Investing with a conscience can be profitable too

The long-held belief that investing in line with environmental, social and governance (ESG) objectives means sacrificing performance is increasingly being debunked.

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  1. Rob Morgan

Vegan burgers have got a lot better over the years. I've had several recently that have challenged my long-held perception that a good burger has to be made of meat. The health and environmental benefits mean I’m likely to buy more, and I don't have to compromise on taste. It’s the best of both worlds.

It’s a similar story with investing. ‘Ethical’ investing, as it’s been traditionally known, was often accused of offering mainly bland, middle-of-the-road funds that applied simplistic restrictions to a universe of shares. To be fair, the experience wasn’t that satisfying in many cases. Simply concentrating on avoiding the ‘bad’ didn’t often deliver great results. That wasn’t necessarily to do with any flaw in the investment approach; it was more a lack of quality in the delivery and, perhaps, less emphasis on positive factors driving businesses.

An improving experience

Some fund management groups didn’t get involved this type of investing; maybe fearing that too much consideration of non-financial aspects of a company would constrain a cherished investment process. Many others did look at these factors, often from a risk perspective, but saw little reason to highlight this aspect of their process. A decade ago the public consciousness on issues such as climate change, plastic pollution and social inequality was less developed.

Other investors considered it very important area and became niche players, often incorporating more positive approaches surrounding the sustainability of businesses on top of the usual exclusions such as weapons or tobacco. Many of these funds now provide a decent track record. Add to this a new breed of investments, also well-resourced and with clear philosophies of adding value for investors through investing responsibly or sustainably – not in spite of it. There are now a large number of funds that marry profit with principles in a credible way and are generating decent performance to boot. As with vegan food, the appetite is there and the market has developed.

No need to compromise

There is mounting evidence that investing in line with environmental, social and governance (ESG) criteria is beneficial to returns. For instance, Lyxor Asset Management found that using an ESG ‘filter’ to exclude 50% of companies with the lowest ESG ratings from a European equity size portfolio added 2.3% per year of return over ten years, while also slightly reducing volatility. In its study, fund manager Hermes also found companies with below-average or worsening governance tended to underperform.

Perhaps most compellingly, a ‘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.

Increasingly, investors are aware that taking these factors into account is a critical part of any investment process – whether or not the end 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.

Need for action

Ethical and sustainable investments are now playing an increasingly important role. As more capital is allocated responsibly with the stewardship of society and the environment in mind, the more companies will take notice and clean up bad practices. Investing in this manner is one of the main ways we can all make a difference as it influences companies’ actions. For example, backing companies that set ambitious targets on climate change and other issues can increase the competitiveness of environmental solutions and products, as well as encourage progress and innovation.

Let’s not forget the opportunity too. The world’s biggest problems are going to require some ingenious solutions, and the prospects for companies that can successfully address huge challenges in areas such as waste recycling, renewable energy and social equality are likely to be bright. Fund managers that spot these opportunities early can potentially harness strong long term returns for their investors.

What are you buying?

One of the obstacles of this type of investing is the broad range of terms applied – ethical, sustainable, responsible, green and, now in common usage, ‘ESG’. None have an industry-wide definition at present, and they overlap with one another. However, the basic idea is that, just like burgers, they share similar characteristics but come in various configurations and flavours – add cheese, hold the relish and so on. It’s important to remember that all investors should examine whether any fund meets with their own values as well as objectives and attitude to risk – the ‘house’ burger may not contain the ingredients you want!

So-called ‘impact’ funds are probably the easiest for investors to appreciate. They usually target firms with a positive and measurable impact on society and the environment, as well as generating a strong financial return. Examples from our Foundation Fundlist are Threadneedle UK Social Bond, WHEB Sustainability and Baillie Gifford Positive Change.

 

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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