Common Misperceptions Related to ESG Investing
Misperception 1: Sustainable, responsible, and impact investments have lower returns
Quite the opposite, as continual research has shown.
Ongoing research studies support the strong tendency for companies with strong corporate social responsibility policies, programs and practices to be sound investments. A 2012 study by Deutsche Bank Group Climate Change Advisors found that incorporating environment, social and governance (ESG) data in investment analysis is “correlated with superior risk-adjusted returns at a securities level”. In other words, ESG investments may likely decrease investment risk levels if tied to certain securities investment portfolios.
A report by the United Nations Environment Program Finance Initiative (UNEP-FI) and Mercer examined 36 representative academic studies and 10 related industry research reports about SRI performance and found that “there does not appear to be a performance penalty from taking ESG factors into account in the portfolio management process.” Additionally, a 2011 study by GMI Ratings found that “on average and in aggregate, [responsible investment] portfolios perform comparably to conventional ones.” For additional research studies, check out FS Insight —a compendium of all the major academic studies on SRI.
Misperception 2: SRI investing solely includes negative screening
Two main strategies are utilized in sustainable, responsible, and impact investment.
One is ESG incorporation; this approach considers environmental, community, other societal or corporate governance (ESG) criteria in investment analysis and portfolio construction. ESG incorporation can be accomplished in numerous ways:
Positive screening: Proactively investing in companies with good ESG practices.
Exclusionary screening: Avoiding or divesting from companies with poor ESG practices.
Full ESG integration: Explicitly including ESG risks and opportunities into all processes of investment analysis and management.
Thematic investing: Targeting specific themes such as climate change, water or human rights.
Community investing—investment that directs capital to communities that are underserved by affordable financial services—also falls under the rubric of ESG incorporation.
Shareowner engagement is the other principal approach to SRI. This involves sustainable investors taking action to communicate their concerns regarding certain companies’ ESG policies to management within portfolio companies who incorporate these investments. In this process, sustainable investors need to ask management to study these issues in order to make improvements. Investors can communicate directly with corporate management or through investor networks. For owners of shares in publicly traded companies, shareholder engagement can take the form of filing or co-filing shareholder resolutions on ESG issues and conscientiously voting their shares on ESG issues that are raised at the companies’ annual meetings.
Misperception 3: SRI involves only public equity investments.
Sustainable, responsible, and impact investing strategies are employed across all asset classes, including public equities, fixed income and loan funds, real estate and private equity.
Alternative investments incorporating SRI strategies identified by the US SIF Foundation totaled $224 billion in 2014, according to the US SIF Foundation’s 2014 Report on Sustainable and Responsible Investing Trends in the United States.
Misperception 4: SRI is not consistent with fiduciary responsibility
Incorporating ESG criteria into investment analysis is very much consistent with fiduciary responsibilities. Global law firm Freshfields Bruckhaus Deringer concluded in a 2005 study that “the links between ESG factors and financial performance are increasingly being recognized. On that basis, integrating ESG considerations into an investment analysis so as to more reliably predict financial performance is clearly permissible and is arguably required in all jurisdictions.”
US regulators have also weighed in on the implications of the Employment Retirement Income Security Act (ERISA) regarding SRI. In its 1998 “Calvert” letter, the US Department of Labor’s Office of Regulations and Interpretations said that the fiduciary standards set by ERISA “do not preclude consideration of collateral benefits, such as those offered by a ‘socially responsible’ fund in a fiduciary’s evaluation of a particular investment opportunity,” but that the same requirements for due diligence apply to SRI and non-SRI funds.