Does ESG investing pay off?

ESG (Environmental, Social and Governance) and Sustainable Investments are among the significant topics of discussion in the financial world, where more and more investors express a desire to align their investments with their values.

Jun 06, 2023


Investment strategy

Isabella S. Rasmussen

At Aleta, we also witness a growing interest in ESG investments. At the same time, we are often confronted with the question of whether sustainable investing affects returns.

Based on current literature and our analyses, our assessment is that, overall, investing sustainably will not negatively impact your returns. However, it's important to emphasize that there are many different ways to invest sustainably, making it challenging to arrive at a one-sided conclusion.

The key arguments for and against ESG investments improving returns

The subject has been extensively debated since ESG investments emerged on the investment landscape. The primary argument in favor of ESG factors having an impact on company performance is that these considerations mitigate a wide range of risks that could otherwise harm a company's growth and long-term profitability.

Furthermore, sustainability has become a crucial aspect of societal discourse and an important factor for many investors. This leads to increased demand for products focused on sustainability and promotes returns.

On the other hand, the main counterargument is that opting for sustainable investments might lead to missing out on investment opportunities and returns. This stems from excluding certain companies from your investment universe, which could potentially provide extra returns.

The prevailing viewpoint often suggests that if you exclude the so-called "sinful" companies, others will invest in them instead, potentially leaving a higher expected return for investors who do not consider responsible investment in their investment decisions.

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While there is no single empirical conclusion, recent years have brought clearer results

There is still no definitive answer as to whether ESG investments are financially rewarding, aside from ethical and moral considerations. One of the significant challenges in reaching a common conclusion in this area is the wide variation in terminology within sustainable investment and the lack of a unified standard for ESG measurement.

This means, for example, that the same company can receive different ESG ratings from various analytical sources. It also means that analyses and studies examining the relationship between sustainability and performance can employ vastly different approaches. However, it appears that research over the last five years has yielded more consistent results.

In a meta-study from 2021, NYU Stern Center for Sustainable Business  and Rockefeller Asset Management analyzed over 1,000 studies in research articles from 2015-2020. Among the studies focusing on the relationship between sustainability and performance based on investment factors such as alpha or Sharpe ratio, 59% indicate that ESG investments yield similar or better results than conventional investment approaches. Only 14% show negative results.

Source: Data Sustainability Generate Better Financial Performance? Review, Meta-Analysis, and Propositions, 2021

The results thus indicate that as an investor, you should not be so afraid that it will cost you in returns if you choose to incorporate sustainability into your investment strategy. On the contrary, it suggests that companies with strong ESG ratings yield at least equally good results as conventional investments

It is essential to remember, however, that historical returns are never a guarantee of future returns. Additionally, the studies can only establish a correlation between a company's ESG rating and its financial performance, not explain the causality.

However, a recent study by the Swiss Finance Institute concludes that the performance of ESG investments over the past decade has primarily been driven by price pressure due to increasing demand for sustainable products. This has resulted in high realized returns that might not necessarily reflect high expected returns going forward.

Example: Returns on ESG ETFs beat the benchmark

As an example, we have compared three funds that consider sustainability with a comparable fund that does not. Specifically, we have compared the MSCI World ETF with three ETFs, all based on the MSCI World but incorporating different ESG factors.

You can see an overview of the funds below:

Source: Blackrock

As shown in the table above, MSCI World ESG Screened has the lowest rating among the three ESG ETFs, while MSCI World SRI has the highest ESG rating.

We have examined the performance of the three ESG ETFs in relation to the broader MSCI World index, considering the timing of each ETF's launch.

In all three cases, the ESG ETFs have outperformed MSCI World. This means that if you had simply invested in the broad index instead of one of the funds incorporating ESG factors, you would have missed out on additional returns.

Answering the big question: Does sustainable investment pay off?

We cannot provide you with a definitive answer, but all indications suggest that it does not significantly affect returns.

Our recommendation is therefore clear: If you are considering sustainable investing, go ahead and get started.

However, you should not invest in sustainability solely for the sake of extra returns, nor should you avoid it because you fear it will affect your returns. Ultimately, it is about making a positive impact on the world with your investments while also achieving good returns.

Our recommendation is for you to first consider your requirements and preferences for sustainability and how much weight it should carry in your portfolio. This way, you can develop an ESG strategy for your investments that can complement your current investment strategy, striking a balance between your goals for returns, risk, and sustainability.

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