Victoria Hoskins: Why you should invest for both social and financial benefit
An investment methodology that benefits both society and your finances may sound too good to be true, but socially responsible investing makes this concept possible, says Victoria Hoskins.
A study of the US market in 2016 found that investors considered environmental, social and governance (ESG) factors across $8.72 trillion of assets; a 33 per cent increase on 2014. There is no doubt that engagement with the subject is rising; 75 per cent of global investors are now interested in sustainable investing.
What is socially responsible investing?
You may have heard the methodology described as ethical, sustainable or impact investing. All broadly mean the same thing: employing investment capital to generate positive financial and social returns. Investors can use their assets to try to positively influence the behaviour of corporations, choosing to only invest in companies which meet their specific criteria.
The origins of the idea began a long time ago – first noted when the Quakers refused to support companies involved in the slave trade 300 years ago. Over the years, consumers have also boycotted the goods and services of companies due to their questionable practices. Johnson & Johnson recently removed a preservative from its baby products in response to a boycott call from the US Campaign for Safe Cosmetics over the company’s use of harmful chemicals in its baby shampoo.
Today’s investors can make sophisticated decisions about where and how they invest their money. A positive or negative ethical screen must align with an investor’s values and also generate an investment return comparable with a traditional investment strategy.
Encouraging best practice
Choosing investments for both an ethical and financial return is a powerful way of encouraging best practice in corporations. Businesses will have to step up their ESG profile if they want to receive their funding. Responsible investing encourages greater corporate accountability and transparency, it improves environmental stewardship and focuses on human rights.
It stands to reason that companies which behave more ethically will ultimately outperform their unethical equivalents. The staff working on the products or services sold by an ethical company will be better protected and more motivated to work hard than the staff being treated poorly by a less ethical company. Consumers will be more satisfied with the product or service they are buying from a company with strong ESG values. A recent study of investor trends also revealed that 71 per cent of investors believed that companies with leading sustainability practices may be better long-term investments. Sustainable corporate practice means better output.
Illustrating the impact of corporate sustainability on financial performance, the National Bureau of Economic Research calculated that $1 invested in 90 large US “high sustainability” companies in 1993 would have outgrown the same investment in 90 “low sustainability” counterparts by more than 46 per cent by the end of 2010.
An investor may have decided to invest responsibly, but how will their values then steer the investment methodology?
Some ethical funds take a best-in-class approach. This means that the funds do have exposure to “unethical” sectors as well, but only to those companies which have a better record on social or environmental issues than other companies in the sector.
If the fund has applied a positive screen, it may mean that it only invests in companies which have good corporate governance and strong environmental values. A negative screen means that the ethical fund has excluded certain sectors, for example, alcohol, tobacco and armaments. These funds can have strict methodologies and as a result, they can be underweight large caps and may avoid certain sectors entirely.
The best-in-class approach is the most commonly seen in socially responsible offerings, but the portfolios the methodology generates do not hugely differ from more traditional funds. Negative screening is considered to be the most traditional form of ethical investment.
It won’t cost you
The biggest myth about responsible investing is that a trade-off has to be made between social and financial well-being. Not so; investing for social good does not necessarily compromise performance. These alternative investment strategies can keep pace with their traditional counterparts.
Recent research by Nuveen TIAA Investments found the long-term performance of a responsible investing index to be comparable to that of two broad market benchmarks, without any additional risk. Responsible indexes and their broad market counterparts had similar risk profiles (based on Sharpe ratios and standard deviation). Their comparable returns suggest an absence of any systematic performance penalty.
Morgan Stanley drew similar conclusions in a performance study it published in 2015. It noted that comparable or improved financial performance could be observed over time across all asset classes on both an absolute and a risk-adjusted basis. It found that its KLD 400 Social Index had outperformed the S&P 500 on an annual basis since its inception in 1990.
The study said: “Investing in sustainability has usually met, and often exceeded, the performance of comparable traditional investments. This is on both an absolute and risk-adjusted basis, across asset classes and over time.”
The future of investing responsibly
Changes in demographics across the world should stand to benefit responsible investing. Millennials (those born between 1981 and 1997) will soon represent 75 per cent of the global workforce, giving them enormous spending power. They also stand to inherit a significant portion of existing wealth. This demographic has a strong appetite for sustainability and is pushing corporations to focus less on profit and more on making a positive impact on society. The increasing number of female investors will also help to propel a shift towards responsible investing as women tend to be more likely to base their investment decisions on sustainability.
The huge emphasis on transparency will also benefit ethical investing as reporting standards must be improved to enable investors to better assess progress and impact. There is also more pressure for the reporting of non-financial factors which may affect future returns.
These cultural shifts are all good news for socially responsible investing. There are still performance myths to dispel, but the rising engagement with the subject looks set to continue. Indeed the future for investment per se will be ‘why not’ invest responsibility, rather than ‘why’?
Socially responsible investing at Rathbones
At Rathbones, we firmly believe in the importance of socially responsible investing. Our sustainable investment unit, Greenbank, was formed in 2004 and now manages £1 billion of ethical investment. Its methodology goes beyond the traditional negative screen and instead constructs portfolios based on a client’s values and objectives. Our research team closely monitors the financial performance of companies as well as their ESG activities, so clients are never exposed to activities which don’t support their values. Greenbank enables our clients to achieve their financial and social objectives.
Victoria Hoskins is an investment director at Rathbone Greenbank Investments
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