Sustainability has become a ubiquitous concept, and goal, within a swath of industries, and investment is no exception. In fact, sustainable investing is taking the investment world by storm. So what is sustainable investing and should you consider it for your own investment portfolio?
Sustainable investing is the full integration of environmental, social and governance factors into investment analysis and decision making. Imagine you just inherited $5,000 and you want to invest it. Your financial advisor recommends two hot stocks that she thinks will outperform the market over the next several years, but you can only invest in one of them because there is a minimum investment of $5,000. You ask your broker to recommend one of them and she says the two stocks are virtually identical: They're in the same industry, have similar product lines, trade at almost the same price, and have similar price-to-earnings ratios, revenues, and cash flow. It's a coin flip, she says. So, you Google the two companies and start doing some research on your own.
You learn that Company A was recently named one of the Best 100 Companies to Work for in America, that four women serve on its nine-member board of directors and that it recently agreed to submit CEO and other top executive pay packages to its shareholders for approval. You also learn that Company A has launched an initiative to reduce its greenhouse gas emissions by 50 percent, to be completely carbon neutral within five years and was named one of 50 green leaders by Business Week magazine for its efforts to integrate environmental stewardship into its business model.
Company B, on the other hand, was fined by the Environmental Protection Agency a few years ago for illegally discharging toxic waste into a river. The CEO, who is also chairman of the company's board of directors, was quoted at the time as saying, these silly laws cost jobs and hurt businesses just to please the tree-hugger lobby. The company's seven board members are all white males, and its diversity problems don't end there. Several former African-American employees recently brought suit against Company B alleging racial discrimination in its hiring, promotion and employment policies.
Which company would you invest in? That's a rhetorical question, of course, as the obvious answer is Company A.
The more
interesting point, however, is the reasoning behind your answer. In choosing
Company A over Company B for your investment, you are actually saying something
about investing, and about markets, that is the central insight of sustainable
investing: that a company's
environmental, social and governance (ESG) record is relevant; that ESG factors are material from a financial
perspective, and therefore from an
investor perspective.
A growing body of research supports this view:
The Association of British Insurers found that between 2002 and 2007, the stock prices of well-governed companies delivered an additional 37 basis points per month, adjusted both for industry and for risk.
The Corporate Library designed a hypothetical portfolio using corporate governance screens that excluded high-risk companies and found that the portfolio outperformed its benchmark by 2.75 percent over a seven-year period, and that 1.21 percent of this outperformance was stock-specific and directly attributable to the governance risk ratings.
Innovest Strategic Value Advisors, a division of MSCI, has conducted studies showing higher returns for companies ranked highly by eco-efficiency measures, outperforming both a market proxy and companies with lower rankings.
The Goldman Sachs GS Sustain initiative reports, Companies that are considered leaders in ESG policies are also leading the pack in stock performance by an average of 25 percent.
I could go on but you get the picture: There is now substantial evidence linking ESG or sustainability performance with financial performance.
The premise underlying sustainable investing is as elegant in its simplicity as it is potentially transformative in its implications. Companies that do a better job integrating ESG or sustainability factors into their business models are better positioned than their less enlightened competitors to provide investment performance over the long term. Thus, combining rigorous financial analysis with equally rigorous ESG analysis in order to identify those companies is arguably a better, smarter way to invest-avoiding the risks associated with substandard ESG performers and capturing the benefits associated with superior ESG or sustainability performers.
Over the next few decades, market capitalism will need to undergo a sustainability revolution equal in significance to the Industrial Revolution that ushered in the modern period. This transition from an industrial age economy powered by coal and oil to a sustainable economy powered by clean energy and new technologies will unleash a new era of economic and investment opportunities. Sustainable investing is an investment approach that not only seeks to hasten this historic transformation, but to harvest the investment returns associated it.
Sustainable investing represents a new investment approach for the new epoch-a potentially transformative investment approach that can align positive investment outcomes with positive societal and environmental outcomes. Good for investors, good for corporations, good for markets, and right for the times. Perhaps it's time to ask your financial advisor or 401(k) administrator about sustainable investing options for your portfolio. n
Joe Keefe is president and CEO of Pax World Management LLC and Pax World Funds in Portsmouth, manager of approximately $2.7 billion in assets including mutual funds, ETFs and separate accounts, all of which follow a sustainable investing approach. For more information, visit www.paxworld.com.