The lesson we draw here is that socially responsible investing can help investment managers to distinguish potentially outperforming stocks from potentially underperforming ones. As we see it, when such a useful investment tool is available to us, we'd be foolish not to use it.
Additional research published by the Quarterly Journal of Economics, among others, has confirmed that ESG issues like corporate governance affect the performance of a company's stock. For example, over the years the Journal has studied about 1,500 companies and found that those with the strongest shareholder rights generally outperformed those with the weakest.
Of course, the use of socially responsible investing principles will be for naught if the investors who apply those principles lack skill, discipline, and above all objectivity. We believe that for socially responsible investing to be fruitful, investors must be capable to begin with and incorporate ESG principles into investment decision making as objectively as humanly possible.
If socially responsible investors fail to keep a grip on their objectivity with the tenacity of a drowning man clinging to a lifeline, the danger is that their investment decisions may be colored by politicized or emotional agendas, which have the potential to diminish investment results, not enhance them.
Climate Disclosures OK'd
Whether or not the principles of socially responsible investing are applied with a measure of objectivity, however, we think more of those principles are likely to be applied more frequently, thanks in part to the Securities and Exchange Commission.
In January the SEC approved a standard requiring public companies to weigh the impact of climate-change laws and regulations in their corporate filings.
Another catalyst supporting socially responsible investing: 63% of institutional clients, such as pension funds and endowments, included requirements for socially responsible investing in their new contracts with investment managers in 2009, according to the UN. That's an increase of 25% from the previous year, and we expect the percentage to continue rising. About socially responsible investing's prospective staying power, we concur with The Economist's observation that as long as some clients and investment managers care about "where their money is invested as about how much they earn, socially responsible investing is not going to go away."
We envision more investment managers caring more about where the money is invested and making a commitment to the UN's Principles for Responsible Investment. We think more managers will come to recognize that socially responsible investing isn't wildly impractical but a pragmatic way to become more proactive shareholders, reinforce desirable corporate behavior, manage investment risk, and pursue superior total returns.
We consider the evolution of socially responsible investing to be in its early stages, like a caterpillar larva. As socially responsible investing matures, its methods are likely to become more refined. As such, we have little doubt that investment managers like us should be better at identifying the impact of ESG issues on companies five years from now than we are today-and still better 10 years hence and so on.
And we have little doubt that as time passes, socially responsible investing should require even less defense against verbal darts than it does today, as it demonstrates that virtue can be not only its own reward but financially rewarding as well.
Rick Wetmore is a chartered financial analyst for Turner Investments, founded in 1990, an investment firm based in Berwyn, Pa. You can get free copies of other Turner position papers by calling 484.329.2329; e-mailing [email protected]; or visiting the Position Papers page of the Resource Center section of www.turnerinvestments.com.