ESG Isn’t a Trade-off, It’s a Trade-Up
We often hear people say, “I like the idea of honoring my values with my investment choices but I’m more concerned about good overall performance and solid returns” or “I’m actually okay with giving up some investment returns because at least I’m investing in companies that I can feel good about.” The assumption is that values-based investment strategies offer no benefit or are even detrimental to performance.
Instead, research has shown us that although Socially Responsible Investing (SRI) methods, primarily based on negative screens, neither improves nor diminishes performance, ESG (Environmental, Social & Governance) factors do provide long-term performance benefits when integrated into investment analysis and decision making.
A 2012 Study by Deutsche Bank Climate Advisors looked at the long-term value of Sustainable Investing, including both SRI and ESG based methods. This study of studies, “Looked at more than 100 academic studies of sustainable investing around the world, and then closely examined and categorized 56 research papers, as well as 2 literature reviews and 4 meta studies.”
The results were very clear. “100% of the academic studies agree that companies with high ratings for CSR (Corporate Social Responsibility) and ESG factors have a lower cost of capital in terms of debt (loans and bonds) and equity. In effect, the market realizes that these companies are lower risk than other companies and rewards them accordingly.”
And most important to investors, “89% of the studies we examined show that companies with high ratings for ESG factors exhibit market-based outperformance, while 85% of the studies show these types of company’s exhibit accounting-based outperformance. Here again, the market is showing correlation between financial performance of companies and what it perceives as advantageous ESG strategies, at least over the medium (3-5 years) to long term (5-10 years).”
Because SRI and ESG criteria has been lumped together as one and the same and because actively managed mutual funds (including SRI/ESG based ones) tend to underperform their respective benchmarks while not justifying their costs, assumptions of underperformance have been confirmed. This may not be the result of ESG factors, though. Actively managed SRI/Green/Sustainable funds have typically relied on negative screens that fit better into the SRI model, which have been shown to add no performance value, and in the end performance suffers due to the drag created by high fund fees and internal expenses in those funds (often 1-2% or more annually).
By focusing first on positive best-in-class ESG screening and then the appropriate negative screening personal to the individual, family, or organization, we can create a customized values-based portfolio that not only honors our clients’ values but may also enhance performance. By including this in our wealth management service we are also reducing the cost (a performance booster) compared to using socially responsible or ESG mutual funds while providing a more personalized values-based portfolio for each client.