Can Value Investors Do Good?

Combining ESG and Value Investing

February 2019. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • ESG factors underperformed the Value factor and market since 2009
  • Integrating ESG in Value investing decreased returns, but increased risk-return ratios
  • Residual ESG factors are likely to generate negative returns given the focus on stakeholders, not shareholders

INTRODUCTION

Value investors frequently comment on how challenging the strategy has been in recent years. However, the CEOs of companies that traded at low valuation multiples likely had much tougher jobs. Value stocks typically trade cheaply for reason, e.g. due to declining sales, a lack of strategy, or too much leverage. In the worst case, it might be a combination of these. Corporate management has to tackle these issues while hoping to have the support of their shareholders.

The recent trend toward better environmental, social, and governance (ESG) standards is unlikely to be appreciated by CEOs in battle-mode. ESG tends to consume additional time and money, which are precious resources when companies are restructuring and potentially face bankruptcy.

Given this, it is questionable if Value stocks can rank high on ESG. In this short research note, we will explore combining traditional Value and fashionable ESG investing.

METHODOLOGY

We focus on the Value and ESG factors in the U.S. stock market and include only stocks with a market capitalization of greater than $1 billion. Value is defined as a combination of price-to-book and price-to-earnings multiples. ESG data is available since 2009 and categorized into four major groups: Citizenship, Environmental, Employees, and Governance. We create long-only portfolios by ranking the top 10% by the factor and weight stocks by their market capitalization. Portfolios are rebalanced quarterly and each transaction incurs costs of 10 basis points.

ESG VERSUS VALUE FACTORS IN THE U.S. STOCK MARKET

We contrast the performance of ESG and Value factors, which highlights that ESG factors underperformed Value and the market since 2009. Investors might be surprised that Value outperformed the market in this analysis, but that can be explained by a concentrated portfolio and the starting point in 2009. Value experienced a significant drawdown in the global financial crisis an