Misperception 1: Sustainable investing results in lower returns.
Research studies demonstrate that sustainable investment funds on average over the long-term achieve comparable or even better financial returns than conventional investments. According to Morningstar’s 2022 Sustainable Funds US Landscape Report, “In 2021, most sustainable funds delivered stronger total and risk-adjusted returns (measured by Sharpe ratio) than their respective Morningstar Category indexes.” Morningstar categorizes group funds, both sustainable and conventional, by similar characteristics such as region, market cap and style. “Slightly more than half of sustainable funds finished in the top half of their Morningstar Category, led by equity funds.” Data for the previous five years showed even better results – the returns of 74 percent ranked in the top half and 49 percent in the top quartile returns.
In 2021, the NYU Stern Center for Sustainable Business released a report ESG and Financial Performance: Uncovering the Relationship by Aggregating 1,000 Plus Studies Published between 2015-2020. Regarding investment performance, the report found that for “studies typically focused on risk-adjusted attributes such as alpha or the Sharpe ratio on a portfolio of stocks, 59 percent showed similar or better performance relative to conventional investment approaches while only 14 percent found negative results.”
See a summary of additional studies here.
Misperception 2: Sustainable investing includes only negative screening.
Sustainable investing encompasses a number of investment approaches, but can be categorized into two broad strategies.
One is ESG incorporation, which considers environmental, community, other societal or corporate governance (ESG) criteria in investment decision-making and portfolio construction. ESG incorporation can be accomplished in numerous ways:
- Positive/best-in-class screening: Investment in sectors, companies or projects selected for positive ESG performance relative to industry peers. This also includes avoiding companies that do not meet certain ESG performance thresholds.
- Negative/exclusionary screening: The exclusion from a fund or plan of certain sectors or companies involved in activities deemed unacceptable or controversial.
- ESG integration: The systematic and explicit inclusion by investment managers of ESG factors into financial analysis.
- Impact investing: Targeted investments aimed at solving social or environmental problems.
- Sustainability themed investing: The selection of assets specifically related to sustainability in single- or multi-themed funds.
Community investing—investment that directs capital to communities that are underserved by affordable financial services—also falls under the rubric of ESG incorporation.
Shareowner engagement is the other principal approach to sustainable investing. It involves the actions sustainable investors take as asset owners to communicate to the managements of portfolio companies their concerns about the companies’ ESG policies and to ask management to study these issues and make improvements. Investors can communicate directly with corporate management or through investor networks. For owners of shares in publicly traded companies, shareholder engagement can take the form of filing or co-filing shareholder resolutions on ESG issues and conscientiously voting their shares on ESG issues that are raised at the companies’ annual meetings.
Misperception 3: Sustainable investing involves only public equity investments.
Sustainable investing strategies are employed across all asset classes, including public equities, fixed income and loan funds, real estate and private equity. Alternative investments incorporating sustainable investing strategies identified by the US SIF Foundation totaled $762 billion in 2022, according to the US SIF Foundation’s Report on US Sustainable Investing Trends.
Misperception 4: Sustainable investing is not consistent with fiduciary responsibility.
Incorporating ESG criteria into investment analysis is consistent with fiduciary responsibilities. In a 2005 report from Freshfields Bruckhaus Deringer, the global law firm concluded that ESG investing is consistent with fiduciary duty, and that the consideration of ESG factors is “clearly permissible and is arguably required in all jurisdictions.”
The Principles for Responsible Investment (PRI), United Nations Environment Programme Finance Initiative (UNEP FI) and the United Nations Global Compact produced a 2015 follow-on report to the Freshfields study. The authors, informed by interviews with policymakers, lawyers and senior investment professionals, concluded that “[f]ailing to consider long-term investment value drivers, which include environmental, social and governance issues, in investment practice is a failure of fiduciary duty.”
The PRI and UNEP FI updated the report in 2020, in which it identified three reasons why ESG incorporation in investment analysis and decision-making processes is consistent with fiduciary duty – ESG incorporation is the investment norm, ESG issues are financially material and policy and regulatory frameworks are changing to require ESG incorporation.
The US Department of Labor (DOL) has also offered reassurance that fiduciaries for private sector retirement plans may look at sustainable investing options and analyze ESG criteria in selecting investments. Its October 2015 Interpretive Bulletin under the Obama administration noted that "fiduciaries need not treat commercially reasonable investments as inherently suspect or in need of special scrutiny merely because they take into consideration environmental, social, or other such factors."
In November 2022, DOL released an updated rule that makes clear that fiduciaries may consider ESG factors in their investment decisions and when they exercise shareholder rights. This reverses the 2020 DOL rule under the Trump administration sought to make it more difficult for private sector retirement plans to offer sustainable investment fund options.