In recent years, Socially Responsible Investing, otherwise known as ESG investing, has exploded in popularity. In the past, this kind of investing has been largely considered an ethical pursuit. The ostensible fact of the matter was that, in order to invest in line with your social or environmental outlook, you’d have to sacrifice part of the return.
This perception of ESG investing has, over time, been stripped away. With both big and small business more concerned with corporate social responsibility than ever before, there are a plethora of choices in the Socially Responsible space and it’s becoming less of a trade-off. Similarly, governments are broadly leaning into the notion of a greener economy, with investments and laws passing to aid the transition.
Today, many would argue that investing driven by social, environmental and governance factors no longer represents an inherent “sacrifice”. There are many cases in which it can be an advantage to include ESG in your investment strategy.
What does Socially Responsible mean?
Let’s start by defining exactly what we mean by Socially Responsible Investing (or ESG investing). Put simply, it is about considering environmental, social and governance factors when making investment decisions. We all want to help make the world a better place and ESG investing is an opportunity to do that.
For a wealth manager like Moneyfarm, Socially Responsible Investing means quantifying and monitoring ESG criteria. We use a number of data points to select the ETFs that make up our SRI portfolios, so we can be confident that we’re investing in impactful companies.
What about the returns?
The performance of a Socially Responsible portfolio depends a lot on how you build it. One of the key differentiators is how stringent the parameters you apply to portfolio construction are, largely because it can limit your options. Despite the potential limitations, let’s have a look at the factors that can benefit ESG portfolios:
Firstly, Socially Responsible investments can protect the investor against ‘ESG risk’. So, what does this mean? Well, both the economy and society at large have begun a path of transition towards a more sustainable model. It’s not always quick and it’s not always successful, but the transition itself can pose a risk to a lot of companies as they struggle to adapt to the new environment.
Integrating ESG factors into your investment portfolio means choosing the companies that are theoretically best positioned to ride the green transition. These are, fundamentally, companies that are more protected from the risks than others. This can have significant repercussions for long-term performance.
Secondly, ESG investing theoretically puts you in the best position to take advantage of government intervention and investment. These are often grand in scale and could become increasingly impactful as the green transition picks up pace. This also ties into the fact that ESG investing is attracting more investors, a trend that could create positive sentiment and favour performance.
Factors that favour traditional investments:
- The investable universe is wider, offering the investor a greater choice
- Companies that don’t need to meet environmental and social standards could have a competitive advantage in certain sectors, or operate at lower costs.
- There are those that argue that ESG risk is already partially priced in, which may somewhat nullify the opportunity for outperformance in future.
Comparing the performance
To analyse the performance of ESG investments, it can be illustrative to compare the performance of the MSCI World SRI Index with that of the MSCI World Global Equity Index. In recent years, we can see that they have performed fairly similarly, with SRI outperforming in some periods and underperforming in others.
The last year and a half have gone in favour of the SRI index, thanks in part to the success of companies like Tesla, which continued to grow during the pandemic. Obviously, past performance is no guarantee of future returns and the trend of the last year or so doesn’t imply that ESG investments will continue to outperform their traditional counterparts, but it’s a signal that these investments can perform even during difficult periods, which is useful for diversification.
Socially Responsible Investments are an option every investor should at least consider as part of their long-term planning. Our team of investment consultants is on hand if you’d like to talk through your options and see how an ESG portfolio could benefit your savings – get in touch today.