SRI: More Proof that you can Do Well and Do Good at the Same Time
by Trailhead Plan… on May 23, 2018
We continue to see more data and research that confirm an important fact of socially responsible investing (SRI): investing in a socially responsible manner does not harm investment returns; in fact, it can improve long-term investor performance.
Why do companies that screen well for environmental, social, and governance factors (ESG) tend to perform well?
Well, for a multitude of reasons.
For example, companies with more gender diversity in the executive suite and on the board of directors tend to perform better. This is likely due to the tendency for group think within more homogenous groups, which inhibits fruitful decision-making.
Similarly, a company that actively seeks to mitigate environmental risk from its operations has hypothetically reduced the risk of a fat-tail (black swan) event. For example, insurance companies have taken global warming very seriously for much longer than both the general public and our government. Why? Well, global warming could mean changing weather patterns, like more hurricanes, floods, and droughts. Additionally, for property & casualty companies, rising sea levels means that property close to the ocean could be underwater in a few decades. In other words, companies that take environmental concerns seriously can mitigate substantial long-term risk.
Starbucks recently made headlines with an incident that rightfully brought critiques from many different sectors and viewpoints. A situation like this could have easily had a dramatic impact on the company’s fortunes. However, over the years Starbucks has put substantial work into the social welfare of its employees and communities. The company is well-known for offering health benefits to both its full-time and part-time workers (a rarity), free college tuition for its employees (another rarity), and recently announced it had reached 100% equal pay for employees of all genders and racial backgrounds (and was planning to bring this worldwide).
In other words, the years of hard work on ensuring the company treated its workers fairly and equitably mitigated the impact of a terrible incident. More, consumers trust Starbucks to put the procedures and policies in place to ensure an incident like what happened in Philadelphia never happens again.
The list goes, on, but it is easy to say that companies that take environmental, social, and governance risks seriously may have an advantage over their competitors.
Two New Reports
JP Morgan on Sustainable Investing
JP Morgan recently endorsed ‘sustainable investing’ as an investment style that can lead to market outperformance. Via Marketwatch:
“We find that ESG investment no longer requires foregoing returns as companies that are socially responsible are likely to lead in overall management capabilities,” JP Morgan wrote. ESG refers to environmental, social, and corporate governance, or the three primary screens that are used in evaluating securities on sustainable metrics.
“ESG investing is now moving into the mainstream and gravitating from negative screening of sinful industries to more quantitative, data-driven and index approaches as the availability and quality of ESG metrics and reporting have increased,” the investment bank wrote. Socially responsible investing “recognizes the fiduciary role for companies and issuers to act in the best long-term interests of beneficiaries.”
Merrill Lynch on the ‘Alpha’ of ESG Investing
In a world of elusive alpha and passive index investing, the path to enhanced returns lies through combining socially responsible and impact investing with another factor, such as dividend yield of value, according to analysts at Bank of America Merrill Lynch.
The alpha from such a combination comes from the fact that stocks with high environmental, social & governance (ESG) scores have overall low correlation to other quant factors, such as high dividend yield, earnings yield or earnings momentum, according to a research note from Savita Subramanian, equity and quant strategist and her team at BAML.
‘Alpha’ refers to risk-adjusted outperformance. In other words, given similar volatility, Merrill Lynch research conlcludes that combining ESG screening with other investment factors, such as high dividend yield, earnings yield, or momentum, can lead to long-term outperformance.
Editor's Note: We at Trailhead are working on a secret project to deliver something very similar to the above to our clients. We are very excited about this new capacity and we will following up with more information soon...
Merrill included a couple of charts to make their point:
When we first started researching socially responsible investing over a decade ago, there was a dearth of actionable data to base any conclusions regarding performance on. Now, thankfully, the tables have flipped, and we are swimming in data and research on this growing and impactful segment of investment markets.
What does the data say? As we have have pointed out time and time again, the data is clear, socially responsible investing at the very least does no harm, and can improve long-term investment performance. Add that together with the fact that investors can align their deeply-held values with their investment decisions and we come to the clear conclusion: You can do well and do good at the same time.
What’s stopping you?