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Do you have to sacrifice returns to do the right thing?

Responsible investing may not have to come at the cost of financial returns. Rather, it has the potential to boost growth in your portfolio, reduce the effect of market swings and increase the long-term resilience of your investments.

Evidence that responsible investing (RI) – also known as environmental, social and governance (ESG) investing – may generate sustainable financial returns has been growing. This research is improving our understanding around why responsible investing has the potential to deliver positive returns over time.

New York University Stern School of Business’s recent analysis of this area made some interesting conclusions. It analysed more than 1,000 research papers between 2015 and 2020 and found a positive relationship between ESG and financial performance for 58% of the studies. Only 8% showed a negative link, with mixed or neutral results for the others1.

NYU Stern said this positive effect becomes clearer over longer periods, which makes sense given that RI encourages sustainability in the way companies operate. For example, as firms move towards green energy and electric vehicles, they are proofing themselves against the negative effect of future oil shortages on their profits and share prices.

ESG portfolios also provide valuable protection for investors during market downturns, such as the 2008 financial crisis and the ongoing COVID-19 pandemic. They fall less sharply compared to non-ESG portfolios included in the study, said NYU Stern.

This is supported by analysis from research firm Morningstar, which showed that ESG funds outperformed non-ESG during February last year in three out of the four investment categories it analysed – global, Europe and large companies. Emerging markets was the only category that didn’t show such an effect2.

Morningstar said this is because ESG investing provides a natural bias against high-risk firms and towards those with robust earnings.

Similarly, fund manager BlackRock identified that 94% of sustainable indexes (groups of companies’ share prices) outperformed their benchmarks during the COVID-19-related crash in the first quarter of 2020. BlackRock attributed this to sustainable characteristics such as strong employee satisfaction, customer relations, firm culture and board effectiveness – crucial traits for helping you through a crisis3.

The NYU Stern study linked ESG to outperformance because sustainability initiatives at companies tend to improve risk management, innovation and efficiency.

Which ESG approaches work best?

NYU Stern found the ‘ESG integration’ investment strategy performs better than negative screening. Integration involves engaging with companies to improve their ESG practices rather than simply taking them out of portfolios (screening).

St. James’s Place is committed to engagement because we believe shareholders can exert considerable pressure on companies, and engagement ensures their voices are heard.

Petra Lee, Responsible Investment Analyst at St. James’s Place Wealth Management, says RI has the potential to add to performance because “looking after limited raw materials, supply chains, local communities and labour rights are all good business practice. By rejecting RI, you are not accounting property for the risks and opportunities in our changing economy.”

How much is ESG investing worth to me?

Global share index provider MSCI found that, in the seven years to 2020, the top third of companies with the strongest ESG ratings outperformed the bottom third by 2.56% a year4. That’s a significant sum, especially when you consider the potential longer-term cumulative returns that could create. Some experts now believe the stronger the ESG processes in your fund or portfolio, the better the potential for returns will be, although more studies are needed to support this point of view.

Will responsible investing outperformance last?

Some investors may also be concerned about valuations over time. Huge flows into ESG funds have pushed prices up this year, potentially making future returns harder to find. But the long-term nature of sustainable practice means there is the potential for plenty more returns should be available from ESG investments in the coming years.

We agree with BlackRock’s analysis that investors’ interest in ESG investing will continue to grow, creating a demand that will keep supporting prices and long-term returns for decades to come.

Our world is changing faster than anyone predicted. We believe responsible investing has a huge role to play in shaping a better world and building a sustainable future.

Past performance is not indicative of future performance.

The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

1 ESG and financial performance, New York University Stern, February 2021
2 How ESG ETFs have performed in the sell-off, Morningstar, April 2020
3 Sustainable investing: resilience amid uncertainty, BlackRock, May 2020
4 ESG investment finds its footing, MSCI, September 2021

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