Social element of ESG growing in importance, impact on returns

MARKET returns are stronger for companies with better social practices, and the difference has grown more pronounced during the pandemic.

According to new research from investment manager Federated Hermes, companies with good or improving social practises can potentially delivery up to 17 basis points (bps) more in returns each month. This is up from 15 bps in 2018.

"Our last study in 2018 proved social factors to be statistically meaningful for the first time," said Lewis Grant, senior global equities portfolio manager at Federated Hermes. "Today, however, we have seen the social premium increase with the ESG (environmental, social and corporate governance) spotlight turning to how companies treat their employees, customers and suppliers."

The study, which analysed correlations between companies with high ESG scores and shareholder returns, found that underperforming firms had poor social and governance metrics.

Across the three ESG factors, the social aspect proved most critical for hyper-growth companies.

The report, released in December, showed that hyper-growth companies that ranked poorly on the social metric observed monthly returns that were nearly 3 bps lower than their better-ranking peers.

Federated Hermes also flagged that investors have of late been drawn towards high-growth companies, undeterred by the fact that they are often "run under dominant management with little regard to traditional standards of corporate governance".

But high-growth names have also not been immune to the "social awakening" among some segments of the market, Federated Hermes said.

It has thus recommended that investors continue to place emphasis on investments that score well on ESG factors.

"We have long argued that ESG factors can generate alpha in both bull and bear markets," Mr Grant said. "Those companies which play an active role in adapting to and mitigating some of the greatest challenges that we face today are likely to be rewarded."