The relationship between ESG and stock price has always been tenuous at best. We’ve long advocated against a strong focus on connecting the two. Dueling studies often come out arguing in either direction, with no clear consensus on whether such a link exists. A recent study from Harvard Business School indicates that between 2012 and 2023 ESG stocks outperformed the market. However, the higher stock price was not driven by company performance. Instead, it was driven by hype. The abstract states:
“I show that the recent returns to ESG investing are strongly driven by price impact from flows towards ESG portfolios. Using data on trades, I estimate the market’s ability to accommodate ESG flows, which is given by the elasticity of substitution between ESG and other stocks. I show that every dollar flowing towards a representative ESG portfolio increases the market value of ESG stocks by $0.8. The growing institutional flows into the ESG portfolio are the main driver of ESG returns and have caused an annual flow-driven return of 1.9%. In the absence of flows, ESG stocks would not have outperformed the market from 2012 to 2023”
To explain this in a way that economists would disapprove of, but is intelligible to the rest of us: ESG was trendy during the period of 2012 to 2023. That trend created hype, which drove higher demand among investors for ESG stocks. The supply of ESG stocks couldn’t keep pace with this new demand. This caused ESG shares to rise in value compared to the rest of the market. Ultimately, the perceived alpha was the result of hype rather than substance. According to this theory, unless ESG is the target of another hype cycle, we shouldn’t expect ESG shares to return to their former glory. There’s no doubt that ESG adds economic value. However, focusing on a link to higher stock price distracts from the real tangible benefits.
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