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Exploring the G in ESG: The Relationship Between Good Corporate Governance and Stock Performance – Part 2

Water Risk: Looking Back and Looking Ahead

Drilling Into Industries Finds What Lifts Energy Stocks With Oil

Most S&P and Dow Jones Islamic Indices Outperformed Conventional Benchmarks in Q1 Driven by Strength in the Technology Sector

Revenue Exposure of the S&P/ASX 200

Exploring the G in ESG: The Relationship Between Good Corporate Governance and Stock Performance – Part 2

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Kelly Tang

Former Director

Global Research & Design

Year-to-date, Facebook (FB) was down 7.13% as of April 12, 2018, compared to its 53% total return in 2017. What started as a data breach issue has expanded to encompass management structure, procedures, and safeguard concerns—issues that are all related to corporate governance. Market participants have a tendency to only care about corporate governance when things go wrong, despite empirical evidence that companies with strong governance tend to perform better than those with weak governance.

We have been exploring the “G” component of ESG, and many tech companies in general do not score favorably on the governance front. In a previous blog, we provided a breakdown of the various elements or dimensions that are part of the S&P Dow Jones Indices’ governance score. In this follow-up blog, we explore the return information contained in the governance component and how investors can manage risk by avoiding companies with low governance scores.

To test whether ESG scores, G in particular, correspond to future stock performance, we formed hypothetical, annually rebalanced quintile portfolios, and we ranked them in descending order by scores and tracked their forward 12-month performance. The underlying universe was the RobecoSAM coverage universe, which comprises 400 global companies starting from December 2000 and increasing to over 4,000 stocks in 2017. The quintile portfolios were formed on an annual basis as of December 31 of every year, and returns are in USD.

In regard to the governance score, looking at the period from inception in 2001 to present, there was little distinction in performance between companies in the top three quintiles. However, there was a clear distinction between these quintiles and the bottom quintile (see Exhibit 1). Securities with the lowest governance scores, on average, underperformed (7.84%) those that ranked higher.

The spread between the top and bottom quintile was greatest for the governance criteria, representing almost double the spread for the total ESG score (0.90%).

The asymmetrical return profile suggests that companies that rank well below average on good governance characteristics are particularly prone to mismanagement and risk the ability to capitalize on business opportunities over time. Management strategy and ability, whether superior or compromised, will manifest over time and therefore, economic dimension-scored portfolios should be viewed over longer time horizons as the time element is necessary in revealing whether the strategy is working or not.

As discussed in Part 1, the EDS is comprised of more than just traditional governance criterion and includes business strategy, risk management, and tax strategy—elements that are long term and strategic in nature. The inception data in Exhibit 2 provides a 17-year timeframe in which to gauge the performance of quintile portfolios. The bottom quintile returned 7.84% annualized compared to 9.51% for the first quintile, 10.02% for the second quintile, and 9.58% for the third quintile.

The underperformance of securities with the lowest governance scores is even more readily apparent when viewed over rolling periods. To demonstrate, we calculated annualized rolling one-year, three-year, and five-year returns, and we reported the averages. On average, across all three calculation periods, the Q5 portfolio, which comprises companies with the lowest governance scores, underperformed the Q1 portfolio by 1.8%-2.0% (see Exhibit 3). The results indicate that market participants may be economically better off avoiding securities that rank in the bottom quintile of the governance universe.

In the next blog, we will continue the discussion on ESG scores and stock performance, however with a focus on the “E” and “S” scores.


Gompers, Ishii, and Metrick (2003) and Bebchuk, Cohen, and Ferrell (2009)

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Water Risk: Looking Back and Looking Ahead

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David McNeil

Senior Analyst, Corporate Services

Trucost, part of S&P Global

Water scarcity risk has been in the spotlight recently with Cape Town’s efforts to avert “Day Zero” and the risk of taps running dry. Although this risk appears to be receding through radical conservation measures, including wholesale elimination of abstraction rights in some cases, it underlines the common global challenge of increasing fresh water scarcity.

From a business perspective, examples such as Cape Town illustrate that water is shifting from an operational concern of securing day-to-day supplies for production sites, to a wider strategic concern for companies. For example, the 2017 CDP Water Survey found that 70% of respondent companies were now disclosing water targets to their board, and they committed to a new investment of USD 23 billion in water projects in 2017.

Nonetheless, Trucost data indicates that most companies have substantial exposure to water risk in their supply chains that is unmeasured and unreported. For a typical company, as much as two-thirds of water-related impacts occur within the supply chain. In some cases, this can be even more pronounced—Nissan Motor’s supplier engagement in 2017 uncovered supply chain water consumption 20 times that of its direct operations.[1]

Where these water risks aren’t adequately measured, they represent substantial “unpriced risk” to companies, with global-listed companies having undisclosed water risks totalling USD 555 billion.[2] When the full costs of water scarcity and pollution are accounted for, this represents a substantial share of average profit at risk across a number of sectors (see Exhibit 1).

While companies have relied upon historical data when assessing the exposure of their supply chain to water risk, this may be a poor indicator of future risk associated with climate change and rising water scarcity. Recommendations by the G20 Taskforce on Climate Related Financial Disclosure[3] emphasize the need for companies to gather forward-looking data and explore the extent to which their business model and profitability is at risk under different climate change and water scarcity scenarios. Water is a crucial element of climate risk, with current projections pointing to a 40% gap in available supply of fresh water to demand by 2030.[4]

As a response to these risks, companies should understand how their business strategy and growth depend on water. Trucost has worked with business leaders like Ecolab to create industry-leading approaches to value water risks, set context-based water targets, and measure their maturity on important factors like governance, water measurement, target setting, and water stewardship. We’ve recently supported Braskem in setting long-term, basin-level water reduction targets that account for changes in local demand in line with rising scarcity, building on 2040 projections by the World Resources Institute.[5]

To manage water risk effectively, businesses need to consider water risks from every angle—looking back into their supply chain to identify hotspots of water risk and looking ahead to ensure their overall business model is resilient in the face of rising water scarcity.

[1]   CDP (2017), A Turning Tide: Tracking corporate action on water security – CDP Global Water Report 2017.

[2]   Trucost (2018)

[3] FSB (2017) Task Force on Climate Related Financial Disclosures: Final TCFD Recommendations Report.

[4] McKinsey & Company (2009) Charting our Water Future: Economic frameworks to inform decision-making.

[5] World Resources Institute (2016) Aqueduct – Water Risk Atlas.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Drilling Into Industries Finds What Lifts Energy Stocks With Oil

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Jodie Gunzberg

Former Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

As oil prices continue to increase, the energy sector is rising but recently the mid and small cap stocks are outpacing the large caps.  Thus far in April (month-to-date through April 12, 2018,) the energy sector is leading all other sectors, but the S&P 500 Energy (Sector) is up just 4.8% versus the gain of 7.4% in the S&P MidCap 400 Energy (Sector) and 7.3% in the S&P SmallCap 600 Energy (Sector).

Source: S&P Dow Jones Indices

This is an interesting turnaround from the major large cap outperformance in energy over the last 1, 3, 5 and 10 years.

Source: S&P Dow Jones Indices

Generally when looking into what drives sector performance, examining the next most granular GICS (Global Industry Classification Standard) level called industry groups is a good starting point.  In the case of energy, there are no separate industry groups, but the next specific level called industries splits the sector into two parts: 1. Energy Equipment & Services, and 2. Oil, Gas & Consumable Fuels.

Immediately, the difference in performance between the two industries is apparent and can give some insight into what is driving the sector.  Annualized over the last 10 years that included the both the 2008-9 oil price decline and the 2014-16 drop, the large cap oil, gas & consumables industry held up better than the energy equipment & services, losing only 40 basis points annualized versus the 3.8% annualized loss over the period.  This shouldn’t be too surprising considering the energy equipment & services contains companies mainly in oil and gas drilling and equipment manufacturing, whereas the oil, gas & consumable industry includes many integrated companies, refining and marketing, and storage and transportation stocks.  The long-term performance split reflects how the upstream versus mid- and downstream oil companies are sensitive to oil price declines.  On the flip side, with the oil comeback, now the energy equipment & services are rebounding strong with returns more than double the oil, gas & consumable fuels in mid and small cap energy.

Source: S&P Dow Jones Indices

Overall, energy stocks may not fully capture oil price moves since companies hedge against some of the volatility, and also make other decisions for shareholder value that may not have direct influence from the oil price.  Large companies are more likely to hedge against oil price moves, and again, the upswing may help upstream more since they are the ones drilling and selling the direct oil rather than buying it to transport, refine and market.  According to the index data from 1995, using the S&P GSCI Crude Oil index as the oil price proxy, for every 1% rise in the price of oil, the large cap energy sector only gains about 37.5 basis points on average, while the mid- and small cap energy sectors gain 61.8 and 64.1 respective basis points. Also, the large cap energy equipment and services gains 54.5 basis points versus the gain of 34.9 basis points from large cap oil, gas and consumable fuels for every 1% rise in oil price.

Source: S&P Dow Jones Indices. Data since 1995.

However, the split between the two industries by weight is not equal but is according to market capitalization, so there may be adjustments market participants may make by deliberately tilting towards small caps or using the S&P Oil & Gas Equipment & Services Select Industry Index to get more exposure to the energy equipment & services industry.  This may be especially potent alongside the S&P 500 Energy sector where the weight to this industry is relatively small at only 14% of the sector.

Source: S&P Dow Jones Indices.

While these weights are only recent, the allocations between industries have held relatively constant through time in large and small caps, though in mid caps, the energy equipment & services diminished from almost 1/2 to 1/3 of the weight from the under-performance in the last 3 years.  Therefore, by either using small-cap energy, or if using large-cap or mid-cap energy, to supplement with the select sector S&P Oil & Gas Equipment & Services Select Industry Index may help protect against inflation and get more upside with rising oil prices.  Remember as oil prices rise, inflation is more likely and the energy sector is potentially more attractive, so it makes sense to pay attention to the more sensitive pockets in the industries of the broad sector.


The posts on this blog are opinions, not advice. Please read our Disclaimers.

Most S&P and Dow Jones Islamic Indices Outperformed Conventional Benchmarks in Q1 Driven by Strength in the Technology Sector

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Michael Orzano

Senior Director, Global Equity Indices

S&P Dow Jones Indices

Most S&P and Dow Jones Shariah-compliant benchmarks outperformed their conventional counterparts in Q1 2018, as the information technology sector—which tends to be overweight in Islamic Indices—led the market by a wide margin, and financials—which is underrepresented in Islamic indices—matched the returns of the broad market.

The Dow Jones Islamic Market World Index and S&P Global BMI Shariah closed the quarter slightly in the red but outperformed the conventional S&P Global BMI by 0.6% and 0.9%, respectively. Shariah-compliant benchmarks tracking Asian and European equities beat their conventional counterparts by the widest margins, while the S&P 500® Shariah eked out a small gain over the conventional S&P 500.

Global Equities Finished the Quarter in the Red in a Volatile Start to the Year

After a strong January in which the S&P Global BMI Shariah gained more than 5%, volatility set in as various risks rose to the forefront, including the potential for rising U.S. interest rates and increased global trade tensions. European and U.S. equities fared the worst among major regions, while developed markets in the Asia Pacific region and emerging markets finished the quarter in positive territory. The Dow Jones Islamic Market World Emerging Markets Index rose 1% in Q1 2018 on the heels of a gain of over 40% in 2017.

MENA Equity Markets Rebounded Following 2017 Weakness

MENA equities had a strong quarter, as the S&P Pan Arab Composite Shariah gained 6.8%, driven by strength in Saudi Arabia and Egypt. Egypt was the region’s top performer in Q1 2018. The S&P Egypt BMI jumped 17.3% in U.S. dollar terms, adding to its 21% gain in 2017, as the nation’s macroeconomic environment continued to stabilize following the IMF-supported reforms initially enacted in November 2016. The S&P Saudi Arabia BMI finished the quarter up 10.5%, as the country’s own economic and equity market reforms have, likewise, led to improved investor sentiment.

*This article was first published in Islamic Finance News, Volume 15 Issue 15, on April 11, 2018.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Revenue Exposure of the S&P/ASX 200

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Utkarsh Agrawal

Associate Director, Global Research & Design

S&P Dow Jones Indices

The S&P/ASX 200 is widely regarded as the institutional investable benchmark in Australia. It is composed of the largest 200 companies listed on the Australian Securities Exchange by float-adjusted market capitalization. Although the majority of the companies are domiciled in Australia, a lot of them derive a significant portion of their revenue from foreign markets. As of year-end 2017, only 60 companies in the S&P/ASX 200 derived their revenue solely from the domestic market, while the rest of the companies had exposure to foreign markets (see Exhibit 1). Consequently, potential risk from political and economic shocks in foreign markets cannot be ignored. Hence, it is worthwhile to review the global revenue exposure of the index.

Some of the key highlights from the total revenue exposure[1] breakdown of the S&P/ASX 200 as of year-end 2017 are as follows (see Exhibit 2).

  1. Only 62% of the index’s total revenue came from Australia.
  2. The index had the highest international revenue exposure to the U.S. (7.9%), followed by China (7.6%) and New Zealand (5.9%).
  3. At the sector level, total revenue exposure was most dominated by financials (28%), followed by materials (21.6%) and consumer staples (17%).

Further observation of international revenue exposure revealed the following (see Exhibit 2).

  1. Out of the 37.9% attributed to international revenue, 17.7% came from the materials sector and 7.0% came from financials.
  2. The materials sector’s revenue exposure to China (6.6%) exceeded its domestic revenue exposure (3.9%).

Since almost 38% of the S&P/ASX 200 revenue came from foreign countries, the economic and political conditions in foreign markets could have a significant impact on the index’s performance. Hence, understanding global revenue exposure is essential to comprehend the index’s inherent potential risk.

[1]   We used the FactSet Geographic Revenue Exposure (GeoRevTM) dataset to calculate revenue exposure. It provides a geographic breakdown of revenues at the country level for all companies with available data. Due to the lack of standardization in the reporting of geographic revenue segments, the dataset uses a normalization/estimation process to assign revenues to specific countries. For more information please visit

The posts on this blog are opinions, not advice. Please read our Disclaimers.