Can you invest for positive returns and do good deeds for society at the same time?
That's the goal of environmental, social and governance (ESG) investing, aka corporate social responsibility (CSR) investing, impact investing or values-based investing. Some studies have indicated that the answer might be "yes" to this question, and financial services firms are developing offerings to respond to investor demand.
ESG investing represents the evolution from socially responsible investing (SRI), which has been around for a few decades and typically shunned "bad" corporations according to specified criteria. Industries typically screened out were tobacco, alcohol, gaming, high polluters and occasionally weapons manufacturers. Companies that remained were fair game for investors.
Evidence has been mixed regarding whether SRI investing increased or decreased net returns compared to investing without such screening.
By contrast, ESG takes a positive rather than negative approach to investing. Instead of ruling companies out, ESG investors seek companies that take continual steps to enhance corporate governance, improve the environment or seek to address important social challenges.
Corporate governance focuses on transparency, disclosure, reporting and incentives. Environmental factors include use of water, alternative energy, climate change and clean tech. Social challenges include improving working conditions, fair treatment of minorities and ethnic groups, and investments focused on improving the lives of women and girls.
Possibilities for investors range from mutual funds and exchange-traded funds that invest in corporations with high rankings in ESG and CSR factors to investing in the securities of specific companies that address the particular interests of the investor.
A 2012 report from Deutsche Bank Group examined more than 100 academic studies of sustainable investing around the world and found that ESG and CSR factors are correlated with superior risk-adjusted returns. Some of its more interesting findings include:
- All of the academic studies found that companies with high ratings for CSR and ESG factors had a lower cost of borrowing.
- Companies that had high ratings for ESG factors outperformed their peers, according to 89 percent of the academic studies.
- The single most important factor that predicted investment performance was the "G" in ESG, or companies that paid attention to good corporate governance, which outperformed their peers. They were followed by "E," environmental factors.
According to another study done in 2012 by Harvard Business School, $1 invested in 1993 with companies with strong social and environmental policies would have grown to $22.60 by 2010, whereas investing that dollar in a control group of companies would have yielded just $15.40.
Late in 2014, Bank of America Merrill Lynch signed the U.N.-supported "Principles for Responsible Investment," a statement prepared by an international network of investors pledging to incorporate responsible and sustainable principles into their investment decisions and ownership practices. The principles are intended to be compatible with a traditional fiduciary framework.
According to Andy Sieg, head of global wealth and retirement services for Bank of America Merrill Lynch, interest in ESG investing is greatest among ultra-high-net-worth individuals, Millennials, and women. These investors want to align their personal beliefs with their investments in order to make money and improve the world at the same time.
One comment from Mark Callaway of The Indigo Group at Morgan Stanley sums it up nicely: "Looking back, I can see a time when my grandkids might say, "You mean you knowingly invested in companies that were polluting or using sweat shop labor?'"
Baby boomers who are concerned about social and environmental issues and are fortunate enough to have substantial retirement savings might want to look at the legacy they could leave through their investment choices.