Does Responsible Investing make Good Sense Financially?
Is it possible to do good and do well?
A look at the research and what trends to be aware of as a conscious investor.
It’s easy to think that doing well financially and doing good with your money are mutually exclusive. Centuries of unrestrained self-interested capitalism have understandably led us to believe that these are mutually incompatible.
However, we’re moving into a new era of stakeholder capitalism (as opposed to shareholder), whereby a company that wants to be successful is expected to heed the needs and desires of customers, employees, shareholders, community members, vendors, and partners, both current and future.
Another major stakeholder that’s finally being given consideration?
Mother Earth — the planet we live on.
Companies who are leading the way in honoring all of these stakeholders and behaving accordingly may be regarded as more responsible or sustainable.
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One approach to evaluating which companies are responsible or sustainable is the framework known as ESG. ESG — Environmental, Social (people and communities), and Governance (execs and pay, business practices, and Board) — has been around since the 1960s; however, it has taken center stage only recently. While there is a lot of controversy and politicizing of that term, regulators are working on stricter standards and clearer definitions of how and what companies need to report on and what should constitute high ESG ratings.
Therefore, whether you look for stocks or funds that align with your values, are responsible or sustainable, or have high ESG scores, you may be wondering, are they a sound financial investment?
Do they offer as good of returns as standard index funds?
Looking Backwards (and Performance)
Tl;dr — Both academics and financial industry analysts have found that sustainable funds and companies with healthy ESG practices have performed as well as or better than the broad market.
According to research published in the MIT Sloan Review, companies who worked toward environmental and social goals as a part of their business had stronger growth prospects and financial performance, lower costs of capital, and higher stock market valuations as compared to their peers without such commitments.
Equity strategists at Bank of America published a report, ESG from A to Z: a global primer (2019), sharing their research into thousands of companies’ ESG efforts. The report revealed that companies scoring highly for ESG practices tended to perform better in terms of operating results and share prices than peers with low ESG scores.
According to an article on Morningstar, through 2021, sustainable funds outperformed standard options. However, 2022 ESG results weren’t as strong due to tech companies (which typically have higher ESG scores) performing poorly and high demand for fossil fuels with the war in Ukraine.
As with anything in the markets, current events can affect short-term performance but won’t necessarily affect long-term trends and performance. More on the future potential in the next section.
Looking Forward (and Trends)
While it is impossible to predict the future or determine future financial performance, there are a number of events and trends that are likely to bolster ESG and sustainable investments.
Environmental
First, according to the (now retired) newsletter For What It’s Worth, the IRA (Inflation Reduction Act of 2022) allocated $216B to companies working toward a greener world, including those that make renewable energy, electric vehicles, biofuels, wind turbines, and more.
Second, younger people, who are the future stakeholders of these companies — customers, employees, and shareholders — are very focused on climate change and sustainability, noted the Morningstar article referenced above. In order for companies to attract these younger people, companies need to show they’re concerned about and moving towards a more sustainable future. Having an easier time getting customers and workers will make companies more successful and profitable, and are therefore likely a good investment opportunity.
Social
It turns out many Americans think businesses should prioritize paying a fair, living wage, according to a survey by JUST Capital, as reported in For What It’s Worth (Nov 17, 2022). Fair compensation of employees not only increase satisfaction and retention, it is also good for business. Furthermore, research suggests that especially for low income workers, higher wages leads to higher productivity (probably in part because of reduced financial stress). The same survey found that people believe business can be a source of societal change.
With younger people estimated to inherit between $30-73 trillion in assets over the next few decades, companies can’t ignore the cares and concerns of younger generations, including their desire for commitments to sustainability and fighting climate change and for fair treatment of employees and broader stakeholders.
Whether responsible or ESG-focused investing will perform better than standard index funds in 2023 will soon be seen. But the historical performance and the macro trends definitely suggest sustainable and responsible investing will generously reward shareholders in the long-term.
