Over the past several years, it has become clear that socially conscious investing is not only here to stay but will also play a large part in the future of investing. As investment in responsible funds continues to grow rapidly (a 42% increase since 2018), there are understandably some lingering questions and misconceptions about the space, and I’ll address two common ones here.
Misconception #1: Responsible Investments Earn Lower Returns
This is a frequent and fair question, often brought on by the fear that applying non-financial considerations, such as ESG or exclusionary factors, to the investment process will reduce the number of investment opportunities, and in doing so generate lower than expected returns and greater volatility. Advocates of responsible investment admit candidly that the application of ESG considerations or exclusionary screens will reduce investment opportunities—after all, its primary goal is to exclude “irresponsible” companies from consideration. A principle called “Stakeholder Theory,” however, suggests that a company’s practices significantly impact future profitability, and thus, integrating this extra layer of analysis into the investment process can have the potential to deliver meaningful benefits by screening out undesirable, underperforming companies. Responsible investing proponents therefore contend that loss of portfolio efficiency when applying an ESG filter could be offset by the remaining companies that may have more attractive investment characteristics based on those initially applied filters.
Studies have shown that well-diversified portfolios with high ESG scores have performed at least as well as their non-ESG counterparts, and that portfolios with high ESG scores can significantly outperform portfolios with weak ESG scores. In fact, according to a 2020 report released by the NYU Stern Center for Sustainable Business, ESG and Financial Performance: Uncovering the Relationship by Aggregating 1,000 Plus Studies Published between 2015-2020, “59 percent [of ESG investments] showed similar or better performance relative to conventional investment approaches while only 14 percent found negative results.” The report also found that “ESG investing appears to provide downside protection, especially during social or economic crises.”
Outside the word of studies, even the CEO of banking giant Credit Suisse, Thomas Gottstein, recently said on CNBC, “There is no contradiction of sustainable investments and sustainable returns, quite the opposite actually. In many cases, sustainable investments are actually higher returning than non-sustainable investments.”
Misconception #2: Sustainable/Responsible Investing Is Only Focused on Climate and Environment
Climate change and environmental concerns (the E in ESG) are of crucial importance for many investors. Social and governance issues (the S and G in ESG) are important considerations for clients as well, and warrant consideration in the analysis of companies and funds. Without question, every investment should focus on the G, as ethical governance practices are critical to the long-term success of companies, and social issues such as data security, employee health and safety, human rights, and diversity practices are becoming ever more important in company analysis.
Very often, E, S, and G issues are interrelated. For example, water stress and insecurity are not only risks to ecosystems, but also affect human health and well-being. They can intensify social and political vulnerabilities across the world. Greater societal stresses can also lead to forced migration across borders, as we’ve seen with political and climate refugees alike. Many of these types of environmental risks have also been found to disproportionately affect lower income communities, women, and young girls. Given the interconnectedness of ESG issues, sustainable investing solutions take into consideration a wide range of sectors and themes, including the environment, corporate responsibility, poverty, and diversity. The old narrative of responsible investing only being pursued by the environmentally conscious few, complacent to leave return on the table, is dead and gone. Responsible investment incentivizes corporate behavior to prioritize people, the planet, AND profits. It does well by doing good.
If you want to learn more, US SIF: The Forum for Sustainable and Responsible Investment, is a great place to spend some time.
This information is presented for educational purposes only and is not intended as an offer or solicitation with respect to the purchase of any security or asset class. The views and opinions expressed by the author are as of the date of the recording and are subject to change. Morton Capital makes no representation that the strategies described are suitable or appropriate for any person.
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Although the data referenced in this report is from sources deemed to be reliable, MC makes no representation as to the adequacy, accuracy or completeness of such information and it has accepted the information without further verification. No warranty is given as to the accuracy or completeness of such information.
Past results are no guarantee of future results. All investments involve risk including the loss of principal.