Misperception 1: Sustainable, responsible, and impact investing (SRI) results in lower returns.
Research studies demonstrate that companies with strong ESG policies, programs and practices are sound investments. In 2017, Nuveen TIAA Investments released Responsible Investing: Delivering Competitive Performance. After assessing the leading SRI equity indexes over the long term, the firm “found no statistical difference in returns compared to broad market benchmarks, suggesting the absence of any systematic performance penalty. Moreover, incorporating environmental, social and governance criteria in security selection did not entail additional risk.” It added that SRI indexes had similar risk profiles to their broad market counterparts, based on Sharpe ratios and standard deviation measures.
In 2015, Deutsche Asset & Wealth Management and Hamburg University published an article titled ESG and Financial Performance: Aggregated Evidence From More Than 2,000 Empirical Studies. The team conducted a meta-analysis of over 2,000 empirical studies since the 1970s, making it the most comprehensive review of academic research on this topic. They found that the majority of studies suggest a positive correlation between ESG and corporate financial performance (CFP). “The results show that the business case for ESG investing is empirically very well founded. Roughly 90% of studies find a nonnegative ESG–CFP relation. More importantly, the large majority of studies reports positive findings. We highlight that the positive ESG impact on CFP appears stable over time.”
Misperception 2: SRI investing includes only negative screening.
SRI 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 analysis 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 SRI. 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: SRI involves only public equity investments.
Sustainable, responsible, and impact investing strategies are employed across all asset classes, including public equities, fixed income and loan funds, real estate and private equity. Alternative investments incorporating SRI strategies identified by the US SIF Foundation totaled $206.3 billion in 2016, according to the US SIF Foundation’s Report on US Sustainable, Responsible and Impact Investing Trends 2016.
Misperception 4: SRI is not consistent with fiduciary responsibility.
Incorporating ESG criteria into investment analysis is consistent with fiduciary responsibilities. Global law firm Freshfields Bruckhaus Deringer concluded in a 2005 study that “the links between ESG factors and financial performance are increasingly being recognized. On that basis, integrating ESG considerations into an investment analysis so as to more reliably predict financial performance is clearly permissible and is arguably required in all jurisdictions.” In 2015, a follow-on report to the Freshfields study was produced by the Principles for Responsible Investment (PRI), United Nations Environment Programme Finance Initiative (UNEP FI) and the United Nations Global Compact. 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.”
US regulators have also weighed in on the implications of the Employee Retirement Income Security Act (ERISA) regarding SRI. In October 2015, the US Department of Labor rescinded a 2008 bulletin that discouraged investors from considering environmental and social factors in the companies in which they invest. The Department of Labor bulletin on Economically Targeted Investments, 29 CFR 2509.08-1, issued in October 2008, arbitrarily disfavored the consideration of environmental and social risks and opportunities in assessing potential investments. The new Interpretive Bulletin brings ERISA guidance in step with today's realities by noting 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 April 2018, the Department of Labor issued a lower level “field assistance bulletin” that generally reaffirmed its 2015 and 2016 guidance while offering specific instructions on the qualified default investment alternative. Learn more in the US SIF press release here.