Head to head: Does ESG investing actually enhance returns?

ESG investing, often referred to as responsible investing, is still in its infancy and we’ll continue to see this space evolve over the coming years.

Does it enhance returns? I think it’s much more complicated than a simple yes or no answer. However, I do think it can help improve the risk-return profile of a portfolio.

Read: Investors cite returns, risk management as drivers for ESG integration

ESG isn’t just about impact investing or negative screening. We also tend to focus more on the ‘E’ than the ‘S’ and ‘G.’ At least for myself, I seem to always think about the environment and climate change first when I hear ESG. But social and governance factors are also very important, especially when analyzing a company or investment portfolio to invest in.

ESG is a new risk to portfolios and, just like interest rate risk or currency risk, I think it should be considered in the investment analysis process. If you’re determining whether to invest in company A or B and company A has started integrating ESG into their business while company B has not, then I’d argue that company A has a better risk-return profile.

Of course, considering everything else is equal, this is where ESG factors have the potential to improve long-term outcomes. If all else is similar when analyzing two potential investments, ESG can be a sort of tiebreaker.

Read: Clear, consistent guidelines required for integrating sustainability in investment decisions in Canada: report

At Canada Post, we’ve recently updated our pension plan’s statement of investment policies and procedures to reflect our ESG beliefs. We believe ESG factors can have a material financial impact on investment performance, particularly over the long term, and should be considered in the investment process. We also expect fund managers to have a strategy and approach to managing ESG-related risks and opportunities.

Amr Addas, adjunct finance professor at Concordia University’s John Molson School of Business

The industry has long asked the question of whether taking ESG factors into consideration when making investment decisions enhances returns.

While the approach is often referred to as ESG investing, a more accurate term, in practice, is sustainable investing. The evidence unequivocally indicates that, at the very least, sustainable investing doesn’t destroy value. More often than not, it enhances returns, reduces risk or a combination thereof.

Read: Majority of global institutional investors implementing sustainable investing: survey

The return profile of sustainable investing ultimately depends on whether that policy successfully incorporates material factors into the investment decision. Not all ESG factors are material for every industry. Good governance is generally an indicator of a well-managed firm regardless of the industry, but environmental factors matter far more for an oil and gas company, for example, than they do for a telecommunications company, whereas social factors are more material for a health-care or technology stock than for a utility. Successfully identifying relevant material factors is key to value creation within a sustainable investing strategy.

Evidence from a 2021 study by New York University’s Stern School of Business and Rockefeller Asset Management International Ltd. adds credence to this argument. In a review of more than 1,000 studies conducted between 2015 and 2020, the study examined the relationship between organizations’ ESG activities and their financial performances.

Among investor-focused studies, 33 per cent showed a positive relationship, 26 per cent were neutral, 28 per cent were mixed and 14 per cent showed a negative relationship. When the studies focused on climate-driven strategies, investor studies showed the positive relationship jumped to 43 per cent of studies, confirming that climate change is by far the most material of all ESG factors.

Read: Report urges pension plan fiduciaries to focus on finance when considering ESG factors