ESG: Will investors jump or be pushed?
Conventional wisdom dictates that applying an ethical or “socially responsible” overlay to your investments means you have to give up returns. This view is reinforced by the language often used to describe the end result – companies are “excluded”, portfolios “divested” and investors are applauded for having “taken a stand” – all seemingly at the expense of returns.
However, there is a significant and material body of evidence which suggests that integrating Environmental, Social and Corporate Governance (ESG) into the investment selection process can in fact have a positive, rather than detrimental, impact on returns.
Historically, investors divested from so-called ‘sin’ companies or sectors on the basis of their business involvement. The issue then was the potential impact on financial returns. A significant investor in the form of the California Public Employees’ Retirement System (CalPERS), may soon reverse a 15-year-old decision to divest tobacco after its independent research showed it had foregone $3bn (€2.6bn) in returns. However, analysis by Karen Shackleton at Allenbridge suggests that the impact on a portfolio from not investing in tobacco is far less significant than an investor might think. Although the relative return for tobacco has been rising, the market cap has fallen from its high point in 1997, and is now running at around 1% to 1.5% of the index. So no matter how high the tobacco sector's return, a passive investor excluding tobacco will only be missing out on around 1/100th of that.
The clear reality is that ESG factors have a significant impact on how an investment performs – one doesn’t need to look much further than the scandal which hit a certain car manufacturer last year to understand this. Knowing everything that’s under the bonnet is becoming not just helpful but essential when making an investment decision. Simply put, many investors are beginning to realise the old argument – that responsible investing equals lower returns – is at best misguided and at worst completely misleading.