The debate around whether investors must choose between targeting pure performance or bringing about positive change is quickly running out of steam, thanks to growing empirical evidence.
This rapid progress within sustainable investing – and the collection of data -- means investors can look to invest in line with their values and not compromise on returns.
While we can see clear societal pressure growing around environmental, social and corporate governance (ESG) issues, a rise in regulatory action in certain parts of the world has made them an important feature in the investment process. Looking to the long term, there is a growing sense of urgency around many of the issues encapsulated within ESG, and which are likely to be important catalysts for future performance.
Figure 1. Source: Mercer Delegated Solutions Europe Sustainable Investment Policy
A broad range of stakeholders have begun incorporating sustainability considerations into their decisions and actions. We believe this is leading us to a key tipping point around ESG investing.
There are many ways to invest in sustainable equities, but most strategies typically offer typical features that help achieve your goals (fig. 2). Both active and passive strategies tend to include exclusions of activities that don’t align with sustainable investment values (e.g. controversial weapons companies) and usually target a reduction in the portfolio’s carbon footprint.
However, active and passive strategies can differ significantly in their underlying holdings.
Many sustainable passive strategies use ESG based tilting to adjust the market cap weights of the underlying holdings. This means they should allocate more capital to companies with good ESG characteristics – such as a having a defined carbon reduction strategy or launching community outreach programmes -- and allocate less to those without. It is important for investors to note that this is a key differentiator between passive strategies. Their performance against a doing “well” or “good” benchmark will likely depend on the materiality and quality of the ESG data they use.
On the other hand, active strategies take a much more targeted approach, focusing on finding companies that are providing legitimate solutions to real world sustainability challenges. Within this group, there is a broad range to choose from, spanning development of alternative energy solutions to strengthening water and irrigation infrastructure.
Figure 2. Source: Mercer. Typical features of active and passive sustainable equity strategies. Features may vary by index provider and asset/investment manager.
Most major global ESG & sustainable indices, have outperformed the MSCI World over five years (Fig 3), while the Solactive Sustainable Global Equity Index has significantly bettered the MSCI World since its launch in 2019. While past performance is no guarantee of what will happen in the future, there is growing evidence that incorporating an ESG/sustainable lens may be beneficial from a risk and return perspective.
It is increasingly possible that doing good with your capital and doing well financially may not be mutually exclusive.
Figure 3.Source: Databank. Returns in USD as of 30 Oct 2020 relative to the MSCI World.
Please see the following link for information on indexes:
“One cannot invest directly in an index. Index performance is gross of fees and expenses an investor would incur if investing in the same securities. The above does not reflect the investment performance of any Mercer client.”
If you are considering introducing sustainability into your portfolio, you would not be alone.
Over the last 10 years, investors around the world have been increasingly interested in and allocating to sustainable strategies. The International Institute for Sustainable Development noted there had been a 68% increase in assets allocated sustainably by developed economy investors between 2014 and 2019, taking the total to $30.7 trillion.
We believe this trend looks set to continue well into the future as investors look to enable positive change with their capital – and we can help you and your portfolio to be part of it.
Sustainability is at the core of Mercer’s investment beliefs and is embedded in our portfolio construction process (fig 4). Our reference portfolios include dedicated sustainable equity strategies that increase the environmental and social sustainability profile of our clients’ investments. These portfolios also target a climate transition plan, setting targets for carbon emission reduction each year that are consistent with global policy targets.
We believe that, as investors, it’s crucial to start thinking about whether a sustainable equity allocation is suitable for your portfolio and future performance.
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