Executive Summary

  • Oil spills, corruption, accounting fraud, child labour, data privacy violations, fossil fuel stranded asset risk, technologies disrupting business models, worker strikes, food contamination, gender pay inequality, excessive CEO pay...all these and other issues can and have led to shareholder losses and/or reputational damage for companies and investors as well as a variety of negative impacts on people, communities and the environment.
  • A growing number of investors aim to insulate their portfolios from such risks and to capture returns from better managed companies by over-weighting companies with strong environmental, social and corporate governance (ESG) ratings and under-weighting or excluding poorly rated companies.
  • More than 2,000 academic studies on the link between ESG and corporate financial performance have been published since the early 1970s. Analysis by DWS and the University of Hamburg (2015) found that the majority of these studies showed a positive relationship with financial performance and very few studies showed a negative correlation.
  • Major banks are increasingly publishing research on the financial materiality of adding ESG data into investment decisions. Goldman Sachs (April 2017) concluded that “We view ESG as a rich and underappreciated source of information regarding company culture and risks, including accountability and controls, regulatory and reputational risk, customer and employee relationships, and more”. Bank of America Merrill Lynch (June 2017) concluded that “ESG would have helped investors avoid over 90% of bankruptcies” and that “ESG is a better signal of future earnings volatility than any other measure”.
  • These findings are part of the reasons that investors are increasingly allocating capital to a variety of ESG index funds. While ESG fund classification can be problematic, we are aided by Morningstar data. We estimate that in the year to March 2018, ESG index funds have grown by 25%, but still account for a relatively small amount of AuM - USD39.2bn compared to an overall market of passively managed funds of USD9.0 trn.
  • Climate change is one of the most important ESG issues. Consequently, numerous investment strategies are being explored to address the risks surrounding the transition to a low-carbon economy as well as the threat to investment returns from the increasing frequency and intensity of extreme weather events. DWS published a review of ways to address climate risk in investment portfolios in June 2017.
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