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 2019, the Morgan Stanley Institute for Sustainable Investing published Sustainable Reality: Analyzing Risk and Returns of Sustainable Funds. The Institute “compared the return and risk performance of ESG-focused mutual and exchange-traded funds (ETFs), as defined by Morningstar, against traditional counterparts from 2004 to 2018, using total returns and downside deviation.” It found that that there is “no financial trade-off in the returns of sustainable funds compared to traditional funds, and they demonstrate lower downside risk.” Moreover, during a period of extreme volatility, the study found “strong statistical evidence that sustainable funds are more stable.”
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.
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 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 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 $588 billion in 2018, according to the US SIF Foundation’s Report on US Sustainable, Responsible and Impact 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 2019, 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 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 notes 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 guidance while offering specific instructions on the qualified default investment alternative.