Asking If “Sustainable Investments” Underperform Is Insufficient

Published: 18th November 2020 (5 Min Read)

I was surprised recently to read an article in the trade press which warned financial advisers that ESG oriented investments might provide disappointing performance compared to traditional portfolios. The author offered no evidence of this, but I believe his advice can be disputed, and is insufficient.

I recognise that “green bonds”, if bought at issue and held to maturity, are likely to underperform equivalent bonds which do not have the “green” moniker, because they start with a lower coupon. I think he was referring to equities, but of course if “greener” companies have a lower cost of debt, that may be an advantage for overall financial performance, and so benefit shareholders.

Sustainable equity portfolios are mainly actively run and are highly differentiated from their benchmark indices. This is made clear by their managers. If anyone wanted a sustainable equity fund to perform with a low tracking error to an equity index, then they might be disappointed. There will be times when they perform quite differently to any index, sometimes better, sometimes worse, but rarely in line with it. People who normally would have invested in a tracker or a passive portfolio might find this a challenge.

As far as absolute returns are concerned the history has been good. My colleague, Mark Arkwright, wrote about this earlier in the year: https://www.gbim.co.uk/news-insight/what-are-the-performance-implications-of-investing-sustainably/?c=6.

Good governance is typically an attribute of better performing companies, and ESG emphasises the need for good governance. There are however other style biases to consider.

Investment professionals seem to be moving towards acceptance that there are different approaches to ESG investing. As regulation in relation to it hones into view, a greater focus upon understanding exactly what the client wants in this respect is to be expected. The Social Finance Disclosure Regulations may be published in late 2020 or early 2021 and are likely to demand a clear understanding of clients’ sustainability preferences.

It seems to be pushing towards three broad categories: “having a clear conscience” by excluding a range of sectors, often known as “ethical” investing; embracing investment in companies which espouse the full range of ESG principles today; and engagement with companies which need to change which, if successful, could lead ultimately to significant impact socially, environmentally and financially.

Clearly the performance of these categories will not be uniform. Simple binary statements about performance are clearly inadequate.