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ESG: Holding “controversial” stocks leads to losses

responsible investingStocks listed in the US and Europe that are considered controversial from a responsible investing standpoint underperformed their benchmarks in a period of study - but those in Asia outperformed.

A research team at fund manager Ossiam investigated the sensitivity of listed companies to severe controversies – such as employment issues - to determine if there was an impact on financial performance and found controversial US and European stocks underperformed other stocks by 7.4% in euro terms during the study period.

Ossiam, which is owned by Natixis Investment Managers, said the research contributed to the weight of importance of environmental, social and governance (ESG) investing.

Of the US and European stocks tested, controversial stocks usually increased volatility and deepened the losses in portfolios, while portfolios with no or low levels of stocks with controversy tended to outperform their benchmarks.

The study period was January 2010 to September 2018 and the phenomenon is attributed to strong market reactions that penalise stocks as a consequence of “controversy rating downgrades”. These equities tend to show a slow recovery in price, said Ossiam, and the research findings are a “strong argument for exclusion of stocks with high controversy scores from investment universes”.

Although the performance of Asia-Pacific controversial equities contradicted the wider findings, Ossiam said these carried the caveat that the sample size was small due to the relative scarcity of ESG-rated stocks in the region.

The firm used ESG ratings data from Sustainalytics to build a controversy monitor.

On average, the number of highly controversial stocks in the US and Europe is in the range of 20 to 40, the study found.

In the US, the stocks included both Facebook and Amazon, which have been going from low to moderate levels of controversy – and ultimately to a high in the case of Facebook.

Other stocks that had some level of controversy and featured in the study included Wells Fargo and Equifax in the US; Barrick in Canada; VolksWagen and G4S in the EU.

Carmine De Franco, head of fundamental research at Ossiam, said: "The difference in performance between stocks categorised as highly controversial and those without controversy was striking. Controversial stocks were considerably more volatile than non-controversial or low controversy stocks.

“We see the controversy indicator as a powerful tool for evaluation of companies on the basis of their vulnerability to the very specific issues we measured and the impact of controversy on a portfolio's long-term performance. Our research contributes to the weight of ESG’s importance as a consideration for investors who view the investment process holistically."

Another study by Amundi published recently also showed how stock returns were impacted by ESG.

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