We believe the ultimate outcome from responsible investing would be for companies to transform their business models towards a more sustainable future, driven in part by collaboration between those companies and their shareholders. That ambitious goal is feasible if responsible investing continues to grow in terms of both the number of investors and the amount of assets. Greater sustainability would clearly be a positive outcome for the planet and everyone on it, for generations to come, but what does it mean for today’s investors who have financial objectives to meet?
Not all that long ago, when responsible investing – or “ethical investing” as it was often called – many people assumed you would have to be willing to sacrifice performance to invest according to strict moral principles. Funds using negative screens may exclude large segments of the market, which can leave them susceptible to variations in relative performance versus the broader index. That helps to explain why many of those early funds struggled to gain mass appeal, especially with pension funds and other institutional investors that had benchmark constraints as well as a fiduciary responsibility to deliver performance.
Responsible investing has evolved
Since those early days, investment managers have created a variety of strategies with different approaches, objectives and philosophies that provide investors a choice of how environmental, social and corporate governance (ESG) characteristics are implemented. This ranges from simple exclusions, which is still relevant at least as part of the solution, to full integration within the investment process. Instead of only avoiding the undesirable companies, many of the more recent strategies focus on how to get the best performance out of those with better ESG characteristics.
There has been plenty of research trying to determine a link between a company’s ESG credentials and its financial performance, as well as trying to determine how to place a value on ESG. While the findings from all the research are not yet conclusive, some points are worth highlighting, such as the tendency for companies with positive ESG credentials to have robust risk management processes in place more generally in the firm. That could suggest lower downside risk.
ESG momentum could provide meaningful insight
Index provider MSCI took their research a step further . They focused on changes in a company’s ESG profile (“ESG momentum”) and whether it had an impact on its share price performance. Based on the MSCI World Index, they found that companies in the top quintile in terms of ESG momentum scores outperformed those in the bottom quintile over the time period June 2009 to February 2018.
They also found that equity markets have tended to react stronger to improvements in ESG characteristics (upgrades) than deteriorations (downgrades) and reacted most sensitively to ESG information for companies that did not have very high or very low scores to begin with.
Conclusions?
As ESG continues to grow as an investment theme, corporate data on ESG will also continue to improve, providing a deeper understanding of how ESG is priced into equities. One thing that does seem to be clear now is that ESG no longer represents a hindrance to investment performance. The question for us today is how to maximise the investment opportunity as companies collaborate with shareholders to improve on the ESG issues within their firms. That’s a “win win” for everyone.
1 Ricerca MSCI, Giese e Nagy, “How markets price ESG”, Novembre 2018
Investment risks
Investment strategies involve numerous risks. Investors should note that the price of your investment may go down as well as up. As a result, you may not get back the amount of capital you invest.
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Data as at 2 September 2019, unless otherwise stated..
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