Why clients are interested in values-based investing

Most impact investments, as they tend to require substantial capital, are private investments. This is the smallest but fastest growing area of values-based investing.

The table below shows Investment Association (IA) numbers for ethical funds under management (1) in £m and (2) as a percentage of total industry funds under management for UK investors investing in both UK domiciled and overseas domiciled funds:

Source: Investment Association

Although ethical funds under management have increased over the past 10 or so years, their share as a percentage of the industry total has remained broadly constant over this time.

Globally, there is $23tn of assets being professionally managed under responsible investment strategies, which equates to 26 per cent of all professionally managed assets globally, according to the 2016 Global Sustainable Investment Review by the Global Sustainable Investment Alliance.

The above differences in industry share are almost certainly due to the different definitions of ethical and responsible investments, so what each does or does not include.

What is the effect of values-based investing on performance? 

Many people fear that such investing can hurt returns. Research has shown that exclusionary screening can indeed have a negative effect.

In the case of ESG investing, however, much research has shown evidence of a positive effect, or at least no performance penalty.

The former is understandable - when investors limit their universe they risk underperformance because they are not selecting the most efficient set of investments.

The latter is also intuitive - bad governance or environmental problems could affect how companies perform over the longer term.

The recent scandal at Volkswagen showed that misdeeds can occur even at well-known firms and hit their share prices badly.

The research covering the performance of impact investing is smaller as this approach is newer.

Also, as with exclusionary screening, there is a wider spectrum of return expectations as investors may be prepared to accept lower returns if they believe in the cause.

The MSCI index data below gives some support to the observation that companies with sounder EGS policies perform more strongly over the longer term, with better returns over five to 10 years to the end of 2017 for the ESG/SRI indices, although the differences are relatively small.

Source: MSCI

In July 2017, Morningstar looked at the performance of US-based sustainable funds (those with an explicit focus on ESG, sustainable investing or similar but excluding ones with a limited set of negative screens).

The Morningstar rating for funds generally, its star rating, measures a fund’s risk-adjusted performance relative to its category and is distributed normally within each category.

There were 97 ESG/sustainable funds in Morningstar’s database with a star rating and performance history of three or more years.