Over the course of the next couple of months, Ryan Nauman of Informa Financial Intelligence will take an in-depth look at the ESG investing landscape, from overall performance and risk to advantages/disadvantages to demand.
More and more, individuals and communities are placing heightened awareness on being environmentally conscious, whether that is through Earth Day events or beach cleanup days. These activities not only have a positive impact on the environment but also socially — who doesn’t enjoy a clean, green environment?
Environmental and social standards pertain to more than individuals and communities. Corporations have been doing their part as well, focusing on environmental, social and corporate-governance (ESG) standards and capturing the attention of Wall Street.
With momentum driven by investors, Wall Street firms are critiquing companies based on their sustainability factors or ESG standards. There is a growing belief that environmentally conscious companies that manage their internal and external relationships well and maintain strong corporate governance will experience sustainable growth into the future.
Some investors may feel morally compelled to invest in companies that follow the strict ESG guidelines, while others may consider ESG funds strictly on performance. Thanks to MSCI and MSCI ESG Research, financial advisors can provide information regarding the performance of ESG funds, and help their clients determine if sustainable investing really pays off or if a “returns at all cost” approach is more suitable for their client’s portfolios.
Below we provide some return and risk analytics to help financial advisors come to conclusions regarding ESG-style investing.
Looking at 1-year, 3-year, 5-year and 7-year annualized returns (Figure 1), the MSCI USA ESG index and MSCI WORLD ESG index have outperformed their respective parent indexes, MSCI USA and MSCI World, in the near term. However, that outperformance shifts to underperformance during longer time periods. The same trend is apparent when comparing the ESG indexes to the S&P 500 index.
Now, we would be remiss if we only looked at returns. One could surmise that investing in companies that follow ESG standards should reduce the risk of your portfolio, given that strong corporate governance is one of the three pillars. As you can see in the Risk/Return graph and table below (Figure 2), both MSCI USA ESG and MSCI WORLD ESG indexes exhibit less risk than their respective parent index over five years, however, both ESG indexes have lower returns and Sharpe ratios. It’s safe to say, that over the past five years, ESG strategies are indeed less risky. The smaller Sharpe Ratio also indicates that if you are looking for an investment that optimizes returns per level of risk, you are better off investing in the broad market.
Figure 3 provides more detail regarding the risk of the different indexes, more specifically, drawdown risk. As expected, the indexes that contain ESG mandates exhibit superior downside protection compared to their broader parent index.
Time will tell if companies that follow ESG standards do experience sustainable growth, but investing in these strategies comes down to more than just numbers. Investors who fund ESG strategies are voting for a clean environment with their wallets. Look around to see which corporations are working to improve the environment, support charities and help the less fortunate. Keep those companies in mind for clients who seek strategies that aim to do more than grow their portfolio and protect the environment.
— More by Ryan Nauman on ThinkAdvisor:
- In Fund Manager Game, Consistent Base Hits Beat a Few Home Runs
- Solving the Issues Caused by Target Date Funds
- Using Sharpe’s ‘Tracks in the Sand’ to Build Better Portfolios
Ryan Nauman is a market strategist at Informa Financial Intelligence. His primary focus is providing value-added market and investment insight along with educating buy-side participants on investment analytics and portfolio management concepts. Before joining Informa Financial Intelligence in 2012, Ryan spent over a decade in the investment management industry as an investment associate while overseeing more than $1 billion in assets. Ryan holds a B.S. in business computer information systems from St. Cloud State University.