SRI Has Evolved
Gerry Wahl’s article ‘SRI – A Noble Idea, But ...’ has missed the evolution from traditional SRI, which focused on screening, to responsible investing which is very clearly defined by the global financial community as “the integration of environmental, social, and governance (ESG) issues into the selection and management of investments.”
In 2003, UNEP FI1 commissioned reports from nine mainstream research institutions to study the financial materiality of ESG issues. They wanted to know if managing issues like climate change or supply chain would have an impact on the share price of a company. A key finding was that there was “agreement that ESG issues affect long-term shareholder value ... and, in some cases, those effects may be profound.”2
Move Into Mainstream
In 2006, the Principles of Responsible Investment were launched by the UN and responsible investment began to move into the mainstream. More than 1,200 pension funds and other institutional investors representing more than $45 trillion have become signatories to the principles and 94 per cent of them have responsible investment policies in place.
ESG criteria is used to help managers identify risks that are not well understood by traditional investment analysis. In doing so they are better able to accurately predict financial performance. This does not diminish the values or social harm-based approach that the article so roundly dismisses, but it does identify the risks and rewards associated with ESG factors. It also provides the information needed for investors to capture the financial benefits of environmental, social, and governance leadership.
A 2012 Deutsche Bank Climate Change Advisors sustainable investment study3 reported it believes that “ESG analysis should be built into the investment processes of every serious investor and into the corporate strategy of every company that cares about shareholder value.”
The researchers looked at 100 academic studies, 56 research papers, two literature reviews, and four meta-studies on responsible investing from around the world.
In conducting the analysis, it observed that ESG factors are consistently correlated with superior risk-adjusted returns at the securities or stock level. In other words, the companies with the best ESG performance were rewarded by the market with higher share prices. Those findings were supported by 89 per cent of the studies they examined with 85 per cent of the studies showing a correlation between ESG performance and accounting-based outperformance.
If price performance and earnings per share aren’t enough, their findings also showed that companies with good ESG ratings have a lower cost of capital in terms of both debt and equity. Almost every comparison of RI versus traditional investment returns points to better long-term risk adjusted returns when ESG issues are taken into account.
The ground-breaking 2005 Freshfields report on fiduciary responsibility said: “In our opinion, it may be a breach of fiduciary duties to fail to take account of ESG considerations that are relevant and to give them appropriate weight, bearing in mind that some important economic analysts and leading financial institutions are satisfied that a strong link between good ESG performance and good financial performance exists.”
In the Responsible Investment Association (RIA) quarterly mutual fund reports (http://riacanada.ca/quarterly-reports/) there are top-performing RI mutual funds in every major category.
Social indices offer further evidence of positive performance by responsible investments. The Jantzi Social Index (JSI) and the MSCI KLD 400 Social Index have demonstrated outperformance since inception more than a decade ago.
Is responsible investing a noble idea? That depends on your perspective, but it is a really good idea that will reduce risk and increase long-term value for shareholders and stakeholders – including pension beneficiaries. Some of us might have a hard time understanding what constitutes ‘social harm,’ but since the global financial crisis in 2008, we’re all pretty good at understanding the concept of risk.
Deb Abbey is the chief executive officer of the Responsible Investment Association.
2. ‘The Materiality of Social, Environmental and Corporate Governance issues to Equity Pricing,’ UNEP FI, June 2004
3. https://institutional.deutscheawm.com/content/_media/Sustainable_Investing_2012.pdf; p. 5