Demonstrating that ESG can lead to superior performance is a game changer

Thirteen years ago, Yannick Ouaknine was asked to apply his number crunching and analysis skills to something new. That loose collective was environmental, social and corporate governance, or ESG, a potentially new sector collapsing three disparate practices into one. “The team was created because we were getting questions from investors wanting to know what they had to consider for ESG along mainstream financial recommendation,” said Mr Ouaknine, head of Sustainability Research at Societe Generale.

One of the first pieces of research to emerge, published in 2006, investigated CO₂ emissions in the automotive industry. “In truth, people were laughing at us,” said Mr Ouaknine. “They said no one cares about CO₂ and restricting it would make European automakers uncompetitive; there was no appetite from the end user for ESG. It was considered good to raise the topic, but there would be no financial impact.

“Today, no mainstream analysis of the automotive industry does not include a review of CO₂ emissions in financial models,” said Mr Ouaknine.
 

What on earth is ESG?

Although there is no universally accepted interpretation of what ESG is and how to weight the parameters, the research team is responsible for guiding the bank and its investors through a labyrinth of new regulations, initiatives and understandings based around the effect that failing in any of these three topics has on a company’s share price. “If you ask in the US, you will hear about diversity and minorities; if you collect this kind of information in France, you will go to jail,” said Mr Ouaknine. “Even in these two mature ESG countries, biases remain and there is a lot of work to do to find a common language that everyone will agree on.”

To identify what is financially relevant and material, the team looks at specific company documentation as well as information from the ESG ratings agencies, such as MSCI, Vigeo and Sustainalytics, and then consults with mainstream analyst colleagues to pragmatically work out what makes sense financially, without accounting for ethical or philosophical views of ESG parameters. “The financial and, or reputational impact of ESG parameters remains our compass,” said Mr Ouaknine.

“There is new motivation from investors – it could be personal value, regulatory development, client demand or an institutional mission,” said Mr Ouaknine. “Investors or asset owners view ESG as part of the fiduciary duties of any kind of investments or asset classes. You don’t really have to believe in it; you don’t even need to be convinced about it; you just have to integrate those parameters into your investment strategy because it has been recognised as a source of value and you’re pragmatic! It has been proved that integrating ESG provides superior performance, which was the real game changer, and the reason for the acceleration over the last five to 10 years.”

The most interested are, for the time being, institutional clients, particularly pension funds, although there has been a recent boom in demand from private banking investors. “We see a high demand from private banking for ESG topics to be included in their asset management,” said Mr Ouaknine. “There is a new investor set in Europe demanding more transparency and better-quality reporting, which is good.”

There is less interest from retail, because ESG is still a relatively complex approach. “We are talking to hedge funds, who are taking it as another thing to integrate into investment decisions, as long as you can prove the superior performance,” said Mr Ouaknine.
 

Demand is booming

The bank now creates a lot of research documents that include financial conclusions showing that ESG is a driver for outperformance. “Our conclusions are not the result of backtesting or wishful thinking,” said Mr Ouaknine. “Showing outperformance against funds following the same benchmark attracts a lot of investors. We understand and know how to combine the parameters.”

One of the benchmarks created that takes all the ESG parameters together outperforms European indexes by 28%, according to Mr Ouaknine.

While many investors are persuaded, or at least encouraged to look at the ESG options for ethical reasons, there is no need any more to convince them. “It’s more, ‘which one do I need to take into account; can you justify why this one better than another; and, can you help me create a process that will include all?’,” said Mr Ouaknine.

Demand is booming. Ten years ago, no one was interested, only charities, but now companies like Blackrock are interested. ESG is not just looked at as a risk, and there are opportunities attached.

The research is predicated around identifying themes or issues that are already critical and will continue to be so, and to try to apply the research team’s conclusions through different sectors and then make recommendations to investors. “We wish that each of those considerations could be financially supported, which is not yet the case, so we often end up with an engagement guide, a long list of questions to be asked to companies where they are keen to disclose more information or financial content around it,” said Mr Ouaknine.

The team also spends time with the companies (and experts) it analyses, completing around 100 one-to-one meetings with them during the year to work out what is meaningful, but also what might be relevant tomorrow, as well as what could be a good proxy for the metrics. Having started with companies in Europe, the analysis now covers 3,400 stocks on a global basis, as well as research papers, some more qualitative and some more quantitative.

“Outperformance proof was a game changer,” said Mr Ouaknine. “We moved from more or less convincing people to a much wider audience, because we now have solid proof that our work definitely delivers some kind of performance.”