Five myths of socially responsible investing

Traditional assumptions about socially responsible investing are increasingly being dispelled.

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  1. Rob Morgan

Myth 1: You sacrifice performance

A common objection to socially responsible investing is that you must sacrifice performance. We don’t believe that’s necessarily the case. Companies managing environmental, social and governance (ESG) risks well should avoid major pitfalls or controversies. In addition, those that are improving could boost their value in the eyes of shareholders as they come to be perceived as higher quality. Any investor assessing a business should find that considering these risks is helpful and potentially beneficial to long term returns.

Now there is mounting evidence that backs this up.  For instance,  ‘meta-study’ of nearly 200 individual studies carried out by Oxford University found that 80% of them showed that superior corporate environmental performance produced better share price returns; and 88% showed that strong ESG practices resulted in better operating performance as measured by accounting indicators. Our own research also shows socially responsible investing has helped returns in the shorter and longer term in respect of funds in the UK and global sectors.

Increasingly, investors are aware that taking these factors into account is a critical part of any investment process – whether or not the product is labelled as ‘ESG’ or ‘sustainable’. Imagine, for instance, investing in the oil and gas sector, without regard for the impact of climate change, or investing in tobacco stocks without thinking about the health consequences of the product and the legislative framework. All investors should be at least considering these sorts of factors.

Stringent ethical or sustainability considerations may at times have a detrimental impact on performance, though. Any process that drastically reduces the number of available investments, for instance by screening out whole sectors and industries, does reduce the opportunity set, and this might lead to periods of underperformance or outperformance against a standard benchmark due to the portfolio biases it creates.

For instance, omitting the energy, mining and tobacco sectors from a portfolio could reduce diversification. These are important constituents of many indices, the UK’s FTSE 100 being a prime example, and if they perform particularly well or badly over a given period then there are consequences for the relative performance of socially responsible funds that do not hold them.

Myth 2: It’s a niche area

Socially responsible investing is not a fad, nor is it a niche area. All investors can benefit from the principles behind ESG, which represent a myriad of factors affecting the potential of, and the risks surrounding, any investment. Indeed, there is increasingly an expectation that such issues must be taken account of in any diligent analysis of an investment. 

This type of investment is now very much mainstream with around $30trillion of money managed worldwide using ESG criteria. It now represents 40% of global professionally managed assets, driven by access to more comprehensive and accurate data, regulation and a greater focus on environmental and social issues. Increasingly, the question is not why use ESG but why not use it – both from the perspective of managing the risks to investment performance and in terms of social conscience – especially if it can uncover important governance issues or other risks that can affect profitability, or, in extreme cases, viability. In addition, the Covid-19 pandemic has only served to intensify the scrutiny of companies on responsible business matters. 

Myth 3: It doesn’t make much difference to society or the environment

Socially responsible investing is one way we can all make a difference. Most businesses are now aware there is increasing emphasis on transparency and high standards that go beyond the traditional financial variables that investors have historically focussed on.  Ultimately, this affects the extent to which they can attract capital and the rates at which they can borrow, so they have a vested interest in improving. The more people that invest responsibly the greater pressure there is on companies to improve, helping drive the pace of change.

Backing companies that address solutions to global issues such as carbon emissions or waste can help combat these problems. Meanwhile, avoiding the worst offenders can make it more difficult for these businesses to raise capital, meaning it’s more difficult for them to undertake new projects or to expand. Engagement also plays an important role. Investors, especially large shareholders, who are conscious of ESG factors, can open a constructive dialogue with companies on all kinds of issues from environmental impact to diversity policy, helping shape future direction and policies. However, it's important to identify investments whose managers have a genuine commitment to having a positive impact on society and the environment and aren't just paying lip service to the issues.

Myth 4: It costs more

If you buy organic produce at your local supermarket it tends to cost a bit more than regular items, often because there are not the same economies of scale. This doesn’t necessarily apply to socially responsible funds, though. Although integrating ESG factors into an investment process can take a bit more work – especially if the due diligence is proprietary and the level of engagement with companies is high – the cost is broadly similar to equivalent funds without an explicit ESG policy.

An exception is funds investing in more specialist areas or according to certain themes, which can be more expensive. Also, passive investments (or ‘trackers’) aimed at following particular socially responsible indices are generally a bit more expensive than the largest and most cost-effective mainstream equivalents because they have less money under management and can’t pass on such significant economies of scale. This should change over time as socially responsible investing becomes more popular.

Myth 5: There is not much choice

In the past, the range of socially responsible funds available wasn’t particularly appealing. The original ethical funds developed in the 1980s applied simple ‘screening’ to a universe of shares in order to exclude certain sectors and activities. There wasn’t much choice and the level of talent and resource dedicated to the area was more limited.  Nowadays there is increasing quality and breadth.

Driving this trend is greater demand owing to the growing public consciousness on issues such as climate change, plastic pollution and social inequality. Fund managers are starting to emphasise the ESG elements of their processes across many funds, not just those explicitly labelled ‘responsible’, ‘ethical’ or ‘sustainable’. Meanwhile, there is a growing range of investment options, encompassing various sectors and styles, that aim to add value for investors through investing responsibly or sustainably – not in spite of it.  We believe this will continue. As the availability, variety and reliability of ESG data improve, more and more fund strategies will be created to embed these characteristics.

For more information on socially responsible investing, including a glossary of common terms, take a look at our dedicated webpage.

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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