Do you have to sacrifice financial returns to invest responsibly?
Sustainable funds provide both financial performance and lowered risk, as well as ways to invest responsibly.
Responsible investment aims to generate good returns whilst also making a positive contribution to our society and environment. Despite growing evidence to the contrary, questions persist about the need to sacrifice financial returns to achieve these goals.
There have been a series of academic studies since 2000, that all point towards statistically equal performance between sustainable and traditional funds. Yet more individual investors believed in 2020 that sustainable investing required a financial trade-off (70%) than in 2019 (64%). Millennials believe in the trade-off myth (83%) more than any other age group (70% for all investors) yet remain the most interested in sustainable investing.
The academic findings that the returns of sustainable funds are inline with traditional ones is supported by recent research by Morgan Stanley. Its white paper, “Sustainable Reality: Analyzing Risk and Returns of Sustainable Funds,” Morgan Stanley presents an analysis of 10,723 funds, using Morningstar data on exchange traded and open-ended mutual funds active in any given year from 2004-2018. The key findings:
There is no financial tradeoff in the returns of sustainable funds and traditional funds. No consistent or statistically significant difference in total returns existed between ESG-focused and traditional mutual funds and ETFs.
Sustainable funds may offer lower market risk. Sustainable funds experienced a 20% smaller downside deviation than traditional funds, a consistent and statistically significant finding.
The results of the study are shown in exhibit 1 below. What is striking is that the returns on sustainable and traditional funds are very similar. While the difference in returns vary slightly in a given year, most of these differences are not statistically significant. There is also no consistency in the direction or size of the differences. In short, the returns are for all practical purposes the same.
Exhibit 1: The relative performance of sustainable and traditional U.S equity funds shows no trade-off in financial performance from 2004-202
Most recent analysis by Morgan Stanley found that US sustainable equity funds outperformed traditional peer funds in 2020 by a median of 4.3 percentage points. This followed two previous years of outperformance. While this may have led to expectations that sustainable funds outperform traditional ones, there is currently no evidence that this is the case.
In short, sometimes sustainable funds do a little better and sometimes they do a little worse. Over the longer-term, the returns have been the same. Responsible investment does not require a financial trade-off nor is it a way to beat the market.