Responsible Investing Myths

Linson

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Linson Chen

Financial Advisor & Associate Portfolio Manager

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According to the 2017 Responsible Investment Association (RIA) Investor Opinion Survey, a majority (77%) of Canadian investors are interested in responsible investing (RI) yet they know little or nothing about it. 

There exists a certain amount of doubt and skepticism about RI and the value that it brings. Here are the most common misconceptions that I hear:

Myth 1: Responsible investing results in lower returns

The most common myth about RI is that you sacrifice returns compared to traditional investing approaches. Critics argue that looking at environmental, social, and governance (ESG) factors limits the investment universe. Responsible investors agree that integrating ESG factors will eliminate companies from their investment universe but argue that the remaining companies will be better long-term investments.

Numerous studies have shown that ESG investing can perform as well as the market or better. When evaluated across multiple funds and time periods, RI exhibits a neutral and oftentimes positive impact on financial performance. A 2015 Morgan Stanley study of more than 10,000 mutual funds found that sustainable equity funds had equal or higher median returns and equal or lower volatility than traditional funds. In 2012, RBC Global Asset Management reviewed four bodies of research on sustainable investing and concluded that socially responsible investing has not resulted in lower investment returns.

Even funds that don’t market themselves as responsible investments are integrating ESG criteria because they recognize the benefits to help steer clear of potential blowups in the market when companies violate ESG regulations. It’s another tool being used by fund managers to help identify risks that are not being recognized through financial statements and traditional investment analysis. Integrating material ESG factors is simply a prudent investment practice that results in better and more informed investment decisions. RI isn’t just about personal beliefs, it’s about managing the risks that affect long-term shareholder value.

Myth 2: Responsible investing is about excluding controversial industries

RI has evolved from simply selecting stocks by screening out negative companies and then selecting among the remainder. People still think that sustainable investing either divests from all controversial industries or exclusively invests in clean technology. ESG strategies are more comprehensive and don’t just simply exclude companies but rather include companies that have good ESG characteristics.

Fund managers may even invest in best-in-class companies with lower ESG characteristic with the goal of improving a company through engaging its management team. Best-in-class means that all sectors are analyzed to be incorporated including the oil sector and sectors of the economy that are perceived to be not as responsible. If a certain energy company is better (or less bad) than its competitors with regards to ESG criteria, then it is possible to find shares of that energy company in an RI fund. The goal is to help every company in all sectors of the economy improve its ESG practice and to raise its industry benchmark.

Myth 3: Responsible investing is a small niche industry

According to the RIA’s 2016 Canadian RI trends survey, over $1.5 trillion is invested in RI strategies in Canada which represents 38% of the Canadian investment industry. This is an increase of 49% in the past two years.

Some of the largest pension funds and endowments in Canada use ESG factors to help manage risk and create more value over the long term. The Canadian Pension Plan Investment Board (CPPIB) says that “responsible corporate behavior with respect to environmental, social and governance (ESG) factors can generally have a positive influence on long-term financial performance.”

Most of the assets of the RI industry are attributed to institutional investors; however, growth of individual investors has almost doubled over the past two years in Canada to reach $118 billion. Recent high-profile ESG cases involving Volkswagen, BP and Wells Fargo have contributed to the growing awareness of responsible investing.

Myth 4: Responsible investing is not consistent with fiduciary responsibility

Fiduciary duty was considered the biggest obstacle to RI because it conflicted with a trustee’s responsibility to maximize investment returns. The result was neglected environmental, social and governance (ESG) risk in the management of investment portfolios and a focus on short-term rather than long-term returns.

In 2005, the United Nations Environment Programme Finance Initiative (UNEP FI) invited global law firm Freshfields Bruckhaus Deringer to consider whether institutional investors such as pension funds and insurance companies are legally permitted to integrate ESG issues into their investment decisionmaking and ownership practices. The Freshfields study concluded that “integrating ESG considerations into an investment analysis so as to more reliably predict financial performance is clearly permissible and arguably required in all jurisdictions.”

In 2016, the UN launched the Principles of Responsible Investment (PRI) and has more than 1,380 institutional signatories to the principles including some of the largest institutional investors around the world. These signatories utilize ESG factors in their risk management to achieve stronger long-term results and to fulfill their fiduciary responsibilities.

Myth 5: Responsible investing does not have any environmental or social impact

Critics have argued that RI funds have limited influence on corporate behavior. Ownership of company stock with strong ESG characteristics is just one of the ways to make an impact. ESG analysis enables better awareness of areas for improvement in terms of environmental or social criteria. Through shareholder engagement, resolutions and proxy voting, RI can establish constructive dialogue with a company’s management to identify key areas to improve their ESG practices.

Climate change and gender diversity are the common ESG areas of focus in 2018. Canadian RI mutual fund managers are also pressing for progress on opioid accountability, access to medicines, indigenous rights, living wage and antimicrobial resistance. RI fund managers are actively promoting more sustainable business practices that is both good for society and for clients’ portfolios.

Conclusion

Who wants to invest in companies that exhibit endangering behavior and unacceptable risk of severe environmental, social or governance damage? Responsible investors recognize the important connection between sustainability and a long investment horizon. They know that the integration of ESG factors into the selection of investments can provide both competitive risk-adjusted returns and a positive societal impact. ■