Performance of ESG Funds

How have ESG Funds performed?

ESG refers to the environmental, social, and governance practices of an investment that may have a material impact on the performance of that investment. The integration of ESG factors is used to enhance traditional financial analysis by identifying potential risks and opportunities beyond technical valuations. While there is an overlay of social consciousness, the main objective of ESG valuation remains financial performance. Investments with good ESG scores have the potential to drive returns, while those with poor ESG scores may inhibit returns.

While this ‘new’ way to approach investing remains relatively young -– approximately 10 to 15 years old — in the last few years there finally is sufficient empirical evidence to suggest that companies that meet high ESG standards are actually likely to outperform the market.

Here is the key: High-sustainability firms tended to have a higher degree of long-term planning for all stakeholders. This leads to better performance which translate into higher financial returns.

Simply put: Investors can do well by backing companies that do good.

Significant data establishes a positive link between ESG and financial performance. There are too many studies that I could list here but let me give you just one example: The Morgan Stanley Institute for Sustainable Investing published Sustainable Reality: Analyzing Risk and Returns of Sustainable Funds in 2019.  In research conducted on the performance of nearly 11,000 mutual funds from 2004 to 2018, the Institute “compared the return and risk performance of ESG-focused mutual and exchange-traded funds (ETFs), as defined by Morningstar, against traditional counterparts from 2004 to 2018, using total returns and downside deviation.”

There were two key takeaways from this report. First, there are “no financial trade-off in the returns of sustainable funds compared to traditional funds, and they demonstrate lower downside risk.” Second, during a period of extreme volatility, the study found “strong statistical evidence that sustainable funds are more stable.” Sustainable funds experienced a 20% smaller downside deviation than traditional funds. Incorporating ESG criteria into investment portfolios may help to limit market risk.

How do you think ESG Funds will perform in the next 6 – 12 months?

The COVID-19 pandemic has taught me to be conservative and flexible when making predictions. However, my general feeling that ESG funds will continue to largely meet or exceed performance expectations. As mentioned, ESG companies have a higher degree of long-term planning, a wider focus on their stakeholders and inherently have a greater sense of employee shared purpose. This leads to greater resiliency and commitment across all stakeholders.

What are some important metrics to highlight when measuring the performance of ESG funds?

Beyond just measuring the financial returns of a particular ESG fund, other important metrics will obviously include all environmental, social and governance returns.

• Environmental examples – energy consumption, pollution, climate change, waste production, natural resource preservation, and animal welfare
• Social examples – human rights, child & forced labor, community engagement, health & safety, stakeholder relations, employee relations, diversity, and inclusion
• Governance examples – the quality of management, board independence, board diversity, conflicts of interest, executive compensation, transparency & disclosure, and shareholder rights

ESG criteria are an increasingly popular way for investors to evaluate companies in which they might want to invest. Acting as a screen, ESG criteria also help investors avoid companies that might pose a greater financial risk due to their environmental, social or other practices.

If you’d like to better understand ESG investing and performance, please send me a note. I look forward to discussing, hearing your thoughts and sharing experiences.