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

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

Chinese steel - building a Sydney Harbour Bridge every 10 minutes

China's steel production, equivalent to building one Sydney Harbour Bridge every 10 minutes, has driven Australia's economic growth. With China's slowdown, what does this mean for Australia's economy and investments?

With markets near record highs, here's what you should do with your portfolio

Markets have weathered geopolitical turmoil, hitting near record highs. Investors face tough decisions on valuations, asset concentration, and strategic portfolio rebalancing for risk control and future returns.

Latest Updates

Retirement

The best way to get rich and retire early

This goes through the different options including shares, property and business ownership and declares a winner, as well as outlining the mindset needed to earn enough to never have to work again.

Shares

Boom, bubble or alarm?

After a stellar 2025 to date for equities, warning signs - from speculative froth to stretched valuations - suggest the market’s calm may be masking deeper fragilities. Strategic rebalancing feels increasingly timely.

Property

A perfect storm for housing affordability in Australia

Everyone has a theory as to why housing in Australia is so expensive. There are a lot of different factors at play, from skewed migration patterns to banking trends and housing's status as a national obsession.

Economy

Which generation had it toughest?

Each generation believes its economic challenges were uniquely tough - but what does the data say? A closer look reveals a more nuanced, complex story behind the generational hardship debate. 

Shares

Is the iPhone nearing its Blackberry moment?

Blackberry clung on to the superiority of keyboards at the beginning of the touchscreen era and paid the ultimate price. Could the rise of agentic AI and a new generation of hardware do something similar to Apple?

Fixed interest

Things may finally be turning for the bond market

The bond market is quietly regaining strength. As rate cuts loom and economic growth moderates, high-quality credit and global fixed income present renewed opportunities for investors seeking income and stability. 

Shares

The wisdom of buying absurdly expensive stocks (or not!)

Companies trading at over 10x revenue now account for over 20% of the MSCI World index, levels not seen since the dotcom bubble. Can these shares create lasting value, or are they destined to unravel?

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.