Achieving competitive returns while potentially reducing portfolio risk through sustainable investments. Sustainable and profitable investment is demonstrating its power in the markets. Today, millions of investors take sustainability issues into account when deciding how to allocate their investments.
Investors not only question a company's carbon footprint, wages and working conditions of its employees, and diversity on its board of directors, among other aspects. They make these investment decisions because data shows that it increasingly makes financial sense.
"Researchers highlight the potential for higher returns and risk reduction when incorporating both environmental, social, and governance (ESG) analysis and traditional investment analysis into decision-making,"
"In the world of structural changes we find ourselves in today, we believe that incorporating sustainable and impact investment themes is an obligation for investors seeking to minimize risk and create potential returns."
says Anna Snider, Head of Due Diligence at the Office of Principal Investments at Merrill and Bank of America Private Bank.
The Numbers Speak
In a 2020 study, Hermes Investment Management found that companies with ESG characteristics outperformed, on average, companies without ESG standards (Federated Hermes International, "ESG Investing: How Covid-19 Accelerated the Social Awakening," Q4 2020). (Federated Hermes International, “ESG Investing: How Covid-19 Accelerated the Social Awakening,” Q4 2020.)
Recently, in the volatile markets of 2022, Morningstar's sustainability index in the United States outperformed its main index, the Morningstar index of large and mid-cap companies in the United States. índice de sostenibilidad de Morningstar en Estados Unidos superó a su índice principal, el índice Morningstar de grandes y medianas empresas en Estados Unidos.
Morningstar Sustainability Rating (A New Approach for Investors), Morningstar Sustainability Rating for funds, provides investors with a new way to evaluate funds based on the sustainability profile of underlying positions.
Given that global challenges pose considerable risks to the economy and individual companies, sustainable investment can also help manage portfolio risk, says Ekaterina Gradovich, ASG Due Diligence Analyst at the Office of Principal Investments at Merrill and Bank of America Private Bank. For example, she says, "The substantial economic transformation required for energy transition and energy independence can determine which companies will remain competitive and profitable in the not-so-distant future."
Furthermore, a framework of sustainable and impact investment could potentially help protect your portfolio from companies whose products or practices may expose them to fines, reputational damage, difficulties in retaining employees, or other issues. "These factors introduce risks that investors must consider," says Gradovich. According to BofA's global research, of the 17 bankruptcies among companies in the S&P 500 index from 2005 to 2015, 15 (90%) involved organizations with poor environmental and social scores.
The ABCs of Sustainable Investment
- Avoid – Evitar
- Consider strategies that seek to reduce negative social or environmental effects and help manage risk by limiting certain exposures.
- Benefit – Beneficios
- Explore strategies that aim to support positive social or environmental practices and enhance the potential for long-term competitive financial returns. For example: Leading companies in energy efficiency metrics.
- Contribute – Contribución
- Look for strategies that seek to promote measurable positive social or environmental outcomes and seek opportunities where impact is intrinsic to financial performance. For example: Social impact bonds.
ESG ratings
Critics of the sustainable investment selection system have argued that the numerous ASG rating services claiming to identify the best (or worst) companies from a sustainability perspective vary in quality and lack consistent measurement standards.
"Some of the criticisms are valid," says Gradovich. "Ratings are only as good as the underlying data and often rely too heavily on past performance without considering where a company is heading," she adds. They may also ignore the fact that a company that is "good" in terms of ASG practices may have a poor financial track record.
Companies that perform well, for example, in social or governance areas but may lag in environmental performance, can still receive high ratings from external data providers.
The growing demand has led to "greenwashing" by some companies that claim to have positive environmental or social outcomes in their corporate statements without significantly transforming their culture and practices. However, Snider points out that "regulators and diligent managers demand greater accountability" to mitigate risks. As a result, more companies are providing detailed ESG data.
Where We're Headed
Achieving the goals of supporting positive and sustainable change while generating financial returns requires more than simply selecting securities from one of the numerous ESG rating lists, warns Snider. "While ratings can be a useful tool as part of a comprehensive assessment of companies or portfolios, they should not be the sole reference for investment decisions," he notes. A thorough analysis of the financial approach of any strategy is paramount.
When evaluating the ESG strategy of an investment, Snider says, "In addition to our fiduciary evaluation of the investment, we observe the depth and consistency of the manager's integration of sustainability risk and return factors. Our primary focus is not on the moral or ethical preferences of the manager, but on the economic and prospective investment projections determined by this type of analysis."
“La inversión sostenible e impacto parece probable que crezca en los próximos años”, cree Snider, “y las herramientas utilizadas para medir el desempeño ASG seguramente evolucionarán y mejorarán”. Con ese fin, sugiere que los inversores consideren integrar la inversión sostenible e impacto como parte de una cartera equilibrada y estratégica, “una que comience con consideraciones personales como metas de inversión generales y el nivel de riesgo con el que se sienta cómodo”, agrega.
"The innovations to address global challenges are creating some of the greatest opportunities we will see in our lifetimes,"
“Las innovaciones para abordar los desafíos globales están creando algunas de las mayores oportunidades que veremos en nuestras vidas”.
Snider asserts.
For more information on sustainable and impact investment, and ways to consider its incorporation into your portfolio, read "Impactonomics®: Performance Realities: Revisited" by the Office of Chief Investments.
Sustainable and impact investment managers and/or Environmental, Social, and Governance (ESG) may consider factors beyond traditional financial information when selecting securities, which could result in relative investment performance that differs from other strategies or market benchmarks, depending on whether those sectors or investments are in or out of favor in the market. Additionally, ESG strategies may rely on values-based criteria to eliminate exposures found in similar strategies or market benchmarks, which could also result in differing relative investment performance.
There is no guarantee that investments applying ESG strategies will be successful. There are many factors to consider when choosing an investment portfolio, and ESG data is just one component to consider.
Social impact bonds are a relatively new and evolving investment opportunity that is highly speculative and involves a high degree of risk. An investor may lose all or a substantial portion of their investment.
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