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April 27, 2011
Report Finds Support for ESG Benefits over Long Term
    by Robert Kropp

A new report by risklab anticipates a renewed investor focus on growth assets, and finds that consideration of environmental, social, and corporate governance factors can lead to substantially reduced risks.

If the long-term benefits of environmental, social, and corporate governance (ESG) considerations can be located anywhere in the investment decision-making process, it should be in the analysis of tail risks. Tail risks occur when an extreme event—such as the collapse of the housing market that led to the financial crisis, for example—risks moving the price of an asset more than three deviations from its current price.

A recent report by risklab, the investment and risk advisor for Allianz Global Investors, demonstrates that the investment risks associated with ESG factors can be considerable, and that incorporating such factors into investment research can lead to significant improvements in portfolio performance.

The report, entitled Responsible Investing Reloaded, assumes that institutional investors want to diversify their portfolios away from bonds and toward more profitable assets such as emerging markets equities. As risklab partner Steffen Hörter states in his introduction, "Investors are increasingly fleeing from low-yielding government bonds into growth assets in order to achieve their investment goals."

However, citing Eurosif's 2010 Emerging Markets Theme Report, risklab warns, "On average there is less ESG transparency and external verification within corporations domiciled in emerging markets, compared to European companies."

According to the report, "The tail risk of an ESG risk-neutral emerging market equity strategy, as defined by the MSCI Emerging Markets index, could be reduced…by up to approximately one-third." In addition, the report finds, the expected return potential can be increased by up to 50 basis points, or 0.5%.

For the purposes of the report, ESG risk factors are quantified over a 20-year period. "Unlike a bottom-up SRI (socially responsible investing) portfolio manager," the report states, "Who may evaluate and score up to 30-50 ESG key performance indicators (KPIs) per company, risklab focuses on a few carefully selected, representative ESG factors and condensed ESG ratings."

Environmental risk factors include increases in the price of CO2 emissions rights and increases in energy prices. Social and corporate governance risk factors include changes in corporate performance that lead to downgrades of the ratings of those companies.


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