Investing Responsibly: Solid Returns, Positive Impact

Responsible Investments Are Competitive and Make an Impact, New Research Finds

Canadians increasingly want to invest in companies that act responsibly in our communities.

Investment surpassed $30 trillion USD in 2022 in funds that embrace ESG (environmental, social and governance) values, Bloomberg Intelligence reports. ESG assets are expected to top $40 trillion by 2030.

But many investors wonder whether ESG-friendly funds perform as well as other funds. They also often ask whether responsible investment really changes how businesses act. Does it really have an impact?

On both questions, research suggests the answer is yes.

Returns vs. values

At PWL, we have long championed evidence-based investment decisions. We rely on data to build portfolios that maximize risk-adjusted returns. We also embraced responsible investing many years ago because we believe in the importance of environmental and social responsibility and adhering to the highest ethical standards.

What exactly is responsible investing (sometimes also known as values-based or ESG investing)? Definitions and terminologies vary, but fundamentally, we believe it’s about promoting positive environmental, social and ethical corporate behaviour, while still meeting financial goals.

But how can we embrace the twin goals of responsible investing while maximizing returns? At PWL, we’ve devoted significant resources to understanding how to best implement responsible investing in a data-driven way. We also strive to share that research with you to explain our choices and support clients who prioritize responsible investing.

Positive performance and impact

In 2018, we analyzed ESG fund performance and impacts in a white paper and followed that up with an eBook in 2019. Both arrived at the same conclusions:

• ESG is a good investment

We found that an ESG portfolio is likely to have a similar risk-return profile as a non-ESG portfolio. In other words, ESG investors don’t sacrifice returns. In fact, some research suggested that companies with strong ESG practices performed better financially than their peers, though the evidence was less conclusive.

• Responsible investing has a positive impact

Many companies are changing their behaviour in response to investor and consumer concerns about corporate environmental and social impacts. Companies are increasingly mindful of the public’s concerns and taking them seriously.

Nearly four in five companies in the S&P 500 Index issued a sustainability report, most of which included environmental and social performance metrics, according to a 2018 review.

Still a sound choice

Since we issued our white paper and ebook, ESG investment has evolved and grown considerably. We wanted to update our research and find out what’s changed. Do our findings still hold true about the financial results and impacts of responsible investing?

Raymond Kerzérho, our Senior Researcher, reviewed 30 recent studies on ESG investing to find out. His conclusion: ESG investing is still a sound investment choice, and it does make a positive difference.

First, the financial results.

• Recent studies have found that ESG and corporate financial performance are positively correlated and that ESG disclosure has a positive effect on corporate financial performance.
• Findings were more mixed about the expected returns of ESG stocks. Of 19 recent studies on the relative expected returns of ESG and non-ESG stocks, 12 concluded that green firms have lower expected returns (though the return difference was not given in most of the papers). Three studies said ESG stocks have a higher expected return than non-ESG stocks, while the remainder found no difference or said ESG firms don’t have a higher expected return.

• One issue is that most of these papers don’t adjust returns for factor exposure. Factors are differentiating characteristics between companies that can affect their expected return, such as size, value, profitability and investment.

To address this gap, we took a look at two U.S.-listed DFA mutual funds (one ESG, the other non-ESG) with identical factor exposure. We found that they delivered returns that are statistically indistinguishable from one another.

As Table 1 below shows, both funds have very similar returns and standard deviations. The ESG-focused DFA U.S. Sustainability Core 1 Portfolio outperformed its non-ESG DFA counterpart in almost every timeframe, including by 0.32 percentage points over 16 years (a statistically insignificant difference).

The results can be seen in Chart 1, which shows essentially the same return on $100 invested since 2008 for both funds.

Table 1

Chart 1

We ran an analysis to confirm whether the two funds have similar factor exposure and found that indeed they do (see Table 2 showing data for 2008 to 2024).

Table 2

The results are evidence that investors can obtain similar risk-adjusted expected returns from an ESG portfolio versus a non-ESG portfolio with the same factor exposure.

DFA offers two funds for Canadian investors—one ESG, the other non-ESG—that have the same factor and country exposure as well. These two funds, however, have only 3 1/2 years of data, making it harder to make conclusions.

Based on the evidence, we believe it is possible to create an ESG portfolio with an identical factor exposure that has a very similar expected return to a traditional portfolio.

• This conclusion is in line with a 2021 study in the Financial Analysts Journal. It analyzed 1,312 U.S. equity mutual funds and found a strong positive relationship between fund alphas (risk-adjusted excess expected return) and factor exposure.

Funds with high ESG scores have different factor exposure than those with low ESG scores. In particular, funds with high environmental scores tend to have high quality and momentum factor exposure.

• These findings are consistent with research we cited in PWL’s ebook. Using a concept known as ESG integration, we reported that it is possible to underweight poor ESG stocks and overweight others with better ESG performance. More than 50 studies found that such an approach can allow the creation of a well-diversified ESG portfolio, free of negative risk-return characteristics.

Making a difference

The second question we explored in our new research was whether ESG investing actually makes a difference and has an impact. Here the evidence is straightforward. All studies that we identified on this topic found that ESG investing improves corporate behaviour.

• One study said that companies reduced their greenhouse gas emissions when green funds increased their stock ownership in the firms.
• Another study found that engaging with companies can be an effective way to influence many firms to act in socially beneficial ways.
• Responsible investing makes firms greener and shifts investment toward green businesses, producing a positive social impact, a third study

Institutions are driving change

Evidence is growing that responsible investing can allow investors to not only reflect their values, but also achieve competitive results.

Responsible investing isn’t for everyone. But it seems likely that interest will only increase as climate change progresses and public concerns grow about environmental and other impacts. Investors and consumers are likely to increasingly demand that businesses act responsibly.

Institutional investors are driving change, too. A survey by the Swiss Finance Institute found that institutional investors believe climate risks pose both financial implications and regulatory risks for their portfolio firms.

Good news for investors and the planet

As environmental, social and ethical concerns increase, responsible investing is becoming more attractive than ever.

Now research is making it clear that doing the right thing doesn’t have to come at a price. An ESG portfolio can achieve similar risk-adjusted returns as a non-ESG portfolio, while having a positive impact in our communities.

We can make a difference in the world while still achieving our personal financial goals. That’s good news for both investors and the planet.