Some clients still believe that investing responsibly has a financial cost. While there’s no doubt that incorporating environmental, social and governance (ESG) factors into an investment portfolio can provide social and environmental benefits, there’s also a strong argument that RI can have a positive effect on both short- and long-term returns.
Furthermore, RI is being regarded less as a political decision and more a matter of astute investing.
“[RI] is about using all available information to make smart, long-term investment decisions,” says Dustyn Lanz, CEO of the Responsible Investment Association. “You can be an NDP [supporter], conservative or liberal, and your portfolio is going to be better off, regardless of your politics.”
Assessing a company thoroughly means going beyond the balance sheet. Weighing ESG factors when making investment decisions can help portfolio managers spot the risks and opportunities that may be overlooked by those relying solely on traditional financial analysis. “ESG analysis can provide a lens to view a company more holistically,” Lanz says.
For example, when a company receives bad press, investors may become concerned. And those negative stories often involve ESG issues. As an example, Lanz points to the Volkswagen emissions scandal that occurred in September 2015. The German automaker was caught violating the U.S. Clean Air Act by falsifying the results of emissions tests for its vehicles. Those vehicles were emitting much higher levels of nitrogen oxide pollutants than U.S. standards allow.
After the scandal became public, Volkswagen’s share price dropped by 35% in one week.
Lanz notes that MSCI Inc. had delisted Volkswagen from its MSCI ACWI ESG Index (an RI index) in May 2015 due to red flags it had observed in the firm’s governance. “So, there were some warnings signs,” Lanz says, “but you had to be looking at ESG factors to spot them.”
Still, whether a portfolio governed by RI principles in fact performs better than a non-RI investing regime remains unclear.
“I think some market participants might be waiting for the holy grail — this bona fide, irrefutable evidence that ESG outperforms, but I’m not going to hold my breath,” says Doug Morrow, director of thematic research in Toronto with Sustainalytics, an Amsterdam-based firm specializing in ESG research.
“What’s interesting,” Morrow adds, “is that despite the fact that studies are coming out mixed, the tilt toward responsible investing and ESG integration has continued unabated. Even though there’s this lingering question about the extent to which ESG outperforms, investor assets flow dramatically into these strategies. I think it says that [institutional and retail investors] have confidence these strategies are not going to damage returns.”
As it stands, popular sustainable indices are beating the broad index. From its inception, on Sept. 28, 2007, to Aug. 31, 2019, the MSCI ACWI ESG Leaders index had a gross return of 5.25% compared with MSCI ACWI’s return of 4.56%.
Similarly, the Jantzi Social Index, from its inception, on Jan. 1, 2000, to July 31, 2019, achieved an annualized return of 6.56%. In comparison, the S&P/TSX composite index and the S&P/TSX 60 had annualized returns of 6.11% and 6.16%, respectively, over the same period.
The RI Funds Quarterly Performance Report, Q2 2019, with data provided by Toronto-based Fundata Canada Inc., reveals that 75% of Canadian RI funds outperformed their average asset class return within the second quarter of 2019. In certain fund classes, such as Canadian equity balanced, Canadian fixed-income, global equity and global equity balanced, all or most RI funds outperformed their average asset class return for the quarter.
The report also shows that slightly less than three-quarters of RI funds outperformed their average asset class return for the year ended June 30, 2019. Over longer periods, almost two-thirds of RI funds outperformed their average asset class return over three years and five years, while 58% of RI funds outperformed over the 10-year period.
ESG and Financial Performance, an extensive study conducted in 2015 by Friede et al, examined more than 2,000 studies investigating the relationship between ESG and corporate financial performance. This study found “strong evidence” of a business case for ESG investing. “ESG outperformance opportunities exist in many areas of the market [including] North America and emerging markets,” the study report states.
When sharing information about RI with clients, Lanz says, remember that charts and data are helpful, but not always the best approach for relaying information because they can be confusing or overwhelming.
“It’s good to have some data handy when it’s needed,” Lanz says, “but many clients prefer to hear more tangible stories and examples. The Volkswagen example is a good one because it’s familiar due to the large amount of media coverage it received.”