For ESG investors, positive change is bringing big profits

Sustainable investments have outperformed in recent years, highlighting the potential returns to be made through a focus on ESG

Sustainable investments are no longer the poor relations of investing. You can do good and still earn good returns – potentially even better than the alternative.

It’s a time-honoured axiom of investing that sustainable funds underperform their traditional counterparts. But there’s been a sea change recently, with decades of investing wisdom turned on its head by a flurry of recent studies that found sustainable funds outperformed their non-sustainable cousins

“One of the enduring myths about sustainable investing is that doing good comes at a price,” says Maike Currie, investment director at Fidelity International. “But investing in companies that rate highly on environmental, social and governance (ESG) factors can provide another opportunity to reach your financial goals while aligning with your values.”

The data takes some unpicking: one of the key factors in this market is the sheer complexity of the information to hand. 

“It gets complicated very quickly, because there are so many different types of sustainable investments,” says James Alexander, chief executive of the UK Sustainable Investment and Finance Association (UKSIF), a trade body. “You can’t put the data into one neat metric. The idea that [measuring green credentials] can be simple and straightforward is not reality.”

Matt Christiansen, global head of sustainable impact investing at Allianz, agrees. “The data is a starting point, but it’s not perfect,” he says. “There’s a lot of alphabet soup. But the conversation is starting to evolve – we are moving on from ESG, which is now embedded into the valuation of companies. Younger people coming into the industry take that as the norm.”

Outperforming indices

Whatever imperfect measure of sustainability you choose, there’s pretty universal agreement about the outperformance. According to financial services group BNP Paribas, over the last five years a range of sustainable equity indices have outperformed standard non-sustainable benchmark stock indices. It noted that the MSCI World SRI (Socially Responsible Investing) index has seen a 14.1% compound annual growth rate (CAGR) in returns since the beginning of 2016, 1.1% more than the MSCI World standard benchmark. The Euronext Low Carbon 100 index has returned 7.1% CAGR since 2016, ahead of the 6.3% of the STOXX Europe over the same period. 

Last summer Morningstar, an American financial services firm, analysed the performance of 4,900 funds to find out whether sustainable funds can beat their traditional counterparts over the long term. It found that a majority of surviving sustainable funds – those that existed 10 years ago and still exist today – outperformed their average surviving traditional peer. 

Over 10 years, the average annual return for a sustainable fund invested in large global companies has been 6.9% a year, while a traditionally invested fund has made 6.3% a year. Over the 10-year period to 2019, 58.8% of surviving sustainable funds across seven categories were considered to have beaten their average surviving traditional peer.

No serious investor can afford to ignore the impact of climate risk on input prices, insurance premia and supply chain resilience 

Vikram Raju, head of climate impact and emerging markets for AIP Private Markets at Morgan Stanley Investment Management, believes non-sustainable investments are now the riskier proposition. “For example, no serious investor can afford to ignore the impact of climate risk on input prices, insurance premia and supply chain resilience,” he says. “Lost shipments due to extreme weather events equal lost sales. On the other side of the coin, there’s also the high growth and premium pricing associated with sustainable brands in every segment from food to textiles.”

In February, a study from the Morgan Stanley Institute for Sustainable Investing found that sustainable investing funds outperformed traditional funds and reduced investment risk throughout 2020, weathering the volatility of the pandemic year better than their counterparts. According to the report, “sustainable funds’ strong risk and return performance during an exceptionally turbulent year further erodes the persistent misconception that sustainable investing requires a performance sacrifice.” For many investors, the lower volatility and steadier performance of sustainable investments is the attraction.

A complex environment

So why do some investors still think sustainability must be traded for performance? In part, the devil is in the details. What does sustainable mean, after all? How green is a company that produces legs for oil rigs that are also legs for wind turbines? Which measures of sustainability are critical: would you prioritise water or biodiversity? Is it enough to do no harm, or should companies be actively seeking change?

There’s a raft of different areas to consider, says Christiansen. For example, “last year Allianz came out of coal – we don’t want long-term exposure to coal, we don’t think it’s going to be a winner. But we don’t have that view on oil, where we are looking at how we can work with energy producers in a more regulated environment.” 

Transition and stewardship are important parts of the sustainability debate. “This is not a divestment agenda,” says Alexander. “We’re not going to change the world by selling all the ‘bad’ companies to people who care less than we do. It’s about using our voice to push management to make changes.”

Sustainability can’t be divided neatly into good and bad, unfortunately for those who prefer their investments clear cut. There is certainly demand for sustainable investing; UKSIF members report a massive increase in the number of people who want to manage their investments sustainably, even if few of us can define what we mean by it. 

However, the financial services industry still has a job to ease the cognitive dissonance that surrounds sustainable investment.

“Being a good ESG company is a kind of proxy for just being a good company,” says Currie. “Companies that are socially responsible, diligent about corporate governance and environmentally friendly tend to be the sort of high-quality, well-managed companies that we all want to invest in.”