Investing ethically doesn’t hurt returns

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Socially responsible investing does not come at the cost of lower returns, according to an extensive review of the evidence.

The Australian Centre for Financial Studies has released a report on socially responsible investing in Australia, including a survey of a wide range of studies on the impact of SRI on investment returns.

The report uses the term socially responsible investing broadly, encompassing environmental, social and governance investment decisions, ethical investing and values-based investing. It looks at any investment process that includes non-financial factors, including the use of so-called “negative screens” and “positive screens”.

Investment theory suggests that imposing negative screens will shrink the investment opportunity set available to an SRI fund manager. SRI funds may underinvest in financially attractive opportunities and suffer from a loss of diversification. The result is that they would be expected to underperform.

Some SRI investors would accept a lower return as a trade-off for making ethical investment decisions.

Further, the added costs associated with screening and monitoring may cause SRI funds to charge higher management fees than conventional funds.

In addition there are reasons why so-called “sin stocks” might outperform: they don’t have to bear the cost of upholding ethical values; and some sin industries have significant barriers to entry, allowing incumbents to make above-average returns.

A counter-argument is that socially responsible companies will outperform by using inputs more sustainably, by generating greater employee and customer loyalty, and by avoiding reputational damage and litigation.

Based on its review of available studies, ACFS found that “the balance of empirical evidence would seem to suggest that socially responsible investing does not come at a detriment to financial returns.”

“The extant literature indicates that there is not a significant difference in risk-adjusted returns between the two groups [SRI and conventional funds],” the report says.

One US study that looked at fund returns between 1981 and 1990 concluded that “investors can expect to lose nothing by placing their money in socially responsible funds.”

Similar findings have been made in studies conducted in the UK, Germany and the US.

The evidence is not unanimous, with some studies reporting evidence of underperformance by SRI funds and some showing outperformance.

Joint analysis of 20 academic and broker studies by the United Nations Environment Program and Mercer found 10 showing evidence of a positive relationship between ESG factors and portfolio performance, seven reporting a neutral effect and three a negative association.

The biggest analysis to date was conducted by Deutsche Asset Management, working with the University of Hamburg. It looked at 2200 studies and reported that 90 per cent of the studies found “at least a non-negative relationship between ESG factors and corporate financial performance and a majority reporting positive findings.”

Socially responsible investment assets in Australian funds grew by close to 250 per cent over the two years to 2016 – one of the fastest growth rates in the world, ACFS says.

In 2016, Australian funds managed US$516 billion of socially responsible investment assets – a 247 per cent increase from US$148 billion of assets in 2014.

Among the markets surveyed, only Japan had a higher growth rate over that period. Growth of SRI assets in Europe was 12 per cent and in the United States 33 per cent.

The total market globally is estimated to be worth US$22.9 trillion, accounting for 26.3 per cent of all professionally managed assets.

Australia ranks third in the Asset Owners Disclosure Project’s Global Climate 500 Index, which rates large asset owners worldwide on their management of climate risks within their portfolios.

Among individual institutions, Local Government Super, AustralianSuper and First State Super were all ranked in the top 20, with AAA ratings.

In Australia, there are 69 investment managers offering a total of 128 SRI products. The Responsible Investment Association of Australia has certified 51 responsible investment products to date.

Regulatory changes have played a part in this growth. The Financial Services Reform Act, which took effect in 2002, introduced a requirement for issuers of investment products to disclose the extent to which labour standards or environmental, social or ethical considerations are taken into account.

And since 2014, Australian Securities Exchange Corporate Governance Principles have stated that listed entities should disclose, on an “if not why not” basis, whether they have a material exposure to economic, environmental and sustainability risks and, if so, what they are doing about them.

The report cites a United Nations recommendation that failing to consider ESG issues may represent a failure of fiduciary duty.

There is still uncertainty on this issue. The Australian Prudential Regulation Authority has noted that imposing positive screens could run counter to superannuation’s sole purpose test.


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