The continued overreaction by investors to bad environmental, social and governance (ESG) news is causing wild fluctuations to the share market, and could lead to long-term financial underperformance of some ‘ethical’ assets.
New research from Monash University shows investors tended to overreact when companies were the subject of negative ESG news, resulting in greater share price falls and an exodus of unit sales.
Analysing more than 331,000 ESG news events between January 2000 and December 2019, the study showed investors or fund managers were better off waiting – in some cases up to 90 days – for any bad ESG news to pass before trade decisions are made.
The study by Dr Bei Cui from the Monash Centre for Financial Studies, in the Monash Business School, is believed to be the first in the world to test the extent of market reaction to ESG controversies up to 90 days after the event. Previous studies have focused on shorter timeframes.
Dr Cui investigated large and mid-cap equities across 23 market countries, including the major economies of Europe and North America, Australia, Hong Kong, Singapore, and the United Kingdom.
When institutional investors observed a negative shock to the ESG attributes of a stock, they were found to have overestimated the probability of further shocks, resulting in a stronger tendency to sell, and a larger fall in the stock price than required.
Dr Cui said her study showed that for US companies, the price reaction to ESG news events is more pronounced for firms with a higher institutional holding before the news release and that there was a significant decrease in holdings following the release of bad ESG news compared with changes after good news.
“The significant negative abnormal return around ESG controversies – each of these countries had statistically significant negative abnormal returns – indicate that investors shun the company’s stock when it is involved in ESG controversies,” Dr Cui said.
“The research findings show traders have an opportunity to buy these stocks at a discount and then sell at a profit. It also suggests that investors wishing to reduce exposure following bad ESG news can sometimes be better off waiting, in some cases up to 90 days after the announcement – to execute the necessary trades at a better price.
“Moreover, all the firms associated with good ESG news are underperforming the market at the end of the observation window.
“There is also considerable evidence that the advanced leaking of information ahead of bad news events, as cumulative abnormal returns began occurring several days before this news was announced.”
Investments in ESG are on the rise globally. Between 2016 and 2018, the total value of sustainable and responsible investment assets in the five major markets, including Europe, the US, Japan, Canada, and Australia / New Zealand – surged by 34 per cent to $30.7 trillion.
Sustainable and responsible investment assets in Australia / New Zealand have remained the highest, with 63.2 per cent of total managed assets invested in ESG.
