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The persistent myth of ESG underperformance

Glenn Freeman  |  05 Jul 2018Text size  Decrease  Increase  |  
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Performance concerns remain a key negative influence among investors considering sustainable investment products, despite a growing body of evidence to the contrary.

Only 19 per cent of financial advisers who recommend so-called ESG investment products - which weigh up environmental, social and governance factors - cite performance as their key motivation, according to a US report released last week.

More than half of the respondents have either used an ESG product in the past 12 months, or plan to within the next year. Of those who don't use ESG investments, 35 per cent attribute this to performance concerns.

And yet there is increasing evidence linking ESG investing principles and solid investment returns.

Just last month, Jeremy Grantham, chief investment officer of asset manager GMO – which oversees about $74 billion in funds under management – told attendees at a Morningstar conference in the US that eliminating some sectors entirely was not particularly harmful over the long term. Grantham found that removing energy from the Standard & Poor's 500 stock index for the past 30 years increased performance by .03 per cent annually.

Locally, however, the "jury is still out" on ESG fund performance, according to Tim Murphy, director of manager research, Morningstar Australia.

"Over the short term … an ESG fund may be doing better than a non-ESG fund because the investments it has are doing well on a cyclical, rather than a longer-term basis," Murphy says.

Figures from last year's Responsible Investment Association of Australia report are less equivocal. The report suggests that funds with core responsible investment strategies are outperforming equivalent Australian and international share funds, and multi-sector growth funds, over most time horizons.

The RIAA identified similar drivers of ESG investment – values/beliefs, environmental risks, increased demand from institutional and retail investors. Performance concerns are also a top detractor, along with a lack of awareness, and capacity constraints stemming from insufficient product availability and a shortage of qualified advice.

plant green ESG investing article

ESG investing 'asks corporate leaders to assume a greater level of social responsibility'

The higher relative costs of investing in green funds versus their non-ESG equivalent is a key issue. Research from actuarial firm Rice Warner suggests rates of return between ethical investment options and non-ethical investment options do not vary materially.

"However, the small amount of assets in these options usually means they are more expensive as they lack scale benefits," Rice Warner says in a recent report on ethical investments.

"This has created a risk that superannuants will trade off their emotions against value in products. Unfortunately, this risk has been realised, with some products on the market which appeal directly to a member's sense of social obligation."

Looking beyond the performance figures, Morningstar's US-based head of sustainability research, Jon Hale, uses the term "sustainable capitalism".

"It acknowledges those central facts and asks corporate leaders to assume a greater level of social responsibility, taking into account the concerns of all stakeholders, not just those of shareholders. In essence, it asks investors to do the same thing as they evaluate companies and, as shareholders, engage with them.

"None of this is to say that firms should no longer maximise shareholder value; it is to say that shareholder value is maximised when managers take a more holistic, responsible long-term view," Hale says.

He references the head of BlackRock, Larry Fink, who adopted a "greed has to go" theme in his January 2018 CEO letter.

"When the CEO of the world's largest asset manager, with more than $6 trillion of investor assets, makes these claims, it's safe to say the whole world is watching," Hale writes.

"I doubt that what Fink says in his letter is going to create 'a firestorm in the corner offices of companies everywhere' [quoting New York Times columnist Andrew Sorkin] because it already reflects the thinking of a growing number of corporate executives."

  

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Glenn Freeman is a senior editor, Morningstar Australia.

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written content of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

is senior editor for Morningstar Australia

© 2020 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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