Contrary to popular opinion, the terms “responsible” and “profitable” are by no means mutually exclusive in the world of investing. Traditional theory holds that when you exclude certain sectors or specific investments based on social responsibility factors, you adversely impact asset allocation, and in so doing sacrifice some return potential. Yet, often, the most forward thinking and best run public corporations are those that realize their reputation as an agent of positive change for environmental and social issues, and maintain a clean track-record of corporate governance which can measurably impact their bottom line.
In fact, a 2017 research study which examined 660 companies that agreed to implement changes to address a variety of ESG issues found that:1
· ESG-engaged companies produced annual returns that were 2.7 percent higher than their peer group over the six months following the implementation of ESG changes;
· Looking at the subset of companies that had previously posted low ESG scores, the outperformance of their stock price was even greater, beating their peer group by 7.5 percent in the year after implementing ESG changes.
Why focus on ESG?
Rather than relying on the subjectivity of your personal ethics, ESG factors allow you to quantify the long-term economic sustainability of any potential investment by assessing:
Environmental factors – such as the company’s carbon footprint, natural resource conservation, waste and pollution, as well as any environmental risks it faces and measures it has taken to mitigate those risks.
Social factors – include employee relations and diversity, worker satisfaction, occupational safety and health, and working conditions throughout the company’s supply chain.
Governance factors – focus on executive compensation and incentives, board structure and member diversity, political lobbying and donations, tax structure and any bribery or corruption allegations.
Instead of employing negative screens to completely exclude any investment in a certain sector of the market (e.g., oil and coal producers), an ESG approach identifies the best companies in that sector based on the transparency and ethics of their management team, how they treat their employees and their efforts to minimize any harm to the environment they cause. It’s a subtle distinction, but an important one in that it doesn’t impede portfolio diversification.
Even in the realm of fixed income investing, sustainable investing seems to be working. A recent study by Barclays Research showed that portfolios constructed of bonds with high ESG ratings consistently outperformed comparable portfolios with low ESG-rated bonds over the past seven years.2 Although these new approaches to socially responsible investing are still in their infancy, the evidence seems to be mounting that may ultimately eliminate the dilemma of having to choose between responsible and profitable.