7 June 2018 Equity Quant Regulation, taxation and interest in ESG and sustainability suggest lasting tailwinds We argue that superior operational performance is backed by long-term fundamental trends. Regulations are increasing in the ESG area, ESG-related taxes are on the rise, consumers are becoming more interested in ESG-related topics and consumers are willing to pay a larger premium for "good" products. These factors suggest that there are lasting operational tailwinds for companies that do better on ESG than their peers. Energy taxes are at historical highs Consumers' willingness to pay for sustainable products and services is rapidly increasing Swedish mutual funds have intensified their ESG efforts Interest in sustainability is growing, especially among millennials ESG performance acts as a leading quality indicator ENERGY TAXES ON THE RISE 240 230 220 210 200 190 180 EUR per tonne of oil equivalent Source: Eurostat INCREASING FOCUS OF SWEDISH FUNDS 35 +44% 30 25 20 15 32.5 10 22.5 5 0 2012 2017 Number of FTEs in 11 large mutual funds in Sweden Source: Company data and Nordea WILLINGNESS TO PAY FOR SUSTAINABILITY 70% 60% 50% 40% 30% 20% 10% 0% 2013 2014 2015 % of population accepting premium for sustainable products Source: Nielsen MOUNTING INTEREST IN SUSTAINABILITY 100% 80% 60% 40% GENERAL POPULATION 71% 75% 52% 52% MILLENIALS 84% 86% 56% 48% 20% 0% 19% 2015 Very interested 23% 2017 28% 38% 2015 2017 Somewhat interested Source: Morgan Stanley, Sustainable Signals Report ESG protects above-market returns in high-quality companies Any quality investor fears investing in companies that have been reporting high and stable returns in the past but that have failed to defend their above-markets returns in the following years. We find that companies that score well on both ESG and quality maintain above-market returns and are more stable than other quality companies. In fact, we see that the earnings quality of a portfolio with high-quality and ESG exposure increases over time in contrast to a pure quality basket. Risk-adjusted returns improve when incorporating ESG into traditional investment strategies Adding ESG exposure to traditional investment strategies has proven to improve riskadjusted returns compared with the traditional investment strategies on a standalone basis. Just like the standalone ESG portfolios, however, the combination portfolios have struggled to deliver alpha in the past two years. Recent underperformance in ESG-based strategies, however, have made a previous ESG valuation premiums evaporate, making it even more compelling to include ESG in investment decisions. Buying top-quality companies will most likely result in exposure to quality deterioration A basket of high-quality companies with strong ESG performance have seen earnings quality improve in recent years THREE-YEAR CHANGE IN MEDIAN PORTFOLIO QUALITY 3% 2% 1% 0% -1% -2% -3% -4% -5% -6% 2010-2013 2011-2014 2012-2015 2013-2016 Quality top 20% Quality+ESG top 20% Source: MSCI ESG Research, FactSet and Nordea 2014-2017 4
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