Socially Responsible Investing

Will investing responsibly cost you money? Pt. II

Here’s the lowdown from a Morgan Stanley review of sustainable investing:

We ultimately found that investing in sustainability has usually met, and
often exceeded, the performance of comparable traditional investments. This is on both an absolute and a risk-adjusted basis, across asset classes and over time. – Morgan Stanley Institute for Sustainable Investing, 2015

I should emphasise again that “sustainable” is not a magic label; investing in a sustainable mutual fund doesn’t guarantee you above-average market returns and a glow in your cheeks from doing good. Do your due diligence. What the studies do point out is those who blanket the industry in a coat of non-profitability haven’t done their homework.

How do we know ESG improves a company’s bottom line?

Or in other words, is SRI even worth thinking about in the first place?

Simply put, yes. Study after study consistently show ESG helps a company make more money.

Since the 1970’s, researchers have studied the link between ESG and financial performance. The largest meta-analysis of SRI and financial performance by the Deutsche Asset & Wealth Management and Hamburg University in 2015, a massive study of 2000 studies and the largest what’s been billed as the “most comprehensive review of academic research on this topic” concludes definitely yes, SRI can be profitable. Comfortably so. 95% of the studies show a positive correlation between ESG factors and corporate financial performance.

But that still means you need to do some homework

Otherwise known as ‘yes, you could make money, if you choose your funds, indices, and managers carefully’.

A caveat is this: studies based on portfolios tend to show a neutral or negative correlation between CFP and ESG factors, which is something your average investor (likely you) should sit up and pay attention to. Even if companies post higher profits because of ESG factors, fees of portfolios may leave you, the investor, with little of that extra profit. mutual funds, like other funds, have fees: management fees, trading costs, etc. With the 2.5% average annual total fee of mutual funds, you as an investor purchasing an ESG mutual fund might see your extra ESG returns being swallowed by fees. If you do your homework, however, there are profitable options.

Reasons why people believe SRI will cost them money

1) Deciding on what companies are ‘socially responsible’ is difficult and costs investors extra money.

First part is true, second isn’t necessarily so. Meta-analyses of SRI like this one show that, at worst, SRI will not cost investors extra money. The returns of your SRI portfolio depend largely on the skill of your fund manager. Yes, making profits is possible, and  read the fine print before you buy.

2) With a smaller pool of companies to invest in (a limited investment universe), you have increased risk and lower expected return.

A reasonable theory at first sight, but too simplistic. Instead, the relationship between screening intensity and corporate financial performance is U-shaped: no screening is better than a low degree of screening, but intensive screening of companies leaves you with the best-performing companies with high rates of return.

4) SRI portfolio managers charge higher fees than conventional portfolio managers

Some do. So pick your portfolio managers wisely.

5) You’re better off making money conventionally and using your earnings to do good.

Assuming all conventional investments fare better, which we’ve already discussed is not the case.