ESG Investors Weight Performance and Moral Considerations

There are many ESG or impact investment programs available, some of which will outperform and many more that will not.

By John Manganaro | November 15, 2016
Page 1 of 3 View Full Article

As more and more assets are invested in portfolios that consider environmental, social and governance (ESG) factors, researchers are attempting to better measure the effectiveness of so-called “impact investing,” both in terms of financial performance and as it pertains to meeting the moralistic goals of ESG.

According to a new analysis published by the Center for Retirement Research at Boston College, “New Developments in Social Investing by Public Pensions,” public pension funds continue to engage in social investing, most recently divesting from Iran and fossil fuels, for example. Other institutional investors, from corporate-sponsored 401(k) plans to university endowments, are making investments that utilize “ESG screens,” and still more are instituting a combination of traditional and ESG investing.

CRR observes there is an increasing amount of empirical evidence across each of these approaches that shows incorporating ESG factors into investment decisions can at least marginally improve the investment selection process and enhance risk-adjusted returns. After all—it’s no real surprise that publically traded companies that utilize their resources more efficiently and which process waste and address social/environmental challenges more skillfully than their competitors would also perform better financially, especially over long-term investment horizons.

However, as in the wider market, there are many ESG or impact investment programs available, some of which will outperform and many more that will not. Put simply, CRR says social investing by large-scale institutions is no sure-fire financial bet, and in fact such investing is more likely to be detrimental to performance when it is so rigid as to declare whole market segments, such as oil and gas development, off limits. Further, especially in the public pension context, ESG investing can “conflict with the views of beneficiaries and taxpayers, and interfere with federal policy.”

CRR adds that social and environmental investing is often not very effective from a moralistic standpoint, either—because there is still a preponderance of market participants who have no interest in ESG or impact investing. In practice, as one large university endowment drops its shares in an over-polluting petrochemical company, for example, other investors happily step in to buy the divested stocks, potentially at a discount due to the large volume being traded. Until this paradigm shifts, it will be very difficult for ESG investments to deliver on their stated ethical and moralistic goals.

CRR concludes that, at least for public pensions in which public taxpayer dollars are being invested and for which the state carries the ultimate benefit liability, it is not an appropriate time to engage in social investing. 

NEXT: Agreement and disagreement from other providers