US and European equities rated as controversial underperform their benchmarks according to research conducted by Ossiam into the behaviour of stocks connected with environmental, social and governance (ESG) issues.

Results showed that between January 2010 and September 2018, controversial equities in Europe and the US significantly underperformed non-controversial stocks by 7.4% in euro terms and 7% in US dollar terms respectively. This phenomenon is attributed to strong market reactions that penalise stocks as a consequence of controversy rating downgrades. These equities tend to show a slow recovery in price. The research findings are a strong argument for exclusion of stocks with high controversy scores from investment universes.

The findings only held for US and European equities, not for the Asia-Pacific region, where a portfolio consisting of highly controversial stocks outperformed its benchmark. The testing and analysis of Asian-Pacific equities carries the caveat that the sample size was small due to the relative scarcity of rateable stocks.

For each company the team collected ESG data and built an aggregated controversy indicator from a subset of specific indicators, ranging from operational through employee-related and societal incidents usually linked with controversies, as investors and the general public perceive them. Companies were rated on a scale from zero (worst) to one hundred (best) according to these indicators. These ratings were then aggregated to produce a single controversy indicator in a range of none, low, moderate and high.

Head of fundamental research at Ossiam, Carmine De Franco said: "The difference in performance between stocks categorised as highly controversial and those without controversy was striking. Controversial stocks were considerably more volatile than non-controversial or low controversy stocks. We see the controversy indicator as a powerful tool for evaluation of companies on the basis of their vulnerability to the very specific issues we measured and the impact of controversy on a portfolio's long-term performance. Our research contributes to the weight of ESG’s importance as a consideration for investors who view the investment process holistically."

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