Sustainable Investing: Establishing Long-Term Value and PerformanceSeptember, 14 2012
This is the key finding of Deutsche Bank report in which DB looked at more than 100 academic studies of sustainable investing around the world, and then closely examined and categorized 56 research papers, as well as 2 literature reviews and 4 meta studies – we believe this is one of the most comprehensive reviews of the literature ever undertaken.
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Frequently, Sustainable Investing is stated to yield “mixed results”. However, by breaking down our analysis into different categories (SRI, CSR, and ESG) we have identified exactly where in the sprawling, diverse universe of so-called Sustainable Investment, value has been found.
By applying what we believe to be a unique methodology, we show that “Corporate Social Responsibility” (CSR) and most importantly, “Environmental, Social and Governance” (ESG) factors are correlated with superior risk-adjusted returns at a securities level. In conducting this analysis, it became evident that CSR has essentially evolved into ESG. At the same time, we are able to show that studies of fund performance – which have been classified “Socially Responsible Investing” (SRI) in the academic literature and have tended to rely on exclusionary screens – show SRI adds little upside, although it does not underperform either. Exclusion, in many senses, is essentially a values-based or ethical consideration for investors.
We were surprised by the clarity of the results they uncovered:
- 100% of the academic studies agree that companies with high ratings for CSR and ESG factors have a lower cost of capital in terms of debt (loans and bonds) and equity. In effect, the market recognizes that these companies are lower risk than other companies and rewards them accordingly. This finding alone should put the issue of Sustainability squarely into the office of the Chief Financial Officer, if not the board, of every company.
- 89% of the studies we examined show that companies with high ratings for ESG factors exhibit market-based outperformance, while 85% of the studies show these types of company’s exhibit accounting-based outperformance. Here again, the market is showing correlation between financial performance of companies and what it perceives as advantageous ESG strategies, at least over the medium (3-5 years) to long term (5-10 years).
- The single most important of these factors, and the most looked at by academics to date, is Governance (G), with 20 studies focusing in on this component of ESG (relative to 10 studies focusing on E and 8 studies on S). In other words, any company that thinks it does not need to bother with improving its systems of corporate governance is, in effect, thumbing its nose at the market and hurting its own performance all at the same time. In the hierarchy of factors that count with investors and the markets in general, Environment is the next most important, followed closely by Social factors.
- Most importantly, when we turn to fund returns, it is notable that these are all clustered into the SRI category. Here, 88% of studies of actual SRI fund returns show neutral or mixed results. Looking at the compositions of the fund universes included in the academic studies we see a lot of exclusionary screens being used. However, that is not to say that SRI funds have generally underperformed. In other words, we have found that SRI fund managers have struggled to capture outperformance in the broad SRI category but they have, at least, not lost money in the attempt.