For ESG investors, positive change is bringing big profits

Sus­tain­able invest­ments are no longer the poor rela­tions of invest­ing. You can do good and still earn good returns – poten­tial­ly even bet­ter than the alter­na­tive.

It’s a time-hon­oured axiom of invest­ing that sus­tain­able funds under­per­form their tra­di­tion­al coun­ter­parts. But there’s been a sea change recent­ly, with decades of invest­ing wis­dom turned on its head by a flur­ry of recent stud­ies that found sus­tain­able funds out­per­formed their non-sus­tain­able cousins. 

“One of the endur­ing myths about sus­tain­able invest­ing is that doing good comes at a price,” says Maike Cur­rie, invest­ment direc­tor at Fideli­ty Inter­na­tion­al. “But invest­ing in com­pa­nies that rate high­ly on envi­ron­men­tal, social and gov­er­nance (ESG) fac­tors can pro­vide anoth­er oppor­tu­ni­ty to reach your finan­cial goals while align­ing with your val­ues.”

The data takes some unpick­ing: one of the key fac­tors in this mar­ket is the sheer com­plex­i­ty of the infor­ma­tion to hand. 

“It gets com­pli­cat­ed very quick­ly, because there are so many dif­fer­ent types of sus­tain­able invest­ments,” says James Alexan­der, chief exec­u­tive of the UK Sus­tain­able Invest­ment and Finance Asso­ci­a­tion (UKSIF), a trade body. “You can’t put the data into one neat met­ric. The idea that [mea­sur­ing green cre­den­tials] can be sim­ple and straight­for­ward is not real­i­ty.”

Matt Chris­tiansen, glob­al head of sus­tain­able impact invest­ing at Allianz, agrees. “The data is a start­ing point, but it’s not per­fect,” he says. “There’s a lot of alpha­bet soup. But the con­ver­sa­tion is start­ing to evolve – we are mov­ing on from ESG, which is now embed­ded into the val­u­a­tion of com­pa­nies. Younger peo­ple com­ing into the indus­try take that as the norm.”

Outperforming indices

What­ev­er imper­fect mea­sure of sus­tain­abil­i­ty you choose, there’s pret­ty uni­ver­sal agree­ment about the out­per­for­mance. Accord­ing to finan­cial ser­vices group BNP Paribas, over the last five years a range of sus­tain­able equi­ty indices have out­per­formed stan­dard non-sus­tain­able bench­mark stock indices. It not­ed that the MSCI World SRI (Social­ly Respon­si­ble Invest­ing) index has seen a 14.1% com­pound annu­al growth rate (CAGR) in returns since the begin­ning of 2016, 1.1% more than the MSCI World stan­dard bench­mark. The Euronext Low Car­bon 100 index has returned 7.1% CAGR since 2016, ahead of the 6.3% of the STOXX Europe over the same peri­od.  

Last sum­mer Morn­ingstar, an Amer­i­can finan­cial ser­vices firm, analysed the per­for­mance of 4,900 funds to find out whether sus­tain­able funds can beat their tra­di­tion­al coun­ter­parts over the long term. It found that a major­i­ty of sur­viv­ing sus­tain­able funds – those that exist­ed 10 years ago and still exist today – out­per­formed their aver­age sur­viv­ing tra­di­tion­al peer. 

Over 10 years, the aver­age annu­al return for a sus­tain­able fund invest­ed in large glob­al com­pa­nies has been 6.9% a year, while a tra­di­tion­al­ly invest­ed fund has made 6.3% a year. Over the 10-year peri­od to 2019, 58.8% of sur­viv­ing sus­tain­able funds across sev­en cat­e­gories were con­sid­ered to have beat­en their aver­age sur­viv­ing tra­di­tion­al peer.

Vikram Raju, head of cli­mate impact and emerg­ing mar­kets for AIP Pri­vate Mar­kets at Mor­gan Stan­ley Invest­ment Man­age­ment, believes non-sus­tain­able invest­ments are now the riski­er propo­si­tion. “For exam­ple, no seri­ous investor can afford to ignore the impact of cli­mate risk on input prices, insur­ance pre­mia and sup­ply chain resilience,” he says. “Lost ship­ments due to extreme weath­er events equal lost sales. On the oth­er side of the coin, there’s also the high growth and pre­mi­um pric­ing asso­ci­at­ed with sus­tain­able brands in every seg­ment from food to tex­tiles.”

In Feb­ru­ary, a study from the Mor­gan Stan­ley Insti­tute for Sus­tain­able Invest­ing found that sus­tain­able invest­ing funds out­per­formed tra­di­tion­al funds and reduced invest­ment risk through­out 2020, weath­er­ing the volatil­i­ty of the pan­dem­ic year bet­ter than their coun­ter­parts. Accord­ing to the report, “sus­tain­able funds’ strong risk and return per­for­mance dur­ing an excep­tion­al­ly tur­bu­lent year fur­ther erodes the per­sis­tent mis­con­cep­tion that sus­tain­able invest­ing requires a per­for­mance sac­ri­fice.” For many investors, the low­er volatil­i­ty and stead­ier per­for­mance of sus­tain­able invest­ments is the attrac­tion.

A complex environment

So why do some investors still think sus­tain­abil­i­ty must be trad­ed for per­for­mance? In part, the dev­il is in the details. What does sus­tain­able mean, after all? How green is a com­pa­ny that pro­duces legs for oil rigs that are also legs for wind tur­bines? Which mea­sures of sus­tain­abil­i­ty are crit­i­cal: would you pri­ori­tise water or bio­di­ver­si­ty? Is it enough to do no harm, or should com­pa­nies be active­ly seek­ing change?

There’s a raft of dif­fer­ent areas to con­sid­er, says Chris­tiansen. For exam­ple, “last year Allianz came out of coal – we don’t want long-term expo­sure to coal, we don’t think it’s going to be a win­ner. But we don’t have that view on oil, where we are look­ing at how we can work with ener­gy pro­duc­ers in a more reg­u­lat­ed envi­ron­ment.” 

Tran­si­tion and stew­ard­ship are impor­tant parts of the sus­tain­abil­i­ty debate. “This is not a divest­ment agen­da,” says Alexan­der. “We’re not going to change the world by sell­ing all the ‘bad’ com­pa­nies to peo­ple who care less than we do. It’s about using our voice to push man­age­ment to make changes.”

Sus­tain­abil­i­ty can’t be divid­ed neat­ly into good and bad, unfor­tu­nate­ly for those who pre­fer their invest­ments clear cut. There is cer­tain­ly demand for sus­tain­able invest­ing; UKSIF mem­bers report a mas­sive increase in the num­ber of peo­ple who want to man­age their invest­ments sus­tain­ably, even if few of us can define what we mean by it. 

How­ev­er, the finan­cial ser­vices indus­try still has a job to ease the cog­ni­tive dis­so­nance that sur­rounds sus­tain­able invest­ment.

“Being a good ESG com­pa­ny is a kind of proxy for just being a good com­pa­ny,” says Cur­rie. “Com­pa­nies that are social­ly respon­si­ble, dili­gent about cor­po­rate gov­er­nance and envi­ron­men­tal­ly friend­ly tend to be the sort of high-qual­i­ty, well-man­aged com­pa­nies that we all want to invest in.”