Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 197

Can socially responsible investing and good returns coexist?

“Do the right thing. It will gratify some people and astonish the rest.” Mark Twain

In the past few years, there has been a significant increase in the interest in environmental, social and governance (ESG) investing. According to a paper released recently, more than $8 trillion of the $40 trillion of money managed in the USA is now under some form of Sustainable and Responsible Investing (SRI) or ESG, up 33% since 2014 and up fivefold from $1.4 trillion in 2012 for money run by fund managers.

Australian fund managers caught unready for this change

If we look at the Mercer survey data for January 2017, the Global Equities strategy section contains 127 global funds sold in Australia. Of this, only five are classed as SRI funds. It is somewhat better for Australian equities with 157 funds in the survey, of which 13 are SRI. If we were to use the ratio of assets in the USA, the number of SRI funds should be 27 and 34 respectively.

One reason could be the view among many people, particularly fund managers, that ‘you can’t have your cake and eat it, too’, that SRI means lower returns for investors.

This misconception of accepting lower returns for being ethical goes against another tenet of conventional investing wisdom: buy good businesses. In his letters to Berkshire Hathaway shareholders, Warren Buffett often discusses the importance of ethics and the quality of the character of the people running the businesses he owns.

Implicitly he is saying that businesses which have an ethos and focus on ‘doing the right thing’ by staff and customers should generate higher returns. Admittedly, he is discussing the character of the people rather than the nature of the business, and some people would find owning Coca-Cola shares unethical. It’s this differentiation between good people and bad unethical businesses that opens an interesting next line of inquiry.

What do the statistics say?

UBS recently published an excellent summary of academic literature which concluded that SRI did not negatively affect investor returns.

Verheyden, Eccles & Feiner (2016) wanted to look at whether a portfolio manager would be at a disadvantage in terms of performance, risk, and diversification if he/she were to start from a screen based on ESG criteria. The empirical evidence shows that all ESG-screened portfolios have performed similarly to their respective underlying benchmarks, if not slightly outperforming them. Put differently, the findings of the paper show that, at the very least, there is no performance penalty from screening out low ESG-scoring firms in each industry.

This is consistent with our own experience as portfolio managers at Hunter Hall, where we outperformed against an all-inclusive benchmark, despite having a restricted ownership list.

Nagy, Kassam & Lee (2016) wanted to see not only if highly-rated ESG companies outperform, but if businesses are rewarded for improving, going from okay to good? The answer was unequivocally yes. Both outperformed, but the improvers outperformed at double the rate.

The most interesting article by Statman and Glushkov (2016) created what they called 'Top Minus Bottom' (TMB) where stocks were ranked on their ESG criteria and then modelled how being long the ‘better-ranked’ versus the ‘worse-ranked’ performed. This concept is similar to the studies above and could be called the ‘good screen’.

The innovation was to look at ‘Accepted Minus Shunned’ (AMS) separately. Here the authors looked at the returns from stocks commonly accepted in SRI funds versus those that are typically avoided. Shunned companies are those with operations in the tobacco, alcohol, gambling, military, firearms and nuclear industries. Call this the “negative screen”.

Like the earlier studies, it was found TMB outperformed the broader market but interestingly the AMS (the bad screen) stocks didn’t outperform, that is, the excluded stocks did better than the broader market. But AMS under-performed by less than the TMB screen outperformed. That is, it was a net positive for investors. I think it is this AMS effect that fund managers have focused on in their view that SRI/ESG does not work.

What does this mean for fund managers?

Investors globally are demanding more focus from their fund managers on ESG issues. The implications of these studies are that ESG does not detract from returns and investors are therefore not irrational to ask for more focus on ESG and SRI issues by their money managers.

But it also says running a positive screen in combination with running a negative screen is a better way to generate returns for investors while also satisfying investor’s ethical investment needs.

 

Chad Slater, CFA, is Joint CIO of Morphic Asset Management. This article is general information that does not consider the circumstances of any individual.

RELATED ARTICLES

Top 10 ESG issues for 2019

Is the fossil fuel narrative simply too convenient?

Elevating responsible investing to solve real world challenges

banner

Most viewed in recent weeks

Maybe it’s time to consider taxing the family home

Australia could unlock smarter investment and greater equity by reforming housing tax concessions. Rethinking exemptions on the family home could benefit most Australians, especially renters and owners of modest homes.

Supercharging the ‘4% rule’ to ensure a richer retirement

The creator of the 4% rule for retirement withdrawals, Bill Bengen, has written a new book outlining fresh strategies to outlive your money, including holding fewer stocks in early retirement before increasing allocations.

Simple maths says the AI investment boom ends badly

This AI cycle feels less like a revolution and more like a rerun. Just like fibre in 2000, shale in 2014, and cannabis in 2019, the technology or product is real but the capital cycle will be brutal. Investors beware.

Why we should follow Canada and cut migration

An explosion in low-skilled migration to Australia has depressed wages, killed productivity, and cut rental vacancy rates to near decades-lows. It’s time both sides of politics addressed the issue.

Are franking credits worth pursuing?

Are franking credits factored into share prices? The data suggests they're probably not, and there are certain types of stocks that offer higher franking credits as well as the prospect for higher returns.

Are LICs licked?

LICs are continuing to struggle with large discounts and frustrated investors are wondering whether it’s worth holding onto them. This explains why the next 6-12 months will be make or break for many LICs.

Latest Updates

A nation of landlords and fund managers

Super and housing dwarf every other asset class in Australia, and they’ve both become too big to fail. Can they continue to grow at current rates, and if so, what are the implications for the economy, work and markets?

Economy

The hidden property empire of Australia’s politicians

With rising home prices and falling affordability, political leaders preach reform. But asset disclosures show many are heavily invested in property - raising doubts about whose interests housing policy really protects.

Retirement

Retiring debt-free may not be the best strategy

Retiring with debt may have advantages. Maintaining a mortgage on the family home can provide a line of credit in retirement for flexibility, extra income, and a DIY reverse mortgage strategy.

Shares

Why the ASX is losing Its best companies

The ASX is shrinking not by accident, but by design. A governance model that rewards detachment over ownership is driving capital into private hands and weakening public markets.

Investment strategies

3 reasons the party in big tech stocks may be over

The AI boom has sparked investor euphoria, but under the surface, US big tech is showing cracks - slowing growth, surging capex, and fading dominance signal it's time to question conventional tech optimism.

Investment strategies

Resilience is the new alpha

Trade is now a strategic weapon, reshaping the investment landscape. In this environment, resilient companies - those capable of absorbing shocks and defending margins - are best positioned to outperform.

Shares

The DNA of long-term compounding machines

The next generation of wealth creation is likely to emerge from founder influenced firms that combine scalable models with long-term alignment. Four signs can alert investors to these companies before the crowds.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.