The idea that sustainable investing is a recipe for underperformance is a myth, said Morningstar in a report issued Monday.
In fact, sustainable or responsible funds and indexes perform on a par with similar conventional funds and indexes, despite the belief by many that investors have to be prepared for lower returns if they want to be socially responsible, Morningstar said in the Morningstar Manager Research report, in which it compared dozens of in-depth studies on the issue.
The problem is that many investors do not know they do not have to sacrifice returns to be socially responsible. Advisors and asset managers need to educate their clients to the reality of sustainable investing, said Morningstar.
More than 1,000 asset managers have signed the Principles of Responsible Investment, backed by the United Nations, which commits them to including sustainable standards in their investment process.
“For the high level of interest in sustainable investing among mainstream investors to translate into actual investments, financial intermediaries need to step in to help their clients incorporate sustainability into their portfolios,” Morningstar said.
Individual investors, particularly millennials and women, are increasingly demanding socially responsible investments, the report said.
Sustainable investing includes two types of screenings: Funds that exclude investments in companies that investors want to avoid, such as tobacco, oil or weapons; and those that include companies that have active programs for improving the environment, social causes and governance (ESG).
Investments that are inclusive for ESG perform slightly better than conventional investments and investments that exclude categories that are considered undesirable do slightly worse than conventional funds, Morningstar said.
Most socially responsible funds and indexes combine an exclusionary and an inclusionary screen, which is why they perform on a par with other funds. Few funds use only exclusionary screens to the detriment of their investors. A focus on company-level ESG factors, rather than using an exclusionary screen, can lead to better risk-adjusted performance for portfolios, according to the report.
As an example, Morningstar cites the oldest socially responsible index, originally know as the Domini 400 Social Index and now known as MSCI KLD 400 Index, which has had its ups and downs along with the rest of the market, but since it was launched in 1990 has slightly outperformed the S&P 500. “The index makes a strong case that socially responsible investments do not lead to inferior returns and, in fact, are capable of producing better returns than those of conventional investments,” the report said.