7 June 2018 Equity Quant Executive Summary Top ESG companies have continued to deliver solid operational performance in the past two years. In fact, AAA-rated companies have never had better ROCE or lower share price volatility versus the market than they do now. Despite this, the best ESG companies have not been properly rewarded by the market. Since 2012, top ESG companies have outperformed the lowest-rated ESG companies by as much as 5% per year, but the trends reversed in 2016 and 2017 when ESG-based investment strategies underperformed. We argue that the recent underperformance offers investors a buying opportunity and we remain convinced that strong ESG performances will be rewarded by better odds for strong share prices and operational performances. With an ever-increasing interest in sustainability, especially from millennials, good ESG companies are set to benefit from tailwinds in the years to come. ESG-based investment strategies have outperformed the market since 2012 but stumbled in 2016 and 2017 ESG set for a comeback Following the popularity of our ESG report from last year, "Cracking the ESG code", we have updated our findings on ESG from a performance perspective. The big picture remains: In Europe, MSCI AAA rated ESG companies have outperformed B and CCC rated companies by an average of ~5% per year since 2012. However, the last two years have had a negative contribution. On the other hand, ESG momentum has performed well, underlining the importance of a company's ESG performance. Increased risk appetite in the wake of strong macroeconomics favoured value and momentum at the expense of defensive strategies ESG has not been the only factor to struggle during the past two years. Defensive strategies such as low volatility and high earnings quality, which share a lot of traits with good ESG strategies, underperformed the market while value names made a strong comeback in 2016. Macroeconomic indicators improved faster and more than expected by most, which increased the risk appetite. First value and later exposure to strong earnings momentum associated with the cyclical upswing grew in importance and other traits became subordinated. Nordea's muted market outlook could trigger a comeback in ESG strategies, if our assumptions prove to be correct As outlined in the report "Nordea View", we believe that equity markets will remain volatile and with a negative tilt as leading indicators trend down and inflationary pressure increases. Such a market should play well with the more defensive qualities of strong ESG companies, providing a short- to medium-term trigger on top of what we argue is a compelling case for long-term sustainable outperformance. The big picture speaks in favour of ESG: 1. ESG performance and share price performance are clearly linked 2. Long-term trends remain positive despite headwinds in 2016 and 2017 TOTAL RETURNS PER ESG BASKET – EUROPE ONLY 125 120 115 110 105 100 95 90 85 80 75 2012 2013 AAA 2014 AA 2015 A BBB 2016 BB Source: MSCI ESG Research, FactSet and Nordea 2017 B & CCC 2018 2
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