Sustainable Investing & The Myth of Long-term Underperformance

Trailhead Planners LLC |

Often, when I tell people that my firm specializes in sustainable investing, I am met with skepticism. "That's great, but don't you give up long-term performance?" Or, "I'm all for socially responsible investing, but I'd like to retire someday and I need my investments to do well."

Here's my usual response:

It's interesting you say that, because it is what I used to think before diving into the data and research. It turns out that socially responsible investing does not negatively impact long-term investment returns. In fact, some studies show that investing according to Environmental, Social, and Governance factors (ESG investing) can positively impact investment performance.

However, many individuals remain skeptical and understandably so.  To that end, before jumping into the data, let's discuss for a bit why we are so wary of socially responsible investing.

Investors have been burnt by opportunistic salespeople

Thomas Friedman, in a follow-up to his classic The World is Flat: A Brief History of the 21st Century, came out with Hot, Flat, and Crowded: Why We Need a Green Revolution and How It Can Renew America in 2008 - a book that scared that living bejesus out of me. Friedman, being the wonderful writer that he is, brought to life many of the unsustainable realities we were living in. Globally, we were starting to accept that overpopulation was a serious problem, especially as growing middle classes in the developing world started to consume more. More, even as countries and societies dealt with strained social systems because of growing populations, we were being confronted with what could be the most important challenge in human history: Global Warming.

I was just starting out in the financial industry during that time, and I remember seeing countless advertisements and marketing pieces pushing 'Green' investments. More, wholesalers, salespeople who market investment products to financial advisers were pushing 'green funds', clean energy funds, and water funds hard. (Good rule of thumb, when you start to see an investment theme heavily marketed, it's usually a good time to run the other direction).

Many investors bought these mutual funds and ETFs because it fit the thesis of the time. We were at peak oil which would continue driving up the price of carbon energy. Emerging Markets were going to take over the global economy.

Why do I bring this up? Well, investors got sold a very specific branch of socially responsible investing: Impact Investing. And it ended up being a horrible period for that type of investment. Markets, of course, crashed in 2008, and the ensuing recovery has mostly left behind many of the popular green tech investments like wind and solar. This led many investors to confuse socially responsible investing with concentrated and high risk bets in solar, wind, water even though nothing could be further from the truth.  Unfortunately, it left many investors with a bad taste in their mouth regarding SRI.

There is a myth in our culture that you can't do good with money

Check your values at the door when it comes to money.

This is business.

Money is the root of all evil.

Most of us have heard phrases like this all our lives and it has left us with a very challenged relationship with money. We are taught at a very young age to check our values at the door when it comes to our financial lives. Classical economists argue that we are simply economic agents, and are only interested in maximizing our earnings, our returns, and our consumption. As a result, we cast a wary eye at anything that seeks to blend values and money. We shut ourselves off. I’m only interested in making as much money as possible. Adding anything else to the equation is hippy-dippy, soft, and lacking seriousness.

Of course, by this logic, socially responsible or sustainable investing can’t perform well. And we are taught to venture no further.

Luckily, we socially responsible investors have data on our side.

The Facts

There is growing evidence that investing according to sustainability factors may improve long-term corporate and equity performance. However, it is more important that we can show that investing according to ESG standards does not inevitably harm long-term performance. The more confidence with which we can state this point allows for the opportunity to negate the argument between investing consciously or investing for long-term performance.

Study #1

One study, done by MSCI ESG Research found that tilting portfolios toward companies that score better on ESG standards, led to long-term outperformance. The research also concluded that overweighting portfolios toward companies that exhibit positive ESG momentum (i.e. their ESG score is improving) led to outperformance (and was superior to a more basic tilt).

Unfortunately, this study only assessed eight years of data. However, it does offer evidence that investing according to ESG standards does harm long-term investment returns. In fact, it may even improve long-term performance.

Study #2

Another study, entitled Corporate Sustainability: First Evidence on Materiality, found that companies that score better on “material sustainability issues” outperform firms that score poorly. Once again, we see evidence that at the very least, higher performance on ESG scales does not harm long-term investment returns.

Study #3

Finally, a third study, ESG and Financial Performance: Aggregated Evidence From More Than 2000 Empirical Studies, found in The Journal of Sustainable Finance and Investment, concluded that the business case for sustainable investment is strong. This means that businesses that screen positively on sustainability factors outperform on various measurements of business success. Hypothetically, this should lead to investment outperformance.

More, the authors argue that there are ESG investment opportunities across the investable universe, not just in US stocks. For the individual investor who desires sustainable investment practices, this means that a global diversified portfolio can be had without damaging long-term return prospects.

And Finally...

Okay, so this isn’t actually a study, but according to data compiled by Schwab, the KLD 400 Social Index, the longest running index of sustainable investments, actually outperformed the S&P 500 Index® from 1990 through January 2017. 

Once again, we see that over the long-term (which in this case is over 25 years), investing according to sustainability factors does not harm long-term investment returns.


And so there we have it. Though popular misconception is that investing consciously and sustainably inevitably harms long-term investment performance, the data simply does not back this up. Socially responsible investing, done right, is not high-risk, low reward. In fact, the socially responsible investor can achieve a diversified portfolio that is invested across global asset classes without necessarily hampering long-term financial success.