Why most ESG-focused investments outperform the broader market

ESG leaders often have less risk, lower costs of capital, better access to debt, more stable earnings, higher dividend yields, access to top talent and more loyal customers.iStock

Picking investments that feature strong performance across environmental, social and governance (ESG) criteria is in fashion, and research suggests these companies can also be long-term financial leaders. Investment and ESG experts point to multiple reasons for the connection.

“ESG performance is a useful indicator for a company’s quality of management,” says Dustyn Lanz, senior advisor with ESG Global Advisors in Toronto. “If a company is well governed and manages its exposure to social and environmental risks, there’s a good chance it’s a better managed company overall. And if a company is ignoring ESG risks, such as the effects of climate change, they’re putting their competitiveness and social licence at risk.”

There is no uniformity around ESG ratings and scores. Still, according to McKinsey research, the majority of ESG-focused investments outperform the broader market.

Mr. Lanz says companies with a robust ESG framework have a lower cost of capital and better access to debt, which is due to their lower risk.

Investors who want to mitigate risk find great appeal in ESG leaders, says Pat Dunwoody, executive director of the Canadian ETF Association. She says such companies tend to have a culture of transparency, and they are less likely to face incidents of bribery, corruption, fraud, labour strikes, and accounting and governance irregularities.

“If you’re a strong ESG player you will have less negative press, which can have a positive impact on investors,” Ms. Dunwoody says.

ESG investing can provide downside protection, especially during a social or economic crisis, according to a meta study from the NYU Stern Center for Sustainable Business, which aggregated evidence from 1,000-plus studies on ESG and financial performance.

A paper last year in the Journal of Portfolio Management also found: “Companies with high MSCI ESG ratings on average have historically been more profitable, displayed more stable earnings and paid higher dividend yields.”

Among the reasons the paper cited were that stronger ESG characteristics are linked to a range of better business practices, such as talent acquisition and innovation.

Jeremy Richardson, senior portfolio manager of global equities with RBC Global Asset Management in London, says ESG leaders focus on achieving sustainable success. That opens the door to a range of opportunities, from attracting the best talent for their workforce, to maintaining access to critical raw materials.

For instance, these companies are likely to promote diversity and inclusiveness in their workforces, and drive employee engagement for the long term, Mr. Lanz says.

While employees can be more loyal, so can customers. Mr. Lanz notes recent consumer surveys from Ipsos and Nielsen that found a majority of consumers have been making more sustainable or ethical purchases. These customers “buy with their values in mind,” he says.

Consumers not only want more sustainable products, they also expect companies to step up and address sustainability challenges. A 2021 EY study found that 69 per cent of Canadian consumers expect companies to solve sustainability issues.

That draws investors who want to vote with their values and their pocketbook. “If people are going to make the same or close to the same amount of money and will make an impact at the same time, they’ll choose to invest in ESG securities and funds,” Ms. Dunwoody says.

So are strong ESG performers always strong overall financial performers? ESG securities might not always deliver better returns, Mr. Richardson says. But if returns aren’t going to be compromised, he says it’s probably a better bet to invest in ESG securities. “Sustainable businesses balance the needs of various stakeholders over the long-term.”


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