long run relationship can also be expected to be the short run relationship.

As Pastor, Stambaugh, and Taylor (2021) note, if share repricing based on ESG is still underway then negative ESG companies can be expected to have lower returns as investors sell them and their prices decline, while positive ESG companies are expected to have higher returns as investors purchase them and their prices increase.

The evidence of a large proportion of global AUM now being invested based on ESG metrics suggests that a substantial amount of repricing has already occurred. However, the actual impact of ESG characteristics on share returns is ultimately an empirical question.