INVESTOR HUB

Financial or ethical performance – can you have both?

November 2018 

New Zealand can justifiably be proud of its reputation of having some of the highest levels of social standards and human freedom in the world. We are often considered as one of the least corrupt countries, frequently top global surveys as one of the most liveable places and our “clean and green” image is driven by our desire to preserve our environment. This reputation has been built by generations of Kiwis whose culture and social fabric has always placed high importance on issues such as equality, opportunity and sustainability. 

It is not surprising that many New Zealanders have high ethical considerations when it comes to where their money is being invested.

Despite many Kiwis having high ethical standards, many have still not taken up investing in socially responsible investment (SRI) funds. One of the reasons often mentioned, aside from general lack of awareness that these types of funds exist, is the concern around performance. 

So, do SRI investment strategies underperform conventional investment strategies? 

One of the assumptions around underperformance of SRI is that it has a smaller number of investment opportunities and therefore this affects the potential for maximising returns. For example, SRI tends to avoid large oil and gas exploration companies, due to the obvious reasons associated with their impact on the environment. When oil prices experience big rises or dips, it can cause significant differences in performance between a conventional and a SRI strategy and this can make some investors nervous. However, there is plenty of evidence against this showing SRI can provide investors with similar return outcomes as conventional investment strategies. 

By comparing the historical performance track record of the widely followed MSCI World Index* and its sister SRI equivalent, the MSCI World SRI Index, we can see the MSCI SRI index outperformed by more than 9% (or 0.5% on an annualised basis) since its inception back in September 2007. 

In fact, the performance of the two indices has been consistent in both direction and level of volatility. This also highlights the power and importance of effective portfolio construction since the MSCI World SRI Index is much smaller in terms of the number of constituents (companies represented within the index). Generally, it is has been made up of around 400 companies whereas the MSCI World Index is four times larger with more than 1,600 companies.

MSCI

Source: MSCI - https://www.msci.com/documents/10199/641712d5-6435-4b2d-9abb-84a53f6c00e4
 

SRI places a lot of emphasis on risk management

One of the key objectives of SRI is to understand risk, not just financial ones, but also risks related to environmental, social and governance (ESG) issues. ESG risks are real and tangible, but usually not taken as seriously by the market as financial risks are. ESG analysis requires an in-depth and qualitative assessment of how exposed a company is across a range of ESG issues. It forces you to take into account more risks and therefore get a better understanding of the quality and long-term sustainability of that company.

ESG screening is very different to exclusions/negative screening. 

Negative screening simply excludes companies in undesirable sectors such as tobacco, gambling and weapons manufacturing, to name a few. It is an overly simplistic methodology and there is still a chance that badly behaving companies could end up in your portfolio. ESG screening is more powerful than negative screening as it captures those companies that pass the “undesirable” test but actually have unethical business practices or are severely harming the society or the environment.

An example of unethical behaviour and of a risk that is probably every investor’s worst nightmare is corporate fraud. Any company, either in an undesirable or desirable industry could engage in fraudulent activity. If caught, this company could likely incur severe financial penalties and legal ramifications and investors would immediately experience a large decline in value of their investment. However, with comprehensive ESG analysis these risks could be mitigated. Companies with good corporate governance are often led by high quality and devoted management teams, have effective boards in place and have better risk, audit and compliance controls. Therefore, through comprehensive governance analysis and targeting investments in companies with good governance profiles you are significantly mitigating these types of risks.   

“Companies with strong ESG profiles are more competitive, generate higher profits and are less vulnerable to market shocks.”

ESG incorporation is widely recognised by many researchers and investment institutions. MSCI, an independent entity recognised for their ESG research, published a study earlier this year, “Foundations of ESG Investing (Part 1)”  where they argue that companies with strong ESG profiles are more competitive, generate higher profits and are less vulnerable to market shocks. The New Zealand sovereign wealth fund, the New Zealand Super Fund, shares a similar view in their white paper, “How we invest – Why we believe responsible investment pays off”  where they state:

“ESG factors helps us to find new opportunities, steer our capital towards more attractive areas, and manage long-term investment risks. We expect that our returns will be higher, and downside risks lower, over the long term.”

The QuayStreet Socially Responsible Investment Fund and Process

As one of the first socially responsible KiwiSaver funds available to the public, the QuayStreet Socially Responsible Investment Fund has fine-tuned its qualitative ESG research over the past decade. 

The SRI Fund is an actively managed portfolio of investments, diversified across multiple asset classes and markets. Our aim is to invest in high quality companies with attractive investment characteristics and strong ESG profiles, while avoiding those that negatively affect the environment or the society. The Fund gives investors an opportunity to invest in a way that aligns with their own personal values and beliefs, without compromising their long-term investment objectives. 

Find out more about the QuayStreet’s Socially Responsible Investment Fund or our SRI policy, process and methodology.

If you have any questions or would like more information, contact the QuayStreet Service Team - 0800 782 900 / info@quaystreet.com

1  https://www.msci.com/esg-investing
https://www.nzsuperfund.co.nz/sites/default/files/documents-sys/White-Paper-ESG-Beliefs.pdf
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