Does ESG investing impair performance?

  • Author : Bill Vasilieff
  • Date : 12 Dec 2019

Ethical investing, socially responsible investing or ESG investing – the label changes but it’s been around for years and the sentiment is broadly the same, to invest your money in ‘good’ causes for the benefit of society or for the planet.

Growing concerns and awareness of long-term issues such as climate change, demographic changes and inequality, have led first to institutional investors as well as retail investors to take action –in particular, but not exclusively, from millennials.

According to the Global Sustainable Investment Alliance (GSIA), over $22 trillion of assets were managed under responsible investment strategies globally in 2016, up 25% from two years before, and independently that is reported to have increased by more than a third since 2016 and now accounts for assets worth more than $30 trillion.

Common sense would tell us that a constrained investment choice should lead to a worse outcome than an unconstrained one as there is a smaller pool of investment opportunity, so is it the case that ethical investing actually leads to relatively poor performance? And if so, how much is an investor prepared to pay to be a good citizen, for it is certainly the case that research shows private investors are reluctant to trade performance for good causes.

In the early days of ethical investing the methodology for selecting eligible investments was to screen out certain companies that were deemed unethical, such as oil or tobacco companies, despite the fact that it’s oil and other carbon based resources that make the world go round. We are still all heavily dependent on it which always seems strange to me (sure there is broadly based recognition in the west that we are facing potentially catastrophic climate change, but that will take years of concerted effort to change). The impact of this was to omit investing in some major opportunities and industries and the evidence was that it did indeed impact on performance and therefore ethical funds in the retail markets never really took off to any great extent. In other words, all else being equal, investors would invest ethically – but not if they had to pay for it.

However recently, MSCI Research has launched a whole suite of ESG Indexes and a rating service that assesses thousands of data points of 6,800 companies across 37 ESG Key Issues 10 Themes and the three Pillars, Environmental, Social and governance. Companies are then rated on a AAA-CCC scale relative to the standards and performance of their industry peers. The interesting thing is that there is now evidence to suggest that contrary to past evidence that ethical investing compromises performance, the opposite is now true and ESG rated funds outperform. Not only that but the higher that funds are rated, the greater is the outperformance.

This enhanced performance and the changing mood within society would certainly indicate that the growth we have seen in ESG investing, is going to continue unabated for the foreseeable future. This is certainly true of the advanced economies where social pressures and the mood of the public has moved decisively towards saving the planet.

This is not to say that ‘unethical’ investing and ‘Socially irresponsible’ practises are going to be wiped out quickly, worldwide. The economic pressures and dependency on carbon fossil fuels on less advanced economies are just too great to contemplate wholesale change any time soon. Take for example the Amazon rainforest where it has been reported that an area of the rainforest, roughly the size of a football pitch, is now being cleared every single minute, according to satellite data. The rate of losses has even accelerated as Brazil’s new right-wing president favours development over conservation and all this despite years of protest. This is the same for many developing countries where the population want the same standard of living that we in the west have enjoyed for years.


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