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Sustainable Investing: Does it lower your returns?

Sustainable investing is the practice investors use to focus on environmental and social goals while maximizing profits. ESG integration is a commonly used example of sustainable investing.

ESG integration is a method of making investment choices based on a company's environmental, social, and governance (ESG) positions and financial performance.

ESG has been a popular topic in both investing circles, and in popular media. Much of the positive public attention focuses on ESG’s commitment to doing good in the world. On the other hand, critics say that ESG is unprofitable and can damage corporations. We will look at the issue of profitability and discuss differences in how ESG supporters and critics view the topic.

ESG: Does It Really Decrease Returns?

In short, no. Over the last five years, stock funds that had companies with positive ESG scores outperformed competitors across global markets according to research that ESG Book shared with Reuters. They found that companies with higher governance scores tended to outperform at a higher rate than those with better social scores.

Why Do Critics Say ESG Reduces Profit?

Critics say that by limiting investments to firms with positive ESG scores, investors have fewer companies to choose from and therefore are reducing their potential profits. One critic, Adam Seessel echoed this sentiment in Barrons, stating “Any restriction inhibits choice—that’s why it’s called a restriction—and limiting choice limits someone’s ability to perform.” This sentiment views ESG as, primarily, a method of limiting choices, but supporters argue that there is a more complex strategy involved.

ESG investors believe that companies with positive ratings are durable, adaptable, and risk-averse. Proponent George Serafeim, responding to Seessel's criticism, told Barrons “From an investor’s standpoint, a sustainable company is one positioned for long-term success, one whose management understands and addresses short-term risks and innovates to exploit long-term opportunities.”

Investors who don’t pay attention to how a company manages ESG issues may have more choices but, ESG proponents would say they also have more risk. For example, companies that ignore the importance of supply chain sustainability put their companies at risk of disruptions that lower profitability. Companies that ignore human rights issues risk having public scandals that reduce their brand value and hurt stock prices.


How Does Strong ESG Performance Increase Profit?

McKinsey Journal outlines 5 key ways that ESG increases profit: top-line growth, reduced costs, improved governmental relations, increased productivity, and optimized investments and assets.

1. Growth of the Top-Line

Firms with strong ESG propositions attract customers and business relationships based on their commitment to sustainability. Corporations with a commitment to sustainability are also trusted by governing authorities, leading to increased opportunities. One example cited by McKinsey is a recent Long Beach, California public-private infrastructure project. The decision-makers chose for-profit companies to work on the large project based on their record on sustainability.

2. Reduction of Costs

Companies that reduce their water consumption and energy usage save money. McKinsey’s research found that companies that effectively implement ESG can reduce operational expenses by up to 60%. 3M has been a long-term example of how improving environmental factors can reduce costs. Their pollution prevention program first started in 1975, has saved the company $2.2 billion. They achieved these staggering savings by recycling, making products more environmentally friendly, and focusing on improved manufacturing and equipment.

3. Governmental Relations

Both a commitment to environmental issues and strong governance are strong assets for firms. Positive ESG ratings can help reduce the risk of government action. According to McKinsey, “typically one-third of corporate profits are at risk from state intervention.” The cost of state intervention can be astronomical with the potential for companies to lose up to 60% of profits, depending on the industry.

4. Productivity

A strong commitment to ESG can help companies acquire talent and keep them happy. Employees tend to have a greater passion for work when they are united by a common mission. Companies that are invested in top-notch governance, and sustainability tend to have higher job satisfaction and productivity. Mars is leading the way by focusing on “wins-wins-wins” for the environment, its suppliers, and its company. They have shown their dedication to employees by giving their farmers opportunities to access capital and providing tech initiatives.

5. Optimized Investments and Assets

Companies can improve their returns by dedicating capital to sustainable opportunities like renewables, waste reduction, and scrubbers. ESG companies are looking to the future and that can give them exciting opportunities. China’s recent commitment to fight air pollution is a recent standout. By 2030 it is predicted that the move will create new investment opportunities exceeding $3 trillion in a wide range of industries from air purification to cement mixing.


ESG Investing is about Social Good AND Profit

Much has been said about ESG’s dedication to social good. It’s right there in the name, Environmental, Social, and Governance focused investing. But what some newer investors may not initially realize is that the focus on these three guideposts is just as much about profit as it is about positive change. The guideposts of sustainability, ethics, and transparency reward a long-term mindset and innovation. When we invest in ESG we are investing in the future and profiting in more ways than one.

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