Deutsche Asset Management and University of Hamburg conducted a study that examines the entire universe of environmental, social and governance (ESG) and corporate financial performance (CFP) academic review studies that have been published since 1970. In this white paper, they draw out the main conclusions from this study. The analysis is based on the accumulation of outcomes and data of 60 review studies. At the time of writing this report, it represented the most extensive review of academic literature as it relates to ESG and CFP.

This study follows on from previous work conducted by Deutsche Asset Management in June 2012 in the report Sustainable Investing: Establishing Long Term Value and Performance, which demonstrated that companies with high ratings for ESG and corporate social responsibility (CSR) have a lower cost of capital in terms of debt and equity. This study concluded that only 10% of the academic review studies displayed a negative ESG-CFP relationship with an overwhelming share of positive results, of which 47.9% in vote-count studies and 62.6% in meta-studies yield positive findings.

Two important findings stand out: first, the weak performance of portfolio studies and second, the disproportionate positive response to integrating ESG criteria in non-equity classes and specifically fixed income and real estate. The study finds a weak correlation between ESG and CFP for mutual funds and indices.

From a regional perspective, there are ESG opportunities in North America and emerging markets.

In terms of the correlation between ESG and CFP over time, the academic studies demonstrate that this has continued to remain constant since the mid-1990s.

In terms of the individual E, S and G sub-categories, there did not appear to be a dominating single factor, but rather combinations seemed to reduce the rate of positive results between ESG and CFP. This would seem to suggest that non-focused approaches led to a less compelling argument to deploy ESG. This might suggest that mixing various approaches together washes out the potential of outperformance.

However, among the individual categories, governance exhibited the highest number of positive responses. This suggests that the increasing number of signatories to the Carbon Disclosure Project (CDP) or the UN-supported Principles for Responsible Investment and the growing ESG awareness in the investment process has not led to decreasing ESG alpha.

Friede, Busch & Bassen find that the business case for ESG investing is empirically well-founded such that investing in ESG pays off financially and appears stable over time.

1. Between 1970 and 2014 there have been a total of 60 review studies with 2250 unique primary studies on the topic of ESG and CFP. The surge in academic literature coincides with the growth in ESG assets under management over this period.
2. Historically most of the analysis has been concentrated on the ESG-CFP link in equity and equity linked portfolio studies, which accounted for roughly 90% of the universe of literature published. However, in recent years there has been a slow, but, steady increase in investigating ESG strategies in non-equity asset markets.
3. The disappointing results of portfolio studies (consisting of studies on mutual funds, indices and long-short-portfolios) are the potential cradle for the perception bias of investors about ESG investing.
4. In 644 studies the authors find relatively similar positive results for E, S and G. However, the highest proportion of positive results occurs in G with 62.3% of all studies delivering a positive correlation. The governance-related aspects also exhibited the highest percentage of negative correlations at 9.2%. If the share of negative findings is subtracted from the positives, environmental studies offer the most favourable result with social focused studies coming last.
5. In a recent Hermes Investment Management survey of over 100 institutional investors into responsible capitalism, 90% of those surveyed believed fund managers should price in corporate governance risks as a core part of their investment analysis, alongside financial metrics.
6. Two main patterns were detected based on 402 studies with a disclosed regional identifier. First, developed markets ex-North America exhibited a smaller share of positive returns, with developed Europe exhibiting the worst results (26.1% positive results) compared to 42.7% for North America. Part of the poor results in Europe reflect the fact that a larger number of portfolio studies have been conducted with the European and Asian/ Australian sample that potentially causes bias.
7. There was a strong correlation between ESG and CFP in the group of emerging market studies with a 65.4% share of positive outcomes. This is significantly higher than in the developed markets.
8. The authors find that part of the ESG alpha is wiped out as a result of fees, which on average account for 2.5% in the average mutual fund(s) around the world. However, these findings relate to only a few dozen portfolio studies, compared to the total sample of more than 2,100 other studies that suggest the opposite.
9. Another area of investigation in the study was whether the ESG-CFP relationship is stable over time. Theoretically, the growing number of PRI signatories and the presumption that investment strategies are becoming increasingly ESG aware might imply a decreasing ESG alpha that is captured by a diminishing correlation between ESG and CFP over time. In the sample of 551 primary studies with disclosed correlation factors the authors find no indications of a learning curve.
10. The orientation toward long-term responsible investing should be important for many types of investors in order to fulfil their fiduciary duties and better align investors’ interests with the broader objectives of society.