The trade-off myth
Many investors still believe that impact investing comes with a trade-off between impact (social and environmental return) and risk-adjusted financial return. In their eyes, the more significant the impact focus is, the lower the return on investment. This perception is understandable if we realize that in the early days of impact investing negative screening was the main technique, which could indeed result in enhanced risk and reduced performance.
Over the past ten years, however, impact investing has grown into a sophisticated investment and risk management approach, giving investors the opportunity to include environmental, social and governance considerations into their investment portfolios without having to give up return.
A large body of academic research shows that analyzing investments across a more holistic set of impact factors, above and beyond traditional risk and return, may enhance investment selection and contribute to lowering overall portfolio volatility, and thus to improving the risk-adjusted profile of portfolios. This research also justifies the conclusion that in the long run, impact investing is able to deliver market-rate returns. Below, we present four examples of such research:
- A review by the German investment fund DWS and the University of Hamburg of more than 2,000 studies, for example, found that 63% showed a strong correlation between ESG performance and positive returns, while 10% showed a negative effect.
- A meta-study by Friede, Busch and Bassen, also in 2015, sampled more than 2,200 pieces of academic work over the past 40 years, all of which analysed the relationship between environmental, social and governance factors and corporate, financial performance. It found that more than 90% of them showed that ESG factors have a positive or neutral impact on financial returns, concluding: "The results show that the business case for ESG investing is empirically very well founded."
- More recently, in its August 2019 report Sustainable Reality, Morgan Stanley concludes: “We found that sustainable funds provided returns in line with comparable traditional funds while reducing downside risk. What’s more, during a period of extreme volatility, we saw strong statistical evidence that sustainable funds are more stable. Incorporating environmental, social, and governance (ESG) criteria into investment portfolios may help to limit market risk.
- Another recent example is the GIIN Perspectives: Evidence on the Financial performance of Impact Investments, which provides a comprehensive review of available research to date on the financial performance of impact investments. The report concludes: “Impact investors seeking market rate returns can achieve them. Across various strategies and asset classes, top quartile funds seeking market-rate returns perform at similar levels to peers in conventional markets. In many cases, median performance is also quite similar. As in conventional markets, however, performance varies from one fund to the next, thus indicating that fund manager selection is key to achieving strong returns. Generally, the range of fund returns in impact investing mirrors that in conventional investing.”
These examples show that (impact) investors do not have to choose between doing good – i.e. generate social or environmental return – or doing well – that is: make a financial return.