Will I earn a lower return if I invest responsibly?
By Mike Ross at Evergreen Advice
One of the most common questions we receive from investors is: Will investing responsibly come at the cost of investment returns? This is an understandable question; however, there is a growing body of evidence that suggests you do not have to forgo returns when investing responsibly and what’s more, it can potentially achieve better returns.
What does history say?
There are more than 30 years of data showing how responsible investing* compares with traditional investing. By comparing the MSCI KLD 400 Social Index (the longest-running responsible investment index made up of 400 US companies) to the S&P 500, you can see that responsible investing has outperformed traditional investing by approximately 0.5% per year.
What does the research say?
Responsible investing has become more mainstream over the past decade and wider research has been undertaken to determine how responsible investment strategies perform against traditional investment strategies.
- A meta-study conducted in partnership with Oxford University in 2014 showed that, on average, companies with good sustainability practices had better operational performance and superior share performance.
- Similar research was completed by the New Zealand Superfund in 2014 which concluded that more than 80% of relevant studies show positive links between ESG ratings, and measures such as lower cost of capital, higher profitability and higher share prices.
- Research completed in 2019 by local fund manager Harbour Asset Management on the New Zealand market shows that companies with better ESG practices may be more profitable and deliver better share price performance.
- Research completed by global fund manager Blackrock in 2020 showed that sustainable investment strategies have outperformed during share market downturns such as the Covid Crash in March 2020.
What other factors should you consider?
While history tells us that over the long-term responsible investors are not sacrificing higher performance, there are some other points to keep in mind:
Considerations
1. With any investment strategy there will be periods of good relative performance and periods of poor relative performance. This means that there will be extended periods of time, years even, when responsible investing strategies underperform traditional strategies. The success of a strategy should be assessed over the long-term.
2. The exponential growth in demand for responsible investment options has created some distortions in the market. When Joe Biden won the US presidency in November 2020, with the promise of recommitting to the Paris Climate Agreement, a wall of money was invested into renewable energy investment options. The iShares Global Clean Energy ETF doubled in price in the months that followed, only to decline by more than 30% when the unsustainable demand subsided.
New Zealand’s renewable energy stock Meridian formed a key part of this index and their share price followed suit, as the graph below shows. Meridian’s share price peaked at $9.40 before falling by almost 50% to its current share price of around $5. Given the popularity of sustainable investing, this type of short-term volatility could happen again in the future and is something to be mindful of as an investor when making investment decisions. If you invested in renewable energy stocks at the beginning of 2021 you would not have had a positive experience.
Additional benefits
1. When people invest in a way that is consistent with their values it can make them more likely to stay invested during down markets. One of the biggest mistakes investors can make is selling their investments after markets have crashed.
2. One of the reasons people might think they have to give up higher performance to invest responsibly is that historically responsible investments had high fees. This is no longer the case as many responsible investment strategies have comparable fees to traditional investments. Fees directly detract from investors future returns, so this change is an excellent development in support of responsible investment performance.
What does this mean for you?
While there will be periods where responsible investing might perform differently than traditional investments, the growing body of evidence supports the assertion that investors today do not need to decide between investing responsibly and maximising returns. They can do both.
