Esg or Not Esg? A Benchmarking Analysis

Sustainable investments are increasingly leaving their niche position to enter financial markets in a remarkable way in recent years. In this scenario, ESG (Enviromental, Social, Governance) practices are emerging alongside the risk-return approaches that for years have exclusively determined the portfolio choices of investors. This paper aims to give a contribution to the flourishing debate on the application of ESG criteria to investments’ selection, using a case study through a benchmarking approach. The empirical investigation focuses on a two-level analysis of GIS Global Bond ESG Fund (EUR Hedged), managed by PIMCO management company. Results highlight that ESG practises should be referred more as a complementary rather than alternative approach for portfolio management.


Introduction
The demand for investments that combine financial return with desired social or environmental impact is growing: redirecting investment and finance to impact oriented investments compatible with the UN Sustainable Development Goals and the Paris Agreement is a key factor in turning around the investment philosophy. The concept of sustainable investment has spread since the 1960s, but still lacks a clear definition: the Global Sustainable Investment Alliance (GSIA) considers it as an investment approach that includes the ESG (Environmental, Social and Governance) facts in the selection and management of the portfolio (Tyler, 2018). Moreover, sustainable investment and ESG criteria are inevitably connected topics. The interest in the search for a virtuous relationship between the real and financial economy has returned to assert itself following the latest financial crisis, that has imposed, on a global level, a rethinking on the role of the financial system in support of the real economy and on the way in which to interpret the same role. The ethical profile of the investments and the responsible behavior of the investors represent an important way for bringing economy and finance closer together, allowing to draw attention to the social dimension of the phenomena. In this context, a new form of finance is emerging, as a sustainable investment strategy, the so-called impact investing. Although the sustainable investment market has traditionally been driven by institutional investors, there is growing interest in this sector also from private investors.
Our study focuses on the analysis of the GIS Global Bond ESG Fund (EUR Hedged) managed by PIMCO (Pacific Investment Management Company, LLC), one of the leading bond investment management companies (about $ 1.844 billion in AuM, as end of June, 2019). Our choice fell on PIMCO's GIS Global Bond ESG Fund (EUR Hedged) because it is one of the first funds in the world to implement impact investing strategies within its investment portfolio, as well as one of the top 40 funds in Europe according to AuM.
The paper is organized as follows: paragraph 1 reviews the literature on the topic; paragraph 2 is for the empirical analysis; the last section concludes by commenting main results and suggesting for further research.

Literature Review
The application of ESG criteria to financial investments is becoming increasingly popular among operators; this trend has led to the development of a flourishing literature on related topics also in academic research. Integrating environmental, social and governance impacts into investment and financial decision making and especially focusing on the upside of ESG (positive) impact investing is a nascent field of research (Wendt, 2017). This review proposes a classification of the main contributions in recent years into two main strands: the first one explores investors' motivations to adopt ESG approach; the second one deals with the relationship between ESG criteria and investments' performance.
In the first strand, contributions identify two main groups of reasons that push investors towards esg approaches: personal attitudes; regulations-oriented behaviours towards sustainability issues. Brodback et al. (2018) provide survey evidence that there is a positive link between altruistic values and the relative importance of social responsibility and this effect is stronger when investors believe that they can make a positive social or environmental impact. Following the value-belief-norm theory (Stern et al., 1999), authors argue that egoistic values are negatively associated with the decision to invest responsibly. Brest et al. (2018), observing that an increasing number of socially motivated investors have goals beyond maximizing profits, deepen the topic of social value. They distinguish investors that seek investments aligned with their social values (value alignment) and investors that may also want their investments to make portfolio companies more social value (social value creation). The thrust of this essay is that while it is relatively easy to achieve value alignment, creating social value is much more difficult. Schramade (2017) refers to UN's Sustainable Development Goals (SDGs) as an engine for a path to value creation, both for society and shareholders. Bialkowski and Starks (2016), using a difference in difference approach, provide evidence that investor demand for socially responsible or sustainable and responsible funds results from investors' non-financial considerations. Moliterni (2018) addresses the topic considering esg criteria as an investment approach within sustainable investment, which can be traced back to seven main strategies: negative screening, norm-based screening, ESG integration, corporate engagement, best-in-class screening, impact investing, sustainability themed investing. Grabenwarter (2017) suggests a new form of "impact first" investing: rather than applying merely a negative screening filter that seeks to identify within a pool of random impact investment opportunities those that happen to meet a given risk/return profile, the focus needs to be on funding concrete impact solutions; once identified, impact solutions shall be translated into financial instruments which combine the risk/return profiles of a sufficiently large spectrum of investors in order to get a given impact solution funded. About ESG motivations, customer demand is certainly a key factor in the diffusion of these forms of investment, but another important aspect is the behavior of asset managers, with particular regard to their compliance with a kind of fiduciary duty towards investors: in this sense, we can refer to the study of Duuren at al. (2016), which on the basis of an international survey among fund managers find that many conventional managers integrate responsible investing in their investment process, using esg information for red flagging and to manage risk. Among the studies that deepen the topic of motivations to adopt ESG approaches in compliance with regulations, we can cite Wilson (2016) and Grabenwarter (2017), that consider the Sustainable Development Goals as business opportunities. Finally, other empirical evidence shows that investors incorporate religious and political values as well as social norms in their investment decisions (Hong & Kostovetsky, 2012).
In the other strand, Landier and Nair (2009) had a first approach to the topic, building a so-called responsible portfolio, starting from the S&P500 and therefore eliminating, year by year, companies that lacked sustainability, based on the KLD Analytics scores. They demonstated that it is possible to include esg criteria in portfolio choices without affecting financial returns. Weber et al. (2014) compare the aggregate performance of some SRI funds with the MSCI World Index and highlight that, on average, the SRI funds performed better than the index, but relying only on sustainability scores in the investment process does not lead to a positive financial return, therefore financial and esg analysis must be integrated. Verheyden et al. (2016) tested the effects of using different esg filters on an investable universe that serve sas the starting point for a fund manager, attempting to determine the extent to which esg data can add value to any investment approach. Their finding is that the incorporation of esg information contributes to better decision-making in every investment approach, with an unequivocally positive impact on risk-adjusted returns, using a 10% best-in-class screening approach. Soler-Domínguez and Matallín-Sáez (2016) assess the performance of the VICEX Fund, which is morally controversial due to its higher return premium on investments in well-established vice companies, representing an opposite extreme for socially responsible mutual funds Their findings suggest that the VICEX Fund underperforms during periods of economic distress, while it outperforms the market during expansion periods. Borgers et al. (2015) suggest that fund managers do not tilt heavily towards controversial stocks because of social considerations and practical constraints. About ESG ratings and Performance, we can also cite the following studies: Capelle-Blancard and Monjon (2014), Halbritter and Dorfleitner (2015), Brière and Szafarz (2017)  the result will depend on the commitment to seek a fair balance between financial and social performance.
The intent of our analysis was to assess whether the use of ESG screening such as the one adopted by PIMCO for bond selection and the implementation of impact investing practices will affect investor performance. To date, the use of an esg filter seems to have a deterrent effect on investment volatility and seems to represent a competitive advantage in a long-term perspective. In the case of PIMCO Global Bond ESG, screening allows the fund to significantly reduce direct and indirect risks that can adversely affect the performance of issuing companies and, consequently, on the fund's portfolio, such as legal costs for social and environmental processes, expenses for business conversions, reputational damage, strikes and accidents at work, etc.
We proposed the analysis of this case for the relevance of the asset managed by Pimco, the company's esg commitment, the complex screening process developed by the same company. The research contributes to studies investigating the relationships between esg approaches and performance and risks of investments. Further investigations may expand the analysis by referring the study of the phenomenon to a wider time horizon.