Royal London and EY’s new paper reviews existing empirical evidence on how responsible investing affects returns.
Interest in responsible investment is reaching new heights, with the impact of COVID-19 providing a real catalyst for change. As this demand grows, the financial industry and society as a whole want to know how to practice responsible investing - and what results investors can expect from it.
Read the full paper Responsible investing: new evidence, new energy
EY and Royal London wanted to contribute to this debate by reviewing existing empirical evidence of how responsible investing affects returns. A number of hypotheses were set out to measure how using Environmental, Social and Governance (ESG) principles could impact investment performance. More than 300 academic and other published papers were then reviewed to determine if the hypotheses were supported by evidence.
Our analysis shows that applying ESG principles can deliver financial benefits, both in corporate performance and in reducing volatility. This is a significant finding and is backed up by the resilience of sustainable companies in the face of challenge, not least now with COVID-19.
Furthermore, this comes at a moment when demand for responsible investing is being pushed to new levels by the social and environmental ripple effects of the pandemic, and when regulatory changes such as the amendments to MiFID II are adding to the significant momentum.
Together, we expect the three key drivers of evidence, demand and regulation will rapidly accelerate the investment industry’s adoption of sustainable practices in a post-COVID world. Developing responsible investment capabilities is no longer an option, it’s a necessity.
1.Regulation – a clear direction of travel
In recent years we have seen an enormous number of ESG-related initiatives worldwide and these have given a real boost to responsible investing. While many of these are focused on climate change, many other sustainability or stewardship regulations have also been introduced.
For financial advisers, perhaps the most significant change is a proposed amendment to Article 25 of MiFID II. This will require firms to take sustainability risks and clients’ sustainability preferences into account.
For asset managers, proposed reforms to Undertakings for the Collective Investment in Transferable Securities (UCITS) and Alternative Investment Fund Managers (AIFM) mean incorporating the consideration of sustainability risks into governance structures and operating models.
The Pensions Regulator has taken several actions for workplace pension schemes. These include telling trustees that weighing ESG risks is consistent with maximising financial returns, and requiring the trustees of local authority, defined benefit and defined contribution funds to disclose their approach to ESG factors. These are just a few of many changes that the industry will need to deal with in the coming months.
2. The evidence on performance is growing
The idea that a company’s adoption of ESG principles could positively affect its performance has been discussed for some time. We believe our review of the empirical evidence can add real weight to this debate. As part of this review we developed a series of hypotheses expressing specific ways in which ESG principles affect investment performance. These include reduced risks, alongside lower volatility and costs of capital. We then tested these hypotheses against the findings of over 300 studies, meta-studies and literature reviews with the findings outlined below.