Performance and sustainability. In harmony.
Integrating environmental, social and corporate governance factors into operational management is not a luxury anymore, and it hasn’t been for some time now. In fact, companies that do so achieve better and more sustainable results compared to the broader market.
This is increasingly recognized and reflected in the stock market as well. Stock market gains and a clean conscience are complementary. And with the corresponding index funds investors can target exposures efficiently.
ESG (environmental, social and governance) stands for criteria that measure a company’s sustainability. To perform well based on this metric, a company’s management must cast its eye not merely on the next quarterly or annual report. It also has to develop strategies geared to drive long-term success while using resources in a responsible manner that minimizes the environmental footprint and promotes social fairness.
As obvious as this sounds, it is still a long way from being implemented in practice. The stock market has been rewarding quarterly revenue and profit figures. Shareholders have, so to speak, been demanding short-term optimization. Investing on the basis of ESG criteria was, then, at best a niche product for investors who were also willing to accept inferior returns.
The new generation of investors takes a different view of this. Today, ESG is not only clearly defined but also rigorously applied and factually measured. That makes it possible to divide the broader market into ESG and non-ESG segments based on objective and constant criteria. To the surprise of many, the performance of ESG- compliant securities is roughly on a par with the non-ESG segment and is as a rule even far superior in terms of risk level achieved. A second glance reveals another compelling argument: a company’s management that, intentionally or unintentionally, aims for a high ESG rating will necessarily be less erratic as well – precisely over the long term – and thus will also have a lower risk bias.
What is more, these results are extremely robust – both over time and across diverse regions. The arguments in favor of ESG- compliant investing are here to stay. A purported argument against ESG-compliant investing – namely, poorer returns – has been conclusively refuted. In emerging markets in particular, ESG criteria are evidently a key to investment success.
Only half of the MSCI companies meet ESG criteria
Out of the 1653 companies, only 808 are included in the MSCI World ESG Leaders Index. Nevertheless, the ESG Leaders Index’s return (period: December 2010 to June 2018) totaled 8.49% last year, only marginally lower than the 9.63% for the MSCI World. And that return comes at a slightly lower risk level.
For a clean investment conscience, then, investors do not have to pay the price in terms of lower returns or accepting higher risk. The contrary is true, as evidenced by the particularly impressive example of emerging market companies: the MSCI Emerging Markets Index delivered an annualized return of 1.80% for the period from August 2010 to December 2017 – at a risk level of 16.89%. By contrast, investors that opted for sustainable emerging market companies and invested in the MSCI Emerging Markets ESG Leaders Index made a return of 5.31% last year – and at a lower level of risk, i.e. 15.74%. The ESG momentum score that has a particularly positive impact on performance in emerging markets is governance, i.e. sound corporate management.
This goes to demonstrate that a sustainable portfolio is anything but an unattractive investment; to the contrary, performance and sustainability harmonize perfectly. And, when the selection process is as rigorous and reliable as in the case of MSCI, with index funds implemented directly and efficiently, there is simply no excuse for not joining the ESG crowd.
Five good reasons for investing in sustainability
Investors are keen to boost their image by selecting investments that not only focus on returns but also have ESG criteria as a motivating factor.
- Legal requirements
Some investors are prohibited from investing in certain sectors such as alcohol or firearms.
- Clean conscience
Investors are interested in making a targeted contribution to alleviating social and environmental problems.
Sustainability can make for a winning sales pitch when dealing with clients.
- Risk minimization
The overall portfolio’s risk/reward profile can be optimized by using sustainable investments.
Source: Credit Suisse