How sustainable investing may improve performance
By: Tim Bennett
29.05.2019
Those who follow sustainable (or “ESG”) investing mandates may inadvertently generate better returns than others who don’t. Tim Bennett explains.

How sustainable investing may improve performance

Sustainable (or “ESG” – ethical, social and governance) investing is gaining traction fast. And it may have an unintended side-benefit in the way it forces investors to behave which, in turn, helps to boost their performance. Here is a short summary.

Background

As investors become more socially and environmentally aware, so the demand for firms and funds, that can show they follow the appropriate mandate, has risen.
Whilst it is early days yet, there is evidence to suggest that ESG fans may also be better investors. Ironically many of them will have little clue as to precisely why as it seems the answer may lie in the way they behave, or don’t.

The observation

In normal circumstances, retail investors tend to underperform institutional ones, sometimes by a significant amount;
However, what is interesting is that when you run the comparison for sustainable investing, the result is much closer;
The question is why, assuming the sample quoted above is representative of a trend. No-one yet has the exact answer, but it appears that an ESG mandate forces better behaviour on otherwise sometimes fickle retail investors.

ESG may reduce three classic behavioural errors

There are many ways in which investors often sell themselves short via inappropriate and unhelpful choices and actions. Here are three;
Is it possible that ESG investors are making these mistakes less often than their non-ESG peers?

Herding

In a nutshell, investors are prone to follow each other in pursuit of the latest great idea. This inevitably leads to buying high and selling low as most arrive at the party too late to benefit. However, it could be that by following an ESG mandate, investors commit to a longer-term view and may do less performance-chasing as a result.

Loss aversion

Many studies have shown that investors fear losses more than they enjoy gains. As a result, they may leave money languishing in unproductive assets, such as cash, for too long. But perhaps an ESG mandate allows investors to better see past short-term trouble and stick to a long-term view by staying invested.
As Jina Penn-Tracy at Centered Wealth puts it;

Recency bias

Many investors are rear-view mirror drivers – they allow past events to frame today’s decisions too heavily. This can lead to inaction when markets dip or over-excitement when they rise for long periods. Sustainable investing, on the other hand, requires discipline and the ability to stick to a mandate. So, when others were running for the hills in 2016 as Donald Trump was being elected, ESG investors will have calmly committed more money, knowing that he was about to abandon certain key climate accords.

Conclusion

The long-term profitability, or otherwise, of ESG investing is still being tested. However, so far it does seem as though its principles force better behaviour on, in many cases, unwitting investors. Time will tell how much of an impact this can have but the signs so far are promising. You can read the full post, on which this article is based, here;