Quarrels involving environmental, social and governance issues have wiped more than $500bn off the value of large US companies over the past five years, according to an analysis by Bank of America.
ESG-related risks are becoming increasingly important considerations for institutional investors and asset managers because of mounting fears about climate change, high-profile scams and damaging corporate governance failures.
Bank of America examined the impact on stock prices of companies in the S&P 500 index, the main US equity market benchmark, of 24 controversies related to accounting scandals, data breaches, sexual harassment cases and other ESG issues.
It found these 24 ESG controversies together resulted in peak to trough market value losses of $534bn as the share prices of the companies involved sank relative to the S&P 500 over the following 12 months.
“The hit to market value of an ESG controversy is significant and the impact is long-lasting. It can take a year for a stock to reach a trough following an ESG controversy,” said Savita Subramanian, head of US equity and quantitative strategy at Bank of America. “Negative headlines stick in investors’ minds.”
Bank of America declined to name any of the companies involved in the controversies.
Fines worth at least $243bn have been paid by banks since the financial crisis, according to Keefe, Bruyette & Woods, the brokerage. Bank of America has paid about $77bn in fines while large penalties have also been imposed on Wells Fargo, Citigroup and Goldman Sachs.
Google has paid more than €8bn in fines for anti-competitive practices in the EU. Facebook disclosed in April that it could be fined up to $5bn for privacy violations by the Federal Trade Commission.
ESG-focused funds are quick to purge their portfolios of controversial stocks but the scale of the losses identified by BofA demonstrates that other investors also reduce their exposure to these companies.
“Fundamental investors might buy a controversy stock back at the right price. But ESG funds that owned companies which have become involved in a controversy can exclude these stocks for five years or more,” said Ms Subramanian.
Interest in ESG strategies has risen significantly over the past decade. Assets in ESG-focused mutual funds hit the $1tn mark in late 2018, according to Morningstar, the data provider.
Inflows into these funds have helped to drive a significant re-rating in the valuation multiples of US stocks that score well on ESG metrics. This has raised concerns that an “ESG bubble” could be forming.
Some active managers also worry in private that companies with similar fundamental characteristics in the same stock market sector can receive markedly different valuations depending on the quality of their ESG disclosures. This could make stock picking more difficult for fundamentally based active managers.
But Ms Subramanian said ESG data was now the best signal of potential risks to future corporate earnings risk.
“Traditional financial metrics, such as earnings quality, leverage and profitability don’t come close to ESG metrics as a signal of future earnings risk or volatility in earnings,” she said.