The case for sustainable investing
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- When judging whether companies are socially responsible, investors are turning to ESG factors to evaluate them
- Sustainability is no longer viewed as a “check-box” exercise for companies
- Investing sustainably does not mean sacrificing returns
Sustainable investments are gaining popularity as more investors place a greater emphasis on socially responsible actions. The increased focus arises from the investment community’s awareness that there does not need to be a trade-off between portfolio returns and making positive impact.
When judging whether an investment is socially responsible, investors (governments, companies, financial institutions, fund managers and individuals) are turning to evaluating companies using environmental, social, governance (ESG) factors.
Sustainable investing means incorporating ESG factors to assess companies and assets alongside with more traditional financial factors. It is an umbrella term often used interchangeably with ESG investing, socially responsible investing, and ethical investing, and covers other forms of investing, such as impact investing.
In DBS NAV’s introduction to ESG investing, some of the issues covered include the following:
5 reasons why we should take an interest
With these issues becoming more important in our daily lives, investors should be aware of sustainability factors and also learn how to incorporate them into investment portfolios.
Here are some points that highlight why you should make sustainable investing a serious consideration.
1. Rapidly changing world
We are not only living in times of great technological advances, but also environmental and sustainability changes like climate change and widening inequality.
With the global community taking notice, the United Nations identified 17 “Sustainable Development Goals” in 2015 that aims to address the global challenges facing the world by 2030.
In 2017, the UN passed a resolution making the SDGs more actionable. This included specific targets for each of the 17 goals along with indicators to measure the global community’s progress. Since 2018, the public can view data across all these indicators on SDG-Tracker.
Sustainability is no longer viewed as a “check-box” exercise for companies. In fact, it has become a fundamental component of a 21st century business.
Likewise, for investors, how and where we choose to park our money matters—not only to us, but to society at large.
2. Companies that do good, do well
Firms with a strong sense of purpose and that embed sustainability in their DNA tend to perform well. For example, index provider MSCI's 2017 research found that companies with higher environmental, social and governance (ESG) ratings are associated with higher profitability and lower tail risk.
Moreover, a University of Cambridge study in 2019 found that Chinese technology small and medium enterprises with gender-balanced management teams performed better during adverse conditions, posting a 19.5% and 24.8% rise in profitability and return on assets, respectively.
Conversely, companies embroiled in controversies increasingly find themselves punished by shareholders, regulators, and the public.
In today’s world, actions by corporates are more closely and critically scrutinised. Moreover, with social media, ESG violations can go viral quickly, hurting a company’s branding and customer trust for a long time.
The loss of “social license to operate” can severely impact business through consumers choosing to boycott a company for committing violations and turning to alternatives (often a competitor). This in turn, can affect financial performance.
3. Sustainable investing and better returns go hand-in-hand
Investing sustainably does not mean sacrificing returns. On the contrary, research has shown that companies with strong sustainable practices tend to outperform the broader market or peers.
In the five-year period from May 2015 to May 2020, ESG leaders in the MSCI Emerging Markets (EM) Asia Index beat the broader index by 266 basis points.
Source: MSCI, DBS, as of 29 May 2020. Performance in USD and net of fees
There are other studies that also show firms with sustainable practices make better investments.
In 2020, a Morningstar study found no risk/reward trade-off to investing in ESG on a global level. A year earlier, Bank of America Merrill Lynch research on US equities found that stocks with strong ESG scores outperformed the broader S&P 500 Index by up to 3 percentage points every year between 2014 and 2019.
A 2015 study on public companies across Asia, Europe and North America, by asset manager Robeco and the Hong Kong University of Science and Technology Business School, concluded that Asian equity investors can enjoy higher returns and lower portfolio risk when they consider ESG factors, particularly corporate governance.
4. A sustainability focus helps mitigate risks
There are cases where companies that fail to manage ESG risks have led to hurting the value of their stocks. While these are often firm-specific, this could change over time as more companies and industries face greater scrutiny from consumers, investors, and governments alike over their ESG practices.
As such, companies are likely to place a greater emphasis on sustainability going forward and this has its benefits.
Sustainability has proven an effective risk management tool for companies and investors alike. From an investment standpoint, sustainable assets or portfolios have demonstrated lower risks.
MSCI’s EM Asia ESG leaders, for instance, show lower standard deviation (a measure of risk) while delivering higher average returns compared to the broader MSCI EM Asia index.
5. Go with the money flow
Sustainability increasingly plays an integral part in investors’ decision-making, investment philosophy and process.
Last year, sustainable funds’ assets under management in the US surged, attracting record flows from investors. In 2020, flows into sustainable open-end and exchange-traded funds available to US investors soared to US$51.1 billion. This was more than double than the US$21.4 billion in 2019 and almost tenfold from 2018 when flows were US$5.4 billion.
Source: Morningstar. Data as of 31 Dec 2020
Moreover, institutional investors like large asset managers and asset owners, as evidenced by the rising number of signatories to the United Nations Principles of Responsible Investing (UNPRI).
Source: UNPRI, as of 31 Dec 2020
The UNPRI encompasses a voluntary set of six principles to incorporate ESG into investment practice. Some companies also use the UNPRI as part of screening criteria to evaluate asset managers.
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Bank of America Merrill Lynch, “ESG Matters – US. 10 reasons you should care about ESG”. Published 23 September 2019. Retrieved 10 March 2021, from https://about.bankofamerica.com/assets/pdf/BofA_ESG-10-reasons-you-should-care-about-ESG-Investing.pdf
IHS Markit, “Exploring ESG trends in the APAC markets.” Published 24 April 2019. Retrieved 10 March 2021, from https://ihsmarkit.com/research-analysis/exploring-esg-trends-in-the-apac-markets.html?fireglass_rsn=true
Morningstar, “A Broken Record: Flows for U.S. Sustainable Funds Again Reach New Heights”. Published 28 January 2021. Retrieved 10 March 2021, from https://www.morningstar.com/articles/1019195/a-broken-record-flows-for-us-sustainable-funds-again-reach-new-heights
MSCI, “Has ESG affected stock performance?” Published 29 November 2017. Retrieved 10 March 2021, from https://www.msci.com/www/blog-posts/has-esg-affected-stock/0794561659
The Conversation, “BP paid a steep price for the Gulf oil spill but for the US a decade later, it’s business as usual”. Published 23 April 2020. Retrieved 10 March 2021, from https://theconversation.com/bp-paid-a-steep-price-for-the-gulf-oil-spill-but-for-the-us-a-decade-later-its-business-as-usual-136905
Robeco, “Corporate governance in Asia generates higher returns” press release. Published 3 July 2015. Retrieved 10 March 2021, from https://www.robeco.com/hk/en/insights/2015/07/corporate-governance-in-asia-generates-higher-returns.html
UNPRI, “About the PRI”. Retrieved 10 March 2021, from https://www.unpri.org/pri/about-the-pri
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