The true market for ethical investing is hard to quantify given the nuances of definition and new products opening or repurposing regularly.
It is dominated by institutional investors but the retail segment is growing rapidly.
A lot of historical criticism has been levied at ethical investing, stemming from the premise that restricting the investment universe of active managers of ethical mandates causes them to underperform their unconstrained counterparts. The evidence suggests this is not the case.
1. Size matters
Data from the Global Sustainable Investment Association showed ethical assets grew 25 per cent over two years to reach US$23trn in 2016. Approximately $13trn came from Europe while around $7trn came from the US. Over the next 20 years inflows equivalent to the size of the S&P 500 are expected into ethical-related equity investments.
2. Shades of green
Ethical investing is not a standard one-size- fits-all proposition, and the approach has evolved over time as well as various nuances prevailing across different geographies.
The dominant ethical strategy in the UK is ‘engagement and voting’, in France it is ‘best-in class and sustainability’ themed, while in the Netherlands ‘negative and norms-based screening’ prevails. In the US, ESG integration is the most widely adopted methodology.
Ethical investing using environmental, social and governance (ESG) factors is fairly mainstream now for institutional investors, and is slowly being adopted by the retail market.
Newer concepts, such as impact investing, where investors can actively use their financial wealth to target specific issues where financial return isn’t the primary objective, are growing fast, in large part as a reaction to increased investor appetite.
3. Winds of change
In 2006 the UN-supported Principles for Responsible Investment was launched with 100 signatories, representing $6.5trn in AuM, committing to incorporate ESG factors into their investment analysis. Today there are over 1,400 signatories with AuM of $60trn. There are many drivers of change, but these three are considered to be the most prominent:
4. It’s good to be green
Ethical investments historically were seen more as a hobby than offering a competitive financial return. You invested because you wanted to do good, rather than achieve alpha. Today there is a growing argument that you can’t have sustainable outperformance without a sound appreciation of
ethical factors.
According to a US SIF study (2016) of fund managers who incorporated ESG factors into their investment process, 80 per cent cited better returns as one of the top motives.
A Morgan Stanley study found ethical investments usually met and often exceeded the performance of comparable standard investments and, further to this, a HSBC study noted improvements in ESG analysis drives share price performance, particularly in emerging markets.
5. Risky business?
Using US data, a Bank of America Merrill Lynch report found that an investor who only held stocks with above-average ESG scores would have avoided investing in 90 per cent of bankrupt companies seen since 2008.
Companies that rank as attractive on ESG attributes have exhibited lower risk based on price volatility, earnings volatility and bankruptcy. Sustainability and ethical factors are being used to drive business innovation and competitive differentiation at a company level.
Due to the ever-increasing connected world which we inhabit, the factors driving share price performance historically may not hold for the world of tomorrow.
Gary Waite is portfolio manager at Walker Crips