Impact of social factors on stock performance rises with pandemic, finds Federated Hermes

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The ‘social premium’ for investing in companies with good or improving social practices is rising, according to new research from US-based asset manager Federated Hermes.

In 2020, social factors were found to add up to 17 basis points each month to returns, which is two basis points higher than the result of a previous study in 2018.

Lewis Grant, senior global equities portfolio manager at Federated Hermes, says that this increase reflects the fact that 2020 was a “huge turning point in society that brought some really difficult and ingrained issues to the fore”. 

The impact of the coronavirus pandemic and the growth of the Black Lives Matter movement after the death of George Floyd at the hands of police in the US, both helped accelerated the trend toward social investing.

“We were already seeing an increase in the importance of social factors. I think that's just what's happening in the world,” says Grant. 

General sustainable funds have grown rapidly in recent years, with sustainable investment now accounting for a third of all assets under management in the US. 

When Federated Hermes first started researching the topic of sustainability premia several years ago, Grant says they did not find any statistical relationship between returns and social factors at all, only for governance factors.

Social factors include a company’s treatment of its staff, rates of employee turnover, health and safety in the workplace, and supply chain standards. 

“Our last study in 2018 proved social factors to be statistically meaningful for the first time,” says Grant.

There is still a much larger premium for good governance than for social factors, according to the research. Social funds also currently lag in terms of capital raising, with environmental and governance factors attracting more investment according to a recent report from The Forum for Sustainable and Responsible Investment. 

Concerns have been raised over whether sustainable investing is becoming a “bubble”. Electric car manufacturer Tesla is trading at more than 1,000 times trailing earnings, and its stock price has risen by 182 per cent over the past six months.

Grant says that social stocks have been less affected by investors bidding up already-high prices, than areas of the market such as environmental stocks.

“It’s easier for people to rush into [an environmental] stock, and bid it up based on sentiment, whereas on the social side, the story might be a little bit more subtle. It is about looking at the broad range of characteristics that a company has, rather than a particular product that is solving a social need, and as such they are less prone to that kind of bubbling behaviour,” says Grant.

Grant says expects that both social and governance premiums will continue to grow if there is progress in the US market, which Federated Hermes’ research found rewarded social and governance factors far less than markets in Europe and Asia-Pacific.

“I think if the US came on board, that's likely to push the number slightly higher. If we started to see social premium rewarded in the US then yes, we will see the number go up slightly.”

Grant stresses that while prices are already high and rising, businesses that score better for ESG tend to perform better. “With sustainability, the very premise is that these issues can have a financial impact and deliver better cashflows, and so they should deliver better prices.”

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