There are almost as many myths surrounding sustainable and responsible investment issues as there are terms for the sector. Sustainable… responsible… ethical… all lack formal definition. But more important than names is the need to look at the options available and dispel some of the myths that can prevent some investors from considering sustainable and ethical funds
A key misconception among investors is that SRI funds underperform relative to their mainstream counterparts. There is evidence to show that this is generally untrue.
The basic tenet of SRI investing is to maximise both the financial return and the social good. These do not have to be mutually exclusive; in fact research suggests both can co-exist to the benefit of investors and broader society. In fact, companies that align themselves to their customers’ environmental, social and governance principles by adopting responsible and progressive policies are better placed to reduce costs and increase market share, thereby achieving sustainable growth and delivering above average returns to investors. By including environmental, social, governance (ESG) criteria in the research process, investment teams can gain a significant information advantage.
Research
Mercer Investment Consulting and the United Nations Asset Management Working Group recently conducted a broad ranging global study of SRI academic and broker research and assessed the contribution that ESG factors add to investment performance. It concluded that, “the argument that integrating ESG factors into investment analysis and decision-making will only lead to underperformance simply cannot be made”.
The report reviewed 20 academic studies and found evidence of a positive relationship between ESG factors and investment performance in half of these cases, with seven reporting a neutral effect and three a negative association. Mercer concluded that “on balance, the evidence suggests there at least does not appear to be a performance penalty from taking wider factors into account in the investment management process”.
It is also false to claim that SRI funds have a limited choice of investment options because they exclude many companies from the outset. Regardless of their underlying philosophy, all fund managers need to ‘screen out’ some companies as it is impossible to invest in every available option. The criteria and process by which a fund manager selects stocks is a crucial factor and screening stocks on the basis of SRI issues is a sound way to proceed for a number of reasons.
Negative to positive
Industry developments over the last 20 years have seen a shift away from reliance on ‘negative screens’, which are principle based exclusions of companies that provide products or services that are ethically questionable. For example companies involved in manufacturing tobacco, alcohol or weapons are likely to be screened out.
Today, most SRI managers also look for thematic and positive screens or ‘best in class’ opportunities – as they seek out companies with a commitment to responsible business practices and positive products and/or services which address the key ESG issues.
Fund managers also use engagement, which mainly takes the form of dialogue between investors and companies on issues of concern, and – if done properly – it should include voting at company annual general meetings. Working with a company at a corporate level to improve performance on ESG issues can also enhance long term returns to shareholders.
Another common myth is the idea that SRI is a ‘fad’ and will soon go out of fashion. This does not take into consideration that a broad range of sustainability and governance issues such as global warming, ozone depletion, poverty and injustice have become ever more significant issues in the global consciousness over the past decades. In the wake of the financial crisis corporate governance has received greater attention as investors become aware of the potential damage mis-management can cause.
Indeed resource scarcity and demographic pressures require a radical increase in the efficiency with which our economies deliver their services and a fundamental change in the nature of these services. This will favour companies which can deliver these services more efficiently.
Political momentum
There is ever-strengthening political momentum behind environmental, social and particularly governance issues. As governments increasingly adopt SRI based principles, this will only help to reinforce the importance of the SRI approach and ensure that these factors remain at the forefront of both public and industry focus. Some critics may point to the lack of ‘real’ headway made in Copenhagen, including the lack of binding international emissions targets. However while investor sentiment on renewable energy companies has been knocked, the fundamentals of the climate change science remain unshaken.
Events such as BP’s Deepwater Horizon Oil spillage off the Gulf of Mexico solidify the market’s ambivalence towards the oil industry. President Obama has called for a move away from dependence on oil towards gas. Many SRI investors have, for some time now, favoured companies with a strategic focus on developing gas operations, as gas consumption leads to approximately 30% less carbon emissions than the equivalent unit of oil.
Small actions, lasting effects
People often tell themselves “as an individual, it is impossible for me to make a difference through the investment choices I make”. However, anyone who has ever recycled will appreciate the principle that, collectively, many small actions can have significant and lasting effects.
By pooling resources with other personal investors, individuals are able to play a major role in shaping the future approaches of major corporate organisations. As large investors fund managers are able to utilise their role as a shareholder and can proactively seek to engage with companies to bring SRI related issues to the forefront of their thinking.
At the end of the day, any assertion that investment based on a sustainable and responsible framework is to the detriment of performance is flawed. Investors should recognise that by identifying long-term sustainable themes and selecting companies well positioned to benefit form these they are well placed to benefit from the shift towards a more sustainable world.
Peter Michaelis, head of sustainable and responsible investment, Aviva Investors
