Goldman Sachs spotlighted 50 companies in the S&P 500 that it expects to benefit the most from ESG selection criteria. Focus was put on evaluating Environmental and Social metrics, with Goldman pointing out that the top quintile companies based on ‘E&S’ factors in the MSCI ACW Index generated 11% annual returns since 2012, vs 8% returns for companies in the bottom quintile.
Goldman also pointed out that structural problems in ESG classifications, such as definitions of what ESG is and problems with information availability and reliability, complicate ESG investing. Despite that, inflows into ESG funds have increased dramatically in 2020, with $28B so far YTD compared to $25B total in the last 5 years.
Most (42%) financial service professionals said that ‘improved long-term returns’ was the main reason to invest into ESG, followed by ‘risk mitigation’ (27%). 70% expect ‘climate change’ to be the main driver of ESG performance over the next 3-5 years.
While the figures cited show that ESG continues to increase in importance in investor allocations, they also show that the market continues to misunderstand—and possibly miss—cybergovernance, which is one of the most important ESG factors and arguably the one with the greatest market impact.
Goldman Sachs highlights the 3% per annum outperformance of the top quintile E&S group vs the bottom quintile. While alpha is a precious commodity and any such returns are to be prized, the return differential produced by the top quintile of companies based on Cyberhedge cyber governance ratings vs the bottom quintile dwarfs the E&S figure: 48.6% outperformance for US equities since December 2016 (12.4% per annum), and 67.4% outperformance (17.2%) for European equities over that same time period.
This Cyberhedge data shows that improved returns already exist for companies with the best cyber governance. Investors state the main reason why they are investing in ESG is for ‘long term returns’. There seems to be a perception by many that ESG is about backing companies that will be winners years into the future—for example when carbon has been replaced by renewables. But outperformance is already evident for companies with strong cyber governance and better executed digital transformation strategies. Investors who are downgrading ESG as a priority should take note.