Pursuing Performance with Principles

By Donald T. Marchesiello

Investors increasingly realise there need not be a trade-off between seeking performance and satisfying one's values.

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. According to a report from McKinsey & Co more than a quarter of the $USD88 trillion in assets under management globally are now invested according to ESG principles.¹

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 per cent compared to 17.1 per cent for the MSCI World Index³ – which tracks large-cap equities from developed markets worldwide.

In Australia it is estimated some AUD622 billion in asset under management (AUM) are now invested through some form of responsible investment strategy. This is up nine per cent from AUD569 billion in 2015 and represents nearly half of all assets professionally managed, according to the Responsible Investment Benchmark Report 2017 from the Responsible Investment Association Australasia.

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 per cent of them had found a positive relationship between ESG criteria and corporate financial performance.⁴

Donald is Citigroup’s Global Head of Traditional Investments

¹From "why" to "why not" Sustainable investing as the new normal – McKinsey October 2017.

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

³The 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.

⁴Gunnar 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.