It is obvious that proper information is a key ingredient in any investment strategy. The investment management process is largely fueled by the information that investors require in order to assess individual investment opportunities. For this reason, it is important to know what type of information ESG managers really need. We asked the opinion of the respondents with respect to the type of information required. A truly fundamental analyst may want access to the raw data on ESG factors in addition to all the regular financial data. This raw data may include annual company reports on ESG factors, press statements, reports from interest groups, and etc. However, investors may be time-constrained and therefore may have a tendency to use processed data such as ESG ratings. Another issue is to what extent ESG information is driven by market wide movements (i.e., at the sector or country level) or by idiosyncratic components. A lot of ESG information may be market wide, such as changes in regulation on the environment or social conditions. However, news about the individual conditions in a specific firm regarding ESG are likely to be important as well. The respondents were allowed to give multiple responses for the questions reported in Table 3. Since the questions focus on the use of ESG information, there are no answers for respondents that did not engage in ESG investing (i.e., ESGSCORE = 1).
Table 3 Use of ESG information
Table 3 shows that respondents on average favor ratings and analysis at a company level over raw data. This result is significant at the 1 % level. It suggests that the managers are constrained in their resources. In addition, investors focus on the analysis at the company level rather than at the more aggregate level (sector or country). This result also is significant at the 1 % level. For most information categories, we observe that the need for information increases with the level of ESG integration. These observations lend strong support to the conclusion that ESG integration is much like traditional active management based on fundamental investing, in the sense that it is characterized by a strong need for company specific information.
ESG strategies can have a profoundly different focus on its individual dimensions. We therefore asked whether the investor has detailed instructions on how to deal with each of these individual ESG dimensions. The average response is reported in Table 4. This table reveals that 60 % of the investors has detailed instructions on governance factors, whereas 43 % of the investors has detailed instructions on environmental and social factors. The difference is statistically significant at a 1 % level. By having a look at the individual data points, we observe that ESG investors have the same response to environmental and social factors. The higher score for governance factors is entirely due to a group of managers who have detailed instructions on governance factors but not on environmental and social factors.
In Table 5, we present the impact of ESG investing on portfolio construction. We first ask the respondents about their use of red flagging. Red flagging is the process of intensively monitoring and/or excluding stocks that are involved with serious environmental, social, or governance controversies or issues. Next, we ask whether ESG has an impact on the size of the investment universe. This is important, as a study by Hong and Kacperczyk (2009) has revealed that excluding a group of so-called sin stocks may have a serious negative impact on the performance of a portfolio. We also ask about the relevance of ESG investing for stock valuation and monitoring. As such, we want to check whether managers actually intend to use the information on a company level.
Table 5 Consequences of ESG information for portfolio construction and management
Table 5 reveals that 58 % of the respondents uses red flagging. Hence, we conclude this is a widely applied technique. With less than 20 % of the respondents using ESG investing to limit the investment universe, this is not the main strategy used in portfolio construction. This is an interesting observation as many critics of ESG—in particular in the 1980s (Ennis and Parkhill (1986); Grossman and Sharpe (1986))—consider especially this as a widely used technique with a negative performance impact. Other popular use of ESG information is to manage the risks (67 %), stock valuation (50 %), and stock monitoring (44 %). Table 6 also provides an interesting insight with respect to the relation between the level of ESG integration and the reported consequences of ESG information and portfolio construction. Here, there appears to be an inverse U-shaped relationship between ESG score and the implications for portfolio construction and management. With the exception of the question relating to the limitation of the investment universe, the scores for almost all variables decrease from the second highest ESG score to the highest ESG score.
Table 6 Outperformance and ESG integration in 2011
Whether ESG has an impact at all on financial performance is a question that has been addressed often before (see e.g., Derwall et al. 2005; Galema et al. 2008; Renneboog et al. 2008; Edmans 2011). Compared to most of this research, our sample is rather limited in size and scope. We only have information regarding the outperformance of the fund relative to their stated benchmark that reflects the individual characteristics of the manager. Therefore, this crude measure of outperformance also contains elements of systematic risk due to the absence of risk factors.
Table 6 suggests that the best crude one-year excess performance was observed among the lower ranking ESG managers, while the crude three-year excess performance was the best for the high ranking ESG managers. The table suggests that ESG investing pays off over a longer period of 3 years. Nevertheless, the results should be seen as only indicative on the relation between ESG investing and performance.
We also analyzed differences between portfolio managers originating from different domiciles. In doing so, we sorted all the data based on the domicile of the manager. Table 7 reports the results for those questions where domicile has a significant impact on the outcomes that we presented earlier.
Table 7 The impact of domicile on SRI
From Panel A, we can observe that there is a remarkable difference in the perceptions of U.S. and European (including U.K.) domiciled portfolio managers. Portfolio managers domiciled in the U.S. on average do not share the strong belief in the existence of a positive relation between SRI and performance by European and U.K. managers. However, more than with European and U.K. managers, they expected a positive impact on long-term performance and risk reduction. Another remarkable observation is that most U.S. and U.K. domiciled managers attach a low weight to environmental and social factors, while U.S. managers follow their European counterparts in attaching a high weight with respect to governance factors.
Domicile of the manager also affects the perceived consequences of SRI for portfolio construction and management. In Panel B of Table 7, we observe that U.K. managers rely more on red flagging as a tool to implement SRI, whereas European managers rely more on limiting the investment universe. The idea the SRI poses an alternative framing of fundamental analysis finds most support in the U.K., whereas European managers attach more value to stock monitoring. In all, our findings regarding the impact of domicile of asset managers suggest that SRI cannot be understood in isolation from contextual factors. This conclusion aligns with that of Gjølberg (2009) about CSR.