Performance or principles? Busting the myth of the ESG trade-off

Interest in sustainable investing has never been higher. But despite its increasing popularity, some still believe that, while investing responsibly might be good for your conscience, it’s less beneficial for your bank balance.

Maybe this was the case in the early days of ‘ethical’ funds. Now though, I believe one of the biggest myths about ESG today, is that being a responsible investor means you have to compromise on your returns. 

Follow the data 

The more ESG becomes part of the mainstream, the less I think this argument about performance vs principles stands up. 

Analysis from the first 12 months of the pandemic showed that a selection of 26 ESG funds (totalling more than US$250 million in assets under management) fared better than the wider US equity market – rising by more than the S&P 500 index. Why? ESG fund managers said the focus on non-traditional risks, such as sustainability scores, had made them more resilient to the downturn caused by Covid-19.

This situation isn’t unique to the pandemic. Research from industry tracker Morningstar has shown that over the course of 10 years, nearly six out of 10 sustainable funds performed better than their wider non-ESG equivalents. 

Of course, this doesn’t mean every fund labelled ‘sustainable’ is a guaranteed winner. What it does mean is there’s now growing evidence that responsible investing doesn’t always equal compromise.

Protection vs opportunities

So how can you keep both performance and principles intact? 

Depending on what sort of ESG fund you choose, there are two main avenues:

On the one side there’s protection – guarding against the potential risks of unsustainable investing. For example, the reason some ESG funds fared better at the beginning of the pandemic was they had sidestepped the big energy companies, whose share prices were hit by a slump in the oil price.

Other ESG investors might also avoid companies where they feel something like poor governance practices, or a lack of diversity could negatively impact the future share price. In five years, according to analysis from Bank of America, issues which could fall under ESG, such as accounting scandals and data breaches, wiped off more than US$500 billion from the values of several large US companies.. 

But ESG isn’t just about not investing in the companies you don’t think make the grade. It’s just as important to consider the other side: opportunities.

Take energy companies. Avoiding an entire sector would be a huge call for any investor to make (and counterproductive as the planet’s energy needs certainly aren’t getting any smaller). But the ESG funds we offer focus on the changing energy landscape, including companies looking at alternative sources to oil and gas, such as wind, hydropower, and hydrogen.

It’s the same in every sector. An ESG fund doesn’t have to just be a negative screen, it also gives investors the prospect to search out those companies prospering from exciting new trends. 

Making companies better 

There’s another way ESG can help improve performance. The collective voice of shareholders is getting louder and pushing big corporations to become more sustainable.

Earlier this year, Exxon Mobil was forced – under the weight of investor pressure – to include three directors on its board, whose mission is to drive down the company’s carbon footprint. Other initiatives, such as the Principles for Responsible Investment are seeing more asset managers taking collective action to ensure the corporate world considers the global good.

How can this benefit investment returns? Greater scrutiny and engagement from the investment community can have a positive impact on company behaviour, and potentially avoid some of the corporate scandals we’ve seen in recent history.

Look carefully

ESG is not a one-size-fits-all approach. And as these funds grow in popularity, we have to be cautious of the dangers of ‘greenwashing’ – companies that claim to be sustainable to get on the good sides of investors, without the evidence to back it up. 

ESG metrics are useful, but they’re not perfect and in future blog posts we will discuss the importance – and the limitations – of scores and ratings.

Just as with any other areas of investing, assessing sustainability and choosing the right funds for you are complex decisions, so taking advice is a good idea before you decide on your approach.