One of the most persistent myths about sustainable investment is that investors have to sacrifice returns for their principles. Raised on a diet of strongly performing oil, gas and tobacco stocks, many assume that in the bruising world of financial markets, investing for positive environmental and social change doesn’t stand a chance.
However, a growing body of evidence suggests this is not, in-fact, the case. Indeed, studies from esteemed institutions including Deutsche Bank and Oxford University show the exact opposite: that taking environmental, social and governance (ESG) factors into account when building an investment portfolio actually leads to greater returns over the long term.
We present five of the most authoritative research papers on ESG outperformance below:
This is one of the most exhaustive studies undertaken on ESG outperformance to date. Analysing 149 individual academic papers published between 1982 and 2015 that encompass more than 2,000 empirical studies, Deutsche Bank and the University of Hamburg found that 90 per cent showed ESG factors had no negative affect on corporate financial performance. More importantly, the large majority of studies also found a positive correlation between ESG and financial returns, an effect that appeared stable over time.
The findings encompass a wide range of different investment vehicles and assets. These include portfolio and non-portfolio studies, different global regions, and even young asset classes like emerging markets, corporate bonds, and green real estate. Most interestingly, it found one of the strongest results in emerging markets, where more than 65 per cent of studies showed a positive link between ESG and financial performance. Real estate presented the strongest result by asset class, with over 71 per cent of studies showing a positive financial link between the two.
Being one of the world’s leading providers of global indices since the 1960s, MSCI is well placed to assess the impact of ESG performance over the long term. For this study the firm applied two ESG strategies to its MSCI World benchmark: a tilt strategy that prioritised companies with strong ESG policies in place and a momentum strategy, which prioritised those that have improved ESG scores. Studying the performance of these strategies over eight years between 2007 and 2015, it found that both outperformed the global benchmark.
Over the seven-year period the momentum strategy performed the strongest, delivering 2.2 per cent more per year than the MSCI World Index, while the tilt strategy delivered 1.1 per cent more per year. While this might seem small, over seven years this suggests that investors could have bagged anything between 8 and 16 per cent extra by applying ESG filters to their portfolios.
A number of studies investigating sustainable and ESG investing were published in 2015 – the same year the UN brokered the historic COP21 climate deal in Paris. Morgan Stanley’s sustainable performance report analysed returns from more than 13,000 US mutual funds and private portfolios between 2008 and 2015. Like Deutsche and MSCI, Morgan Stanley found that investing sustainably has usually met, and often exceeded the performance of traditional investments. Again this was across asset classes and over time and on both a gross and risk-adjusted basis (accounting for the higher risk/reward dynamic involved).
Morgan Stanley found that US sustainable mutual funds returned just as much or more than the mainstream funds – with equal or less volatility – in 64 per cent of the periods that it examined. Private portfolios fared less well, with just 36 per cent running a sustainable mandate outperforming – though 72 per cent had lower volatility than traditional investments. On an individual firm basis, it found that those companies that actively pursue improvements in their ESG policies tended to have lower costs and higher share price performance.
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Focusing purely on the performance of individual companies, Oxford University and Arabesque Partners examined over 200 different academic studies, industry reports, newspaper articles and books looking for evidence of ESG influenced outperformance. They found that in 80 per cent of the studies share price performance was positively influenced by sustainability factors, while 88 per cent showed that better ESG practices led to better operational performance.
Like Morgan Stanley, the researchers also found that 90 per cent of studies showed that sound ESG practices lowered the cost of capital for companies compared to their mainstream peers. Individual studies also revealed interesting findings, including a report from the London Business School and Boston College in 2013 that concluded that successful ESG engagement led to a company’s share price outperforming by 7.1 per cent in the year following engagement.
This 2014 study from Harvard Business School focused on the long-term benefits of ESG for companies in the US. The researchers examined 180 companies and found that corporations that voluntarily adopted sustainability policies by 1993 (deemed high sustainability companies) had a number of advantages over lower sustainability companies by 2009. These included better organisation structures and chief executive engagement on ESG issues and, most importantly, stronger financial performance.
Over an 18-year period, it found that the share prices of companies with better sustainability profiles performed up to 4.8 per cent better than their lower sustainability peers, while return on equity and return on assets was also higher. Perhaps unsurprisingly, it also found that companies that sold products to individuals saw the most pronounced benefit thanks to stronger brands and reputations as a result of their ESG policies.
