Separating fact from fiction in sustainable investing

Separating fact from fiction in sustainable investing

NAV TL;DR

If you don’t have time to read through the whole article, you can check out a summary below:

  • Effective sustainable investing uses traditional financial analysis along with ESG factors to arrive at investment decisions.
  • Sustainable funds have grown at record pace in 2020, with net inflows in the last three months at an all-time high.
  • Some misconceptions on sustainable investing include labelling it as a passing fad and that it sacrifices returns for purpose.

In recent years, sustainable investing has become a buzzword, not only among the investment community but the general public. More importantly, the piqued interest is coming at a time where society is paying far greater attention to how our actions can make a positive societal impact.

Sustainable investing is often undertaken by using traditional financial analysis along with environmental, social, governance (ESG) factors to arrive at whether an investment should be undertaken or not.

Fact from fiction

An increasing number of investors are making the case for sustainable investing as a way to long-term competitive financial returns.

However, the greater interest in sustainable investing has also brought its fair share of doubters questioning its efficacy.

Some questions raised include whether sustainable investing is merely a passing fad or how portfolio performance is negatively impacted when considering ESG factors.

Here are some common misconceptions of sustainable investing, debunked.

1. Sustainable investing is a passing fad

Contrary to popular belief, sustainable investing is nothing new. In fact, sustainable investing can trace its roots back to more than 3,000 years and was tied to religious beliefs.

A more recent, organised form of sustainable investing came about in 18th century, when religious groups in the US set out guidelines on the types of companies their followers should invest in. This included the Methodists as well as the Quakers – both groups opposed investing in slavery-related businesses.

Over time, the scope of sustainable investing evolved, and by the 1960s, social movements led investors to exclude stocks and industries involved in unfavourable practices, such as tobacco production, gambling as well as funding weapons manufacturers, among others.

The scope of impact investing has since broadened to encompass global change, covering issues like climate change, pollution, corruption, and diversity. The broad range of issues along with greater interest by society has seen sustainable investing break free from being a niche subject.

Most importantly, this means that sustainable investing is here to stay. The money doesn’t lie either as institutional and, increasingly, retail investors are ploughing money where their values are.

Separating fact from fiction in sustainable investing

According to Morningstar, global sustainable funds drew US$152.3 billion in net inflows in the fourth quarter of 2020 (Q4 2020), up 88% from US$82.6 billion in the prior quarter. Supported by record inflows, repurposed assets, and upward-trending markets, global sustainable fund assets climbed to US$1.65 trillion.

The strong inflows speak of the growing investor interest in ESG issues, especially in the wake of the Covid-19 outbreak. The disruption caused by the pandemic reflected the importance of building sustainable and resilient business models based on multistakeholder considerations.

2. Returns are sacrificed when making sustainable investments

In the past, socially responsible investing was said to sacrifice profit. On the contrary, sustainable investments have outperformed the broader market. In fact, there is growing literature that suggests socially conscious companies can be more profitable.

A 2018 study by Morgan Stanley’s Institute for Sustainable Investing showed that sustainable funds generated returns in line with comparable traditional funds while reducing downside risk. Moreover, during times of extreme volatility, there was strong statistical evidence that sustainable funds are more stable. As such, incorporating ESG criteria into investment portfolios may help to limit market risk.

Separating fact from fiction in sustainable investing

Likewise, MSCI’s ESG Leaders benchmarks have posted stronger returns than broader indices, across different regions and time periods. In addition, integrating ESG factors has been shown to improve portfolio risk-reward.

3. There’s no space for sustainable investments in my portfolio

Another common misconception regarding sustainable investing is the assumed difficultly of fitting ESG-compliant financial instruments into an investment portfolio.

The reality is quite the opposite. Many already have ESG-compliant stocks, bonds, exchange-traded funds (ETFs) and unit trusts.

Moreover, investors can acquire ESG-focused financial instruments across securities, asset classes, investment styles, and products. If a portfolio does not have any ESG-focused investments, ESG products can act as a complement or a replacement to existing investments in a portfolio.

Hence, there is bound to be something that fits your investment needs.

Separating fact from fiction in sustainable investing

4. There is a limited pool of sustainable assets out

The universe of investable assets and products is large, diversified, and growing.

This is true across different asset classes, from stocks and bonds to impact investing-focused alternatives such as private equity (PE), venture capital (VC), and real asset funds.

Separating fact from fiction in sustainable investing

5. Sustainable investing is only about the environment

Although popular narrative suggests that sustainable investing goes beyond going green.

While investors might be most familiar with the environmental in ESG — thanks in part to awareness of climate change and its tangible effects, investing sustainably means paying attention to social and governance factors too.

Here are some examples of how social and governance factors can play an important role in risk management and performance.

Separating fact from fiction in sustainable investing

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Sources:
Cambridge Associates, Private Equity and Venture Capital Impact Investing – Index and Benchmark Statistics. Data as of 31 March 2020. Retrieved 16 March 2021 from https://www.cambridgeassociates.com/wp-content/uploads/2020/08/PEVC-Impact-Investing-Benchmark-Statistics-2020-Q1.pdf

Cambridge Associates, Real Assets Impact Investing – Index and Benchmark Statistics. Data as of 31 March 2020. Retrieved 16 March 2021 from https://www.cambridgeassociates.com/wp-content/uploads/2020/08/Real-Assets-Impact-Investing-Benchmark-Statistics-2020-Q1.pdf

CFA Institute’s interview with Jeroen Bos, Head of Global Equity Research, ING Investment Management, “How to Integrate ESG Considerations into Investments”. Retrieved 16 March 2021 from
https://blogs.cfainstitute.org/investor/2014/01/20/how-to-integrate-esg-considerations-in-investments/

Edmans, A. (2011). Does the stock market fully value intangibles? Employee satisfaction and equity prices. Journal of Financial Economics, 621-640. Retrieved 16 March 2021 from http://faculty.london.edu/aedmans/Rowe.pdf

Schroders, “A short history of responsible investing”, published November 28, 2016. Retrieved 16 March 2021 from https://www.schroders.com/en/insights/global-investor-study/a-short-history-of-responsible-investing-300-0001/

MSCI, “ESG 101: What is ESG.” Retrieved 16 March 2021 from https://www.msci.com/what-is-esg

Morningstar Manager Research, Global Sustainable Fund Flows report, 4Q20. Data as of 10 January 2021. Retrieved 16 March 2021 from Retrieved from https://www.morningstar.com/lp/global-esg-flows

MSCI, “ESG Ratings”. Retrieved 16 March 2021 from https://www.msci.com/esg-ratings

MSCI, Number of constituent equities and bonds in MSCI ACWI ESG Leaders Index and MSCI USD Investment Grade ESG Leaders Corporate Bonds Index, respectively, as of June 2020. Retrieved 16 March 2021 from https://www.msci.com/msci-esg-leaders-indexes

Disclaimers and Important Notice
This article is meant for information only and should not be relied upon as financial advice. Before making any decision to buy, sell or hold any investment or insurance product, you should seek advice from a financial adviser regarding its suitability.

All investments come with risks and you can lose money on your investment. Invest only if you understand and can monitor your investment. Diversify your investments and avoid investing a large portion of your money in a single product issuer.

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