The findings of a new long-term study counter the assertion that investing sustainably comes at the expense of returns.
The importance of environmental, social and ethical aspects when investing has increased in the wake of the pandemic. Many private investors say they are confident that sustainable investments are helpful for establishing ethical standards in the economy, improving social conditions at companies, and protecting the environment and climate. This was shown, for example, in the LGT Private Banking Report 2020. The Report also found that that there is significant interest among investors in taking ESG criteria into account for investments. The abbreviation ESG stands for environment, social and governance, and is often equated with sustainable investing.
While professional investors such as pension funds have embraced sustainability in their portfolios, there is still a gap sometimes between the importance private investors say they attach to sustainable investments and the role that sustainable investments actually play in their portfolios. This is also confirmed by the LGT Private Banking Report 2020, for which over 350 private banking clients in German-speaking countries were surveyed.
According to the study, one important reason for this is that many private investors believe that the inclusion of sustainable criteria comes at the expense of returns. But what would happen if the conflict between the objectives of generating returns and sustainability did not actually exist? What if lower returns were only a misconception? This is exactly what a new long-term study has found: it counters the assertion that sustainability comes at the expense of performance.
Morningstar, the well-known research and analysis firm, examined the performance of 4900 European-domiciled investment funds from seven popular asset classes over one, three, five and ten years for the period ending in December 2019, as well as during the Covid-19-related sell-off in the financial markets in the spring of 2020 (as at 31 March 2020). Among the funds assessed were 745 sustainable funds – both actively managed and passive strategies (index funds). Morningstar defined the selected categories based on the availability of sustainable funds with ten-year returns. In terms of assets under management and the number of sustainable funds, they are the largest in Europe, thus making them more relevant to investors.
The results of the study show that even skeptical investors should take a closer look at sustainability. Because the conclusion is clear: sustainable funds outperformed their traditional peers across all time periods examined. This is reflected both in the level of returns and the success rates in the seven fund categories.
For example, the majority of sustainable funds delivered superior performance relative to their traditional competitors. This finding can be observed over different time periods, i.e. over one, three, five and ten years. Over ten years to the end of 2019, 59 percent of sustainable funds outperformed traditional funds.
The success rate of sustainable funds varied by asset class as can be seen in Table 1, which highlights how many sustainable funds survived over a given period while also exceeding the average of their conventional counterparts.
Table 1 shows that after ten years, five out of seven sustainable fund categories had a success rate of more than 50 percent; sustainable emerging market equity funds had a success rate of 50 percent; only funds for EUR corporate bonds had a rather modest success rate of one-third after ten years.
“The results debunk the myth that sustainable investments go hand in hand with a performance trade-off,” says Hortense Bioy, Director of Passive Strategies and Sustainability Research at Morningstar. Andrea Ferch, Head Sustainable Investing at LGT Private Banking, is not surprised by the results of the study. According to Ferch, sustainability-oriented companies often operate in innovative industries, use precious resources more sparingly and are less likely to be involved in costly legal proceedings arising from environmental damage or human rights violations, which can result in very high fines and compensation payments.
The Morningstar study also found that sustainable funds performed better than their traditional counterparts during the COVID-19 sell-off in the spring of 2020 (as at 31 March 2020). The performance of sustainable funds was more stable in all but one category, with average excess returns in the first quarter of 2020 ranging from 0.09 to 1.83 percent.
The outperformance of sustainable funds during the COVID-19 sell-off in the first quarter can be explained by a combination of factors. According to the study, the first reason was that an underweight in sectors such as oil and gas and an overweight in sectors such as technology and healthcare benefited many sustainability-oriented portfolios. However, traditional factors such as quality and low volatility also contributed to this outcome: the balance sheets of companies with high ESG scores tend to be more solid and they often have greater competitive advantages, and these are attributes that make companies more resilient during market downturns. Thirdly, companies with a higher sustainability quality tend to be well-managed and treat all their stakeholders fairly, address their environmental issues and are less subject to controversy. According to Morningstar, many such companies are better equipped to survive periods of uncertainty.
The findings of the Morningstar study do not stand alone: recent research shows that the business case for sustainable investments is empirically very well founded. Approximately 90 percent of academic studies have found a non-negative relationship between ESG criteria and financial performance, with the vast majority of studies identifying a positive relationship. More importantly, the positive ESG impact on financial performance remains stable over time according to these studies. There is a particularly high correlation between ESG and financial performance for asset classes such as emerging markets, corporate bonds and green real estate. These findings are based on a meta-analysis published in 2015 by a team of researchers who studied over 2000 primary sources. The aim of this approach was to render comparable the many different individual studies that had been conducted. The researchers found that the results thereof contradict the general perception among investors. Their most important conclusion was that the focus on long-term, responsible investments is important, in order to better align the interests of investors with the more general goals of society. However, this requires a detailed and in-depth understanding of how ESG criteria can be integrated into investment processes to realize the full potential of value enhancing ESG factors.
LGT supports its clients in making their investment portfolios more sustainable. With its usstainability funds, LGT invests in companies, organizations and countries that have an exemplary environmental and social track record and that add long-term value from a financial perspective. You can find more information here.