ESG Funds Do Not Have A Performance Penalty

Shanny Basar

Morningstar, the research provider, has compiled the academic research which shows there is no performance penalty associated with environmental, social, and governance investing to counter the continuing assumption of underperformance.

Jon Hale, head of sustainability research at research provider Morningstar, summarized the findings of academic studies on sustainable investing in a paper this month. He concluded that sustainable/responsible funds and indexes perform on par with comparable conventional funds and indexes, companies with higher ESG scores and ratings can outperform comparable firms in both accounting terms and stock market terms and that a focus on company-level ESG factors, rather than exclusionary screening, can lead to better risk-adjusted portfolio performance.

The paper summarised the findings of research into performance from 2007 until this year. For example, Hale said a 2015 meta-analysis of 85 primary studies by Revelli and Viviani found that the adoption of ESG standards does not generate notable costs or benefits for an investor with a global perspective, challenging the theory of socially responsible inefficiency, which implies poorer performance due to a limited investment universe.

Hale continued that the performance of sustainable/responsible indexes is also generally in line with conventional indexes. For example, the oldest SRI index created in 1990, the MSCI KLD 400 Index has slightly outperformed the S&P 500 over time.

“After more than a quarter-century, the performance of the MSCI KLD 400 Index relative to the S&P 500 makes a strong case that S/R investments do not lead to inferior returns and, in fact, are capable of producing better returns than those of conventional investments,” added Hale.

In addition, Hale analysed the Morningstar ratings of sustainable/responsible funds using 25,000 observations over a 16-year period and said the distribution of stars was similar to the overall fund universe. He said: “Thus, our findings are consistent with the research literature: Socially conscious funds have similar risk-adjusted performance that, if anything, skews positive relative to conventional funds.”

Hale also summarized the research on the link between company sustainability and financial performance which suggests that firms that effectively address the key ESG risks and opportunities they face in their businesses tend to be stronger financial performers over the long run.

A report from Arabesque Partners and Oxford University in 2015 reviewed more than 200 studies and concluded that more than 80% indicated a connection between better company sustainability practices and lower cost of capital, better operational performance, and better stock-price returns. Companies with superior overall sustainability performance also have better credit ratings and significantly lower cost of equity.

Hale concluded that the idea that sustainable investing is a recipe for underperformance is a myth.

“Like most myths, there is a kernel of truth to it-that exclusionary screening for non-financial reasons can limit portfolio performance,” he added. “We found evidence in the research that exclusionary screening can have a negative effect. But the research also finds intriguing evidence of a positive ESG inclusion effect, which is bolstered by company-focused research suggesting that firm-level sustainability performance is associated with better financial outcomes.”

Eurosif, the Brussels-based association for the promotion and advancement of sustainable and responsible investment across Europe, published its seventh biennial market study last week. The report said sustainability themed investments have grown by 146% over the past two years, ranging from 30% for stewardship (engagement and voting) to 385% for impact investment.

Eurosif said: “SRI is growing faster than the broad European investment market (25%) with retail investors returning to the market (up 549% since 2013).”

The report said there have been a shift in SRI assets from equities to fixed income driven by the growth in the issuance of green bonds. Flavia Micilotta, Eurosif’s executive director and Will Oulton, Eurosif ad-interim president, said in the report that the green bond market has broken through the $150bn barrier and France and Finland have become the first states to issue green bonds.,

Data for the Eurosif survey was collected from January to June 2016 across 13 European markets. In total, 278 asset managers and asset owners with combined assets under management of €15 trillion participated, which Eurosif said represented market coverage of 81%.

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