As you'd guess by the total return chart presented, the various investable universes have very high correlations with the S&P 500 Index. Although the return stream is slightly less volatile for the socially responsible-screened universe, the screen does have a negative impact of 0.43% per annum over this time period versus the un-screened S&P 500 Index. We should note that this is a generic screen, and one size certainly does not fit all.
The ESG-screened universe outperformed the S&P 500 Index in four of five calendar years. The total return for the ESG-screened universe edges the return of the unscreened S&P 500 Index over this time frame by 0.09% annualized, again with slightly lower return volatility. By definition, the ESG-screened universe has superior risk-adjusted returns to the S&P 500 Index over this time period. Here, we must re-iterate that this is a simple negative screen for bottom-quintile ESG; we make no attempt to overweight stocks with the highest ESG scores.
Finally, applying both negative screens, we find the resulting universe underperforms the unscreened index by 0.37% during this period, albeit with the lowest volatility of any series tested.
We find most advisors and consultants are quite interested-and maybe a bit surprised-by these results. Not only do the various negative screens described in this article have a rather limited impact on the market cap of the potential investment universe, but the return impact is also quite muted. With respect to a negative ESG screen, we have found that a "passive" ESG-screened portfolio had returns slightly better than the S&P 500 Index over the 62 months ended November 30, 2009, with slightly lower volatility. The correlation of the return streams for the S&P 500 Index with and without the ESG screen was .9998 (the tracking error is 0.33%). There is no apparent cost-and perhaps a modest reward-for using negative ESG screens.
Our research has found the perceptions surrounding negative screening used in most SRI/ESG strategies bears little resemblance to the facts. Combine this with clients' increased desire to live and invest in a fashion more consistent with their collective beliefs, and a well-educated, thoroughly discussed decision can be reached with respect to whether negative social screens and/or ESG screens should be integrated into your client's investment strategy.
Jon Quigley is a managing partner, investment management, and Lyn Taylor is a research associate for Advanced Investment Partners, a quantitative U.S. equity investment boutique in Safety Harbor, Florida. The company has a 13-year history of managing assets for a range of clients, including two of the world's largest pension plans and several large U.S. brokerage firms. The company's Sustainable Responsible LargeCap Strategy recently completed its fifth year, and has topped the S&P 500 Index by better than 2% annualized since inception. AIP is owned by individual partners and Wayne Hummer Asset Management.