Does sustainable and responsible investing come with a performance penalty?
It is a strongly held belief among many sustainable and responsible investment (SRI) managers that environmental, social and governance (ESG) analysis enables the selection of better companies in which to invest. Our analysis confirms this - but with some important nuances.The question "does sustainable and responsible investing come with a performance penalty?" has been as extensively studied, picked over and critiqued as almost any other question in contemporary asset management. For many, the definitive guide to this question came in 2007 with the joint publication by Mercer, the investment consultant, and the UN of a report which reviewed 20 academic studies on the topic. The headline result? 10 of the studies found evidence that SRI funds actually outperform, 7 were broadly neutral or removedally supportive of their outperformance and three found evidence that SRI funds underperform.
Since then there have been numerous additional studies, the majority of which have also found that SRI strategies generate outperformance. The most recent of these - a study by RCM (part of Allianz Global Investors) found that 'investors could have added 1.6% per annum to their returns over a five-year period by allocating to portfolios that invest in companies with above-average ESG ratings'.
Other recent studies for example by Macquarie Research and UBS (focusing primarily on governance) have also reinforced this finding - though have emphasised that companies with strong ESG ratings tend to outperform most in times of heightened risk aversion and weak equity markets. In other words, when investors are most worried about risk, the companies with inadequate approaches to ESG issues are the ones that underperform, or as Warren Buffett has famously put it, "You don't know who's swimming naked until the tides goes out".
Our work at Henderson has also tended to support these conclusions. This is particularly true in certain sectors where we find that highly rated companies from an ESG perspective typically display stronger share price performance than their lower rated peers. This is particularly true over time periods of greater than three years - with the relationship sometimes reversing over shorter time periods. We still need to roll out this analysis across a broader range of sectors using larger sample sizes, but to date our analysis at the sector level has tended to point towards strong out-performance of high ESG rated companies. Though clearly, this does not mean that investments might not lose value. As elsewhere, these can fall as well as rise and you may not get back the amount you originally invested.
We have also reviewed performance at a portfolio level - and here too we find that a basket of highly rated companies from an ESG perspective outperform poorly rated peers. Again this is particularly true in times of heightened market stress. For example from the start of 2011 to the middle of August we found that our 'SRI preferred' portfolio outperformed their non-preferred peers by 9%. Over five years the group of SRI preferred companies returned 34.5% but their non-preferred peers returned only 5.2%. Though this also comes with the traditional financial disclaimer that past performance is not a guide to future performance.
No doubt the debate will rumble on and SRI 'sceptics' will remain sceptical. However with each passing year the academic evidence - and increasingly the experience of practitioners too - points strongly to the conclusion that not only does SRI does not come with a performance penalty, but it actually delivers share price outperformance over a greater than three year time horizon.
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