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How to pursue both performance and principles

Donald T. Marchesiello

By Donald T. Marchesiello

Global Head of Traditional Investments

July 10, 2017Posted InEquities, Investment Strategy and Investments

Do investors have to choose between their deeply held values and pursuing returns? There is a widespread belief that investing virtuously means foregoing potential returns and diversification. Supporters of this view point to the strong performance over time of several controversial industries such as tobacco, armaments, and fossil fuel. Excluding such investments may be beneficial for one’s conscience, but not necessarily one’s returns.

For investors seeking to reflect personal principles to their investment strategy, there are several possibilities. Ethical or responsible investing typically involves avoiding companies, industries and countries that conflict with certain environmental, social and governance (ESG) principles. Refraining from holding investments in companies that make cigarettes or guns is an example of this.

A variation of this approach is sharia-compliant investing. This involves investing according to the principles of Islamic religious law. To be deemed compliant, an investment must be approved by an Islamic scholar. Companies whose primary source of business derives from charging interest, alcohol, tobacco, pork, gambling, pornography, or otherwise seen as opposed to Muslim spiritual values are unacceptable.

Sustainable investing, by contrast, positively seeks out investments with the highest ESG standards. This typically means ranking a universe of companies according to a set of ESG criteria. These can include environmental impact, relations with employees and the community, and whether the business’s products or services benefit society. Portfolios are then constructed from the highest ranking assets.

Perhaps the most direct option of all is impact investing. With impact investing, the social results of the investment are equally important as the financial return. Investments can include projects centered upon sustainable agriculture, renewable energy, microfinance and enhancing access to basic services, particularly in developing countries. The social impact of the project in question is then specifically measured and reported to investors. 

ESG investing is hardly a new concept. It first emerged in the US amidst the politically-conscious climate of the late 1960s. However, it is only more recently that funds applying these principles have started to see more significant inflows. Data from Morningstar Inc. shows there was a net inflow of $3.7 billion into ESG equity funds from 1 December 2016 through 28 February 2017, accounting for 96% of the net inflows over the whole year ending 28 February  2017.1

What might be driving today’s growth? Given the timing of the inflows, one explanation may be investor reaction to the proposed policies of the Trump administration in the US. While past performance is not indicative of future results, recent performance has also been positive. In the twelve months to 31 May 2017, the FTSE4Good Index2 – which includes equities deemed to show strong ESG principles – achieved a total return of 18.8% compared to 17.1% for the MSCI World Index3 – which tracks large-cap equities from developed markets worldwide.

We believe that increasing awareness of the potential benefits of ESG investing over time might also be a factor. Numerous studies have demonstrated that ESG investments can potentially perform as well as – and perhaps even better than – non-ESG strategies over time. For example, a 2015 survey aggregated 2,200 academic studies concluded that some 90% of them had found a positive relationship between ESG criteria and corporate financial performance.4


1 21 March 2017

2 The FTSE4Good Index Series is designed to measure the performance of companies demonstrating strong Environmental, Social and Governance (ESG) practices.

3 The MSCI World Index, which is part of The Modern Index Strategy, is a broad global equity benchmark that represents large and mid-cap equity performance across 23 developed markets countries.

4 Gunnar Friede, Timo Busch & Alexander Bassen (2015) ESG and financial performance: aggregated evidence from more than 2000 empirical studies, Journal of Sustainable Finance & Investment, 5:4, 210-233, DOI: 10.1080/20430795.2015.1118917