Does ESG investing produce better stock returns?
9 in 10 asset managers believe that integrating ESG analysis into their investment strategy will improve long-term returns, and a majority of institutional investors have reported that their ESG products have outperformed traditional counterparts.
The evidence from academic research and industry reports shows that there is no trade-off between investing in ESG portfolios and achieving competitive returns. On the contrary, ESG investing may offer some benefits in terms of lower volatility, higher resilience, and better alignment with long-term trends.
(2017)] and [Pedersen et al. (2021)] is that the more ESG- sensitive investors there are, the higher the demand for firms with better ESG performance. Higher investor demand will translate into higher stock prices and subsequently lower stock returns.
Some studies suggest that companies with high ESG scores tend to outperform the market, while others indicate no significant difference. The relationship between ESG factors and stock performance may vary based on the time horizon, sector, and region. Q: How can I identify ESG stocks?
“ESG characteristics are important, but so are more traditional metrics like cost,” he says. “Expense ratios for ESG funds have decreased over the years, but they are still higher than other funds on average.” That means you may be paying a slight premium to invest in funds that are targeting ESG criteria.
However, there are also some cons to ESG investing. First, ESG funds may carry higher-than-average expense ratios. This is because ESG investing requires more research and due diligence, which can be costly. Second, ESG investing can be subjective.
A Look at the Attributes of ESG Companies
However, the table below shows that we also saw an inverse relationship between ESG score and monthly return: The Better ESG portfolio had a monthly return of 0.89%, compared with 1.06% from the Worse ESG portfolio.
A lot of their underperformance is thanks to missing on just a handful of tech stocks, according to a report from Morningstar. Last year, 82 out of Morningstar's 146 sustainability indexes underperformed their non-ESG equivalents, making 2023 the second worst performing year on record, after 2022.
Globally, ESG Leaders earned an average annual return of 12.9%, compared to an average 8.6% annual return earned by Laggard companies. This represents an approximately 50% premium in terms of relative performance by top-rated ESG companies.
ESG performance improves stock price synchronicity by reducing information asymmetry. The “noise reduction” effect of ESG performance is significantly lower in non-state-owned enterprises and enterprises with low investor trust.
Why are people against ESG investing?
Critics of ESG — such as a group of Republican states that banned Blackrock and other “ESG friendly” asset managers from their state pension plans — argue that considering environmental and social factors violates the fiduciary duty that asset managers have towards their clients.
Investors increasingly believe companies that perform well on ESG are less risky, better positioned for the long term and better prepared for uncertainty. Companies that realign to the stakeholder capitalism agenda may have a competitive advantage over those that try to return to business as usual.
In its basic form, greenwashing uses manipulation and misinformation to garner consumer confidence around a company's environmental, social or governance (ESG) claims.
| Pros | Cons |
|---|---|
| Can help investors diversify their portfolio | ESG funds may carry higher than average expense ratios |
| May reduce portfolio risk | ESG investing is still a fairly new concept and there isn't a ton of reporting on performance |
| Rank | Name and Ticker | Market Cap (billions) |
|---|---|---|
| 1 | Nvidia (NASDAQ:NVDA) | $1,520 |
| 2 | Microsoft (NASDAQ:MSFT) | $2,952 |
| 3 | Best Buy (NYSE:BBY) | $15.7 |
| 4 | Adobe (NASDAQ:ADBE) | $279.2 |
Despite of current economic challenges, ESG investments have shown to increase profits by 9.1% over the last three years, making it a smart investment choice.
ESG investing reflects an approach to ethical decision making known as the common good framework. Those who appeal to the common good claim that we ought to cooperatively work towards establishing systems, institutions, and environments that benefit all stakeholders.
The success of ESG investing depends in some part on government policy. If legislators make a law which rewards ethical investing decisions, the funds can benefit greatly. A good example is policies which incentivise electric car purchases.
“ESG is considered to be a progressive cause,” says Maloney. “Proponents argue that traditional shareholder capitalism is too narrowly focused on returns to shareholders while ignoring negative impacts on non-shareholders. ESG is offered as an alternative that expands the scope of issues considered by fiduciaries.”
Six predictions for ESG in 2024: The year ESG emerged from fad to essential business. This year, 2024, will be the one in which companies will begin to take environmental, social & governance (ESG) activities seriously, proving once and for all that ESG is here to stay.
Do 85% of investors consider ESG?
The survey, which canvassed opinions from 250 C-suite executives and 250 global investors, also revealed that 84% of executives see ESG as a key to a more robust corporate strategy. Additionally, 85% of investors believe that ESG investments lead to better financial returns and more resilient investment portfolios.
Why have some Republican officials criticized ESG investing? Republican politicians have criticized ESG because they say they consider it an effort to use financial tools for the purpose of advancing liberal political goals.
One of the biggest criticisms of ESG is that it perpetuates what it was partly designed to stop – greenwashing.
The ESG movement, originally driven by good intentions, has been co-opted by lobbyists, special interest groups and various NGOs, and recent reviews have revealed its lackluster performance in creating meaningful environmental change and have highlighted chronic abuse of flawed methodologies.
This makes ESG priorities a powerful resource to find companies with the greatest potential for long-term resilience. According to a 2021 Morgan Stanley's report, ESG investments consistently outperformed their traditional counterparts between 2004 and 2020.
