Companies that help to protect the environment, promote diversity and give back to society may be doing good, but are they doing well financially? Some investors worry about sacrificing returns when putting money into companies that invest in improving environmental, social and governance (ESG) performance; however, a growing body of research suggests companies that do this may in fact be helping their bottom line.
A 2015 report by Oxford University and Arabesque Asset Management, which reviewed more than 200 sources on ESG performance, shows that in 88 percent of the research "robust sustainability practices demonstrate better operational performance, which ultimately translates into cash flows." It also said 80 percent of the studies reviewed show "prudent sustainability practices have a positive influence on investment performance."
Companies that focus on advancing their ESG performance may also be considered less risky. For example, an oil company that invests more time and resources to improve health and safety measures at its operations and in protecting the environment could reduce its chances of a costly crude spill. On the social side, companies with strong relationships with stakeholders — including employees, suppliers, communities and investors — can benefit from a strong reputation and potentially more business.
Studies also point to the advantages of having more women on the board or in leadership positions. Companies with more women on their corporate boards can be less likely to overpay for acquisitions, according to a study from the University of British Columbia, while a Catalyst report shows Fortune 500 companies with the highest representation of women board directors attained, "Significantly higher" financial performance.
Companies that spend money to continuously improve their ESG performance may also see a return on their investment through higher market and accounting performance, as well as a stronger business reputation and improved stakeholder relations, according to the Corporate Investment in ESG Practices report, put out by The Conference Board Inc. That, in turn, can lead to more product innovation and increased revenues.
The bottom line: An overall strong ESG track record may help to increase shareholder value, says Gina Chong, a relationship manager at RBC Wealth Management in Singapore.
"ESG should be marketed as something that enhances a portfolio not inhibits it," says Chong. "It reflects in the value of the company."
ESG vs. the benchmark
One example of strong ESG investment returns may be seen in the recent performance of the RBC Blue Water Equity™ portfolio, which includes 20-to-40 global water-related equities. The actively managed portfolio has seen a return of nearly 23 percent year-to-date, as of Nov. 21, which was above the 21-percent return for the MSCI All Country World Index (ACWI).
Because of its niche holdings, some investors may consider the water portfolio more volatile, "It shows it is possible to achieve strong returns with sustainable investments," says Ai Ling Toh, a relationship manager with RBC Wealth Management in Singapore. "Following your values doesn't have to mean giving up returns."
Still, Toh recommends investors diversify their holdings when selecting ESG investments. "We still want to pay attention to portfolio allocation," says Toh. "For most investors, we wouldn't want to put their entire wealth into one of these specialized funds."
ESG investments should also be made for the long-term, she says. "You have to be committed to it" to experience the benefits and improvements companies are making over time.
ESG and Warren Buffett
In some ways, ESG investing is similar to the investment principles deployed by investor Warren Buffett, says Gregory Yong, a relationship manager at RBC Wealth Management in Singapore. Not only is Buffett a long-term investor, but he looks for high-quality companies with strong management teams, which aligns with elements of ESG investing.
"These are companies that run more efficiently and, in turn, may maximize profit and minimize risk," says Yong.
He also notes that Buffett recommends investors only put their money into companies they understand. "For ESG, if that's what you care about, it's what you should invest in," Yong says.
Buffett has also put some of his money directly into a few sustainable ventures, including new solar and wind energy projects as well as some renewable technologies in the auto sector.
Two-thirds of institutional investors use ESG considerations as part of their investment approach, according to a recent RBC Global Asset Management study and one quarter expect to increase their allocation to managers with ESG-based investment strategies within one year.
In recent EY survey of more than 300 global institutional investors, more than 60 percent reported recently decreasing their holdings or monitoring holdings closely due to so-called "stranded asset" risk. The risk is that an asset loses its value due to changes in regulation, social expectations, disruptive technology or environmental conditions.
"Investors increasingly see that by understanding these risks and benefits, they can avoid the downside and embrace the upside in a valuation that flows from non-financial business activities," the report says. "While the broad change in investor sentiment cannot be attributed to a single incident or cause, it seems that we have reached a subtle but noteworthy inflection point, and ESG investing has entered the mainstream."
For the average investor, spotting ESG risk can be challenging. ESG factors may not be evident in financial statements. However, more companies are regularly disclosing their ESG targets and performance amid increased scrutiny from investors and regulators.
Some of this information may be found in annual reports or separate corporate social responsibility reports corporations produce. More companies are also providing voluntary disclosure through organizations such as the Global Reporting Initiative or the Carbon Disclosure Project. Investors need to familiarize themselves with the potential risks within a company and stay on top of the news about their investments, Yong says.
“Right now it's an education process to shift the thinking," says Yong. He also recommends investors consult professional investment advisors to help them understand which companies may be considered an ESG risk, as well as those that may make good investments.
"We scope for companies that, in addition to their financial capabilities, have strong social and environmental track record. This may also has a positive impact on investment returns," Yong says.
While ESG investing isn't for every investor, Toh suggests, "For many, investing in companies that do well and give back to the world may be the best way to go."