Nomura research shows link between ESG ratings changes and performance

Analysis highlights role of downgrades by research firms

Analysis from Japan-based brokerage giant Nomura has shown a link between changes in companies’ environmental, social and governance (ESG) ratings and market outperformance.

In a series of research reports, Nomura Equity Research has demonstrated the positive impact that downgrades by ESG research providers can have on portfolios.

But analysts Sayuri Otsuka, Yusuke Takimoto and Masako Yamamoto say ESG information needs to be used in tandem with financial information.

Their conclusion is that “using ESG ratings as a screening criterion and then basing stock selection on financial performance could make it possible to prioritize ESG and also achieve strong performance”.

Their approach, including ESG and traditional stock selection, “substantially outperformed” the TOPIX main market benchmark.

But the team finds no correlation between good ESG ratings and performance. Analysis of seven years of data (four for emerging markets) found no boost to near-term performance using only stocks with high ESG scores.“We find no confirmation of significant ESG alpha [market outperformance],” they say.

But the idea is developed over five separate analyses, released at the end of last year, that negative screening by excluding downgraded stocks could improve investment returns.

Nomura reckons that ESG research firms respond quickly to negative events at the companies they cover – changing their evaluations “before the impact of these events is completely reflected in the market”.

“We think excluding downgraded stocks is an effective approach that can be expected to improve the performance of existing portfolios in the case of active as well as passive investment.”

Social and corporate governance downgrades have more impact that environmental downgrades – although the team thinks there needs to be more data “and plan to investigate further”.

The research was based on data from Italy-based ESG firm ECPI, which has the reports in its website