More than three-quarters of 401(k) retirement savers believe ESG companies perform better over time than non-ESG companies. That's according to a retirement survey from asset manager Schroders. Are these savers right about the superior financial performance of sustainability-focused companies, or is that belief unfounded?
Taking a step back, ESG stands for environmental, social, and governance. These three topics create a framework for companies to track and report their sustainability initiatives. Examples of those initiatives include reducing carbon emissions, auditing suppliers for compliance with human rights policies, and increasing board diversity.
Third-party organizations like Sustainalytics and MSCI track and score corporate ESG performance. Companies with higher scores are often called "ESG companies" or "ESG stocks."
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What the research says about ESG stocks
There is a good reason retirement savers believe ESG stocks earn higher profits. Some research supports that theory. For example:
- Comparing companies that had made progress on material ESG issues versus companies that had not, a team of researchers from Harvard Business School and Northwestern University found that the ESG companies "significantly outperformed" the others. Interestingly, how material ESG issues were was an important factor, the research found: Companies that targeted immaterial ESG issues actually underperformed their peers.
- Morningstar researcher Jon Hale found that ESG equity funds and ETFs suffered smaller losses during the pandemic-prompted market downturn in early 2020 versus their non-ESG counterparts.
- Researchers from New York University and Rockefeller Asset Management reviewed more than 1,000 studies on the financial performance of ESG companies. They concluded that ESG investing provides downside protection for investors. They also found improved financial performance related to ESG investing becomes more significant over longer time frames.
Sounds compelling, right? But other reports share less-compelling conclusions about ESG companies. For example:
- 2019 International Monetary Fund research concluded ESG funds don't underperform or outperform non-ESG funds.
- A 2021 paper from Hans Taparia for the Stanford Social Innovation Review cites three flaws in the research that supports the link between an ESG focus and better financial results. First, the positive differences in performance tend to be small and dependent on how and when profits are tallied. Second, a link between financial performance and ESG performance does not mean the ESG activity caused those higher profits. And third, the research relies on ESG scoring systems that are flawed in themselves and have low standards for good corporate behavior.
- Deutsche Bank surveyed its customers on the performance of their ESG assets in 2021. A total of 70% of the U.S. respondents said their ESG investments performed the same or worse than their non-ESG investments. Specifically, 63% saw the same performance between ESG and non-ESG assets, and 7% said the ESG assets performed worse.
Your money, your values
The aggregate research might not definitively support the theory that ESG companies are more profitable and/or resilient -- today. This isn't surprising. ESG programs are long-term initiatives, after all. The true value of a company -- say, reducing its reliance on nonrenewable resources or investing in its workforce -- will only show itself over time.
It is equally important, however, that the research doesn't definitively disprove the link between ESG and financial performance. That means strong profitability and good corporate behavior can (and sometimes do) coexist.
What does that mean for you as an investor? You don't have to sacrifice returns to invest according to your values. Of course, research is still necessary to avoid unpleasant surprises. You can't assume a stock with a high ESG score will produce the returns you want or create the ESG outcomes you expect. But if you want to put your money to work for you and the greater good, this is one potential avenue for you to consider.
