Have you ever wondered whether your possible returns in SRI are going to be lower just because they are SRI related? Some of us can have such doubts, but the answer to the question is “no”. And now let us try to explain why.
To begin with, here are some facts: investments in SRI (sustainable, responsible and impact) assets are 33% higher than in 2014 (according to US SIF). In other words, $1 of every $4,6 under professional management is invested in SRI. The companies which are better at implementing ESG (environmental, social and governance) approach benefit from high-quality management and good stock performance. The quality, structure and compensation of management, and relations between employees are the main factors deciding about the company’s success.
A crucial ESG factor – corporate governance, tests them. What is more, an active ESG participation shows management teams’ ability to think forward and this helps companies to make use of some long-term opportunities. Consequently, lower costs of capital, higher operational and stock price performance become the reward for the companies which aim at constantly improving ESG actions.
Academic research reviewed 190 high quality academic studies on sustainability and business performance and proved the truth of the theory. According to a research paper by Oxford University from 2014, 90% of the studies showed that sound sustainability standards helped companies lower the cost of capital, and 80% of the studies proved that good sustainability practices have a positive impact on stock performance. 88% of the studies demonstrated that operational performance of companies was positively influenced by implementing ESG practices.
Pepsi can be a good example which proves the theory. What led Pepsi to the stock prices increase? It was the company’s action aimed at water conservation, which brought positive results for both the firm and society. Thanks to the involvement in one of the social issues, Pepsi saved more than $80 million in years 2001-2015.
How about investable SRI funds?
Morgan Stanley conducted a study in 2015 which showed that most of the kinds of sustainable equity mutual funds are overrepresented in the highest quartiles of returns and in the lowest quartiles of volatility. When it comes to the question about some short-term variance between SRI indices and non SRI indices performance, it finds the explanation in the fact that sector allocation of some SRI indices is different when compared to the parent index. It is mostly seen in the cases of those which exclude whole sectors and industries. As it is with KLD 400 Social Index, it is overweight information technology by 6 percent and by 4,6 percent it is underweight financials.
In consequence, discrepancies come out when the two sectors show some performance differentials. Many ESG portfolios experienced huge outperformance in 2015 and then, in 2016 they were systematically going down. What can be the reason of such a scenario? It can be the fact that plenty of ESG portfolios turn out to be underweight energy. On the other hand, since generally ESG practices have a positive impact on businesses, in the long run, ESG criteria bring higher and higher returns.