Responsible Investing Proves Investors Can Do Good Without Sacrificing Returns

Responsible Investing (RI), also sometimes called Socially Responsible Investing (SRI), refers to the practice of considering environmental, social and governance (ESG) issues during the selection and management of financial investments. Environmental factors usually focus on climate change, water supply and biodiversity; social factors mainly consist of human rights, worker rights and cybersecurity; lastly, governance factors tend to focus on diversity and gender equality within the firm. Every investor, money manager or investment fund puts varying emphasis on each of the three components. 

Up until a few years ago, Responsible Investing was not popular among investors. It was perceived that there was a strict tradeoff between investing responsibly and high returns: these funds would underperform compared to the broad market indexes. However, data published from a 2015 study by Tessa Hebb found that socially responsible equity mutual funds outperformed industry benchmarks 63% of the time. Responsible Investing reduces investors’ exposure to risks that may not appear on a company’s financial statements, providing a better picture of the company’s long-term success potential. A study from Deutsche Bank Climate Change Advisors states that the lower risk of responsible investments in the long run results in lower cost of capital (for both equity and debt) for the company in the short run, contributing significantly to its financial outperformance. Nowadays, most investors believe that if companies do well on ESG metrics, they will have better risk-adjusted returns since those efforts will result in their businesses becoming more sustainable in the long term through lower risks, greater profitability and higher dividend yields. The two most prevalent examples of failure to comply with ESG would be BP and PG&E. Following its oil spill incident in April 2010, BP’s stock lost more than half of its value in the following days and the company has not recovered to its initial level ever since. More recently, PG&E now trades at 90% lower than its level before a report blamed the company’s aging equipment for the destructive wildfires in California. The common theory that there is a trade-off between responsible investing and successful returns has been disproved.  

Investors have started adopting an ESG lens in their asset allocation decisions. Surveys conducted by the Global Sustainable Investment Institute showed the number of U.S. funds incorporating ESG criteria increased from 206 in 2007 to 1,002 in 2016. Global ESG Assets have grown from $18 trillion in 2014 to $31 trillion in 2018. This amount includes all sustainable investments, including negative screens: keeping certain companies or industries out of their portfolio based on ethical or moral criteria (i.e., tobacco, weapons, cannabis manufacturers). $17.5 trillion of the $31 trillion have ESG incorporated as a factor of consideration in the financial analyses of corporations. $1.8 trillion is invested by positive screening: investing in certain companies for higher ESG performance than industry peers or working on specific causes. $500 billion went to impact investing: selecting funds that have the intention to generate measurable positive social or environmental impacts alongside a financial return. Impact investing is the most assertive form of responsible investing.

Socially Responsible Investing (SRI) is rapidly gaining popularity among developed nations. A Morgan Stanley survey found that three-quarters of the total population expressed their interest in sustainable investing. This change is mainly led by millennial investors who do not only want their investments to see financial performance, but also to create positive change. Many investment managers, funds, ETFs, and robo-advisers have started offering socially responsible investment options due to soaring demand. Even the biggest names on Wall Street are hearing out their customers and weighing in on the Responsible Investing. Goldman Sachs launched GS Sustain: a global, long-term investment research strategy that includes ESG performance in its alpha. Morgan Stanley recently launched Impact Quotient: a new tool to provide investors insight on the impact of their investment portfolios. Almost every large investment management firm has created teams to research trends on sustainable investing and methods to incorporate them into their investment strategies for their investors. BlackRock CEO Larry Fink explains the launch of their “Investment Stewardship” approach as “Our clients – who are our company’s owners – are asking you to demonstrate the leadership and clarity that will drive not only their own investment returns but also the prosperity and security of their fellow citizens.” BlackRock, the world’s largest money manager with $6.84 trillion in assets under management, is also the largest investor in renewable energy. In Canada, Desjardins Group CEO Guy Cormier announced that they have partnered with the Responsible Investment Association to provide training to 500 RI advisors, to be able to offer clients better decision-making support. Index funds are a major shareholder in public companies; with their significant voting power, they have the power to influence corporate behaviour on ESG performance directly. Some have started to exercise their voting power through active climate-related shareholder resolutions. CEO Robert O’Hanley of State Street Corporation (the third largest index fund manager) has announced that they have made sustainability issues around ESG a central focus of their active stewardship practice. Investors are pressuring fund managers to start taking actions against environmental and social issues. 

Climate bonds are a demonstration of how the reach of Responsible Investing extends beyond the stock market and has become a significant component of debt capital markets too. Money raised in climate bond issuances is invested in climate change mitigation or adaptation, including areas such as renewable energy, energy efficiency, and sustainable waste management. According to the Climate Bonds Initiative, climate bond issuances surpassed $150 billion this year.

Green bonds are broadly defined as fixed-income securities that raise capital for a project with specific environmental benefits. The first green bond was issued by the World Bank in 2008 and since then, governmental organizations and provincial governments all around the world have been frequent issuers of green bonds. Manulife became the first insurance company to issue a green bond in Canada, with a C$600 million offering. Canada Pension Plan Investment Board (CPPIB), Canada’s largest institutional investor, issued Canada’s largest green bond to date, worth C$1.5 billion. The issuance was 80% oversubscribed, indicating the robust demand from investors.

Consumers and governments have been pushing corporations to reconsider their environmental and social impacts. Now, investors have the power and influence to expedite the process through responsible investing. Responsible Investing is not the future, it is the present.