In the past several years, the public’s awareness of – and often firsthand experience with – issues such as climate change and social inequality has propelled sustainability to the forefront of the global agenda. The real-world implications of neglecting environmental, social and governance (ESG) factors came sharply into focus amid the pandemic, and the sense of urgency to make transformational changes has only increased. The result has been a shift from companies’ voluntary participation in ESG-related initiatives to binding legislation from regulatory bodies around the globe, a substantial capital need to support sustainable development and increased acknowledgment of the crucial role investments can play
in the transition.

A Brief History of Responsible Investing

The history of responsible investing can be traced back to the 18th century, when religious groups placed restrictions on the types of companies in which their followers could invest. The practice did not emerge in any substantive form until the 1960-70s, however, when it was typically referred to as socially responsible investing (SRI) and focused on a moral imperative to invest one’s dollars in companies that were aligned with one’s morals. At the outset, the approach was relatively simplistic and involved little more than excluding sectors such as tobacco, oil and gas, and arms – often dubbed “sin stocks” – from one’s portfolio.

Other terminology has been in use since that time, including socially conscious, sustainable, green, or ethical investing. Today, ESG is the most commonly used term and refers to measuring the sustainability of an investment opportunity from environmental, social and governance perspectives and their underlying considerations such as:

• Environmental: Climate change, energy efficiency, resource depletion, and water and waste management
• Social: Employee and community relations, diversity, human rights, quality of life, knowledge enhancements and supportive technology
• Governance: Bribery and corruption, board diversity, executive pay, accounting standards, shareholder rights and corporate behavior

The term ESG was coined around the time of the launch of the UN Principles for Responsible Investment (PRI) in 2006. However, it was the arrival of the UN Sustainable Development Goals in 2015 that led the paradigm shift establishing the first voluntary link between sustainability and financial services.

Sound Investment Sense

At the heart of responsible or sustainable investing is the simple idea that companies are more likely to succeed and deliver strong returns over the long term if they create value for all of their stakeholders, including customers, employees and suppliers, as well as benefit society more broadly in the physical environment in which we all operate. In short, companies that design a business model that is more sustainable are likely to be more resilient as an investment option in the long term.

ESG analysis offers valuable insight into factors that can have a significant impact on a company’s reputation and ultimately its financials. Therefore, ESG factors are key considerations in identifying companies with, or working toward, “future-proofed” business models that can remain successful and deliver stable cash flows through the transition to a sustainable economy. At the same time, ESG analysis can uncover companies that cannot or will not mitigate material ESG risks and therefore help to avoid related underperformance or capital impairment.

Doing Well While Doing Good

While reducing exposure to poorly managed firms from an ESG perspective is prudent and can assist analysts in their evaluation of appropriate portfolio holdings, the magnifying glass has historically been focused more on reducing negative exposures and less on the potential positive upside to ESG investing. However, the tide is shifting, as analysts increasingly explore how ESG credentials can affect and explain corporate financial performance and investors realize that focusing on values does not necessarily mean giving up returns.

One recent example is a meta-study conducted by the NYU Stern Center for Sustainable Business in partnership with Rockefeller Asset Management examining the relationship between ESG activities at organizations and their financial performance (study conducted between 2015-2020). While past performance is not indicative of future results, nor should the findings be interpreted as reflective of the returns of any particular security or investment, the study was released in February 2021,
and uncovered the following:

• As an investment strategy, ESG integration, in which ESG considerations are balanced with more traditional financial analysis and may incorporate engagement, generally performed better than negative screening approaches.
• ESG investing provided enhanced downside protection, especially during a social or economic crisis.
• Sustainability initiatives at corporations appeared to drive better financial performance due to mediating factors such as improved risk management and more innovation.
• Improved financial performance due to ESG became more noticeable over longer time horizons.
• Managing for a low-carbon future tended to improve financial performance.
• ESG disclosure without an accompanying strategy did not appear to drive financial performance.

There are myriad investment opportunities arising from the migration toward a more sustainable global economy, and some investment professionals believe there is a link between sustainable development, innovation and long-term compounding growth. Companies with goods or services that are associated with sustainable themes, and those already planning for trends such as decarbonization, the circular economy and digitization, should be better positioned than their peers for the future. What’s more, having positive ties to these themes helps ensure that investment in these evolving companies makes a positive impact on people and the planet.

The Rise of ESG Is Poised to Continue

The world is facing a sustainability crisis, including climate change, an aging population and immense social inequalities, all of which require radical solutions that will bring vast, yet hard to predict, changes to the global financial system. At the same time, investors are becoming increasingly aware of ESG challenges around the world and the fundamental role that corporations can play in improving, or worsening, these issues. Moreover, there is growing evidence that adopting an ESG investment approach does not necessarily mean resigning oneself to inferior performance.

Ultimately, we believe the need to create a sustainable global economy and investors’ desire to align their values with their financial goals is expected to continue to fuel demand for ESG investments. And ESG investments can potentially contribute to strong risk-adjusted returns for investors and a brighter future for all.

GATHERING MOMENTUM

1800s+

Religious groups introduce responsible investing based on certain exclusions

1960s+

Increased investor interest, with “sin” sectors excluded from portfolios

1990s+

1987 United
Nations report
prompts investing
around
sustainable
development

2000s+

“ESG” coined
around 2006
launch of the
UN Principles
for Responsible
Investment

MID-2010s

Broader industry
uptake following
UN Sustainable
Development
Goals (2015)
and UN Paris
Agreement
(2016)

TODAY

Widespread
adoption
of ESG
considerations
and Responsible
Investing styles
and objectives

1800s+

Religious groups introduce responsible investing based on certain exclusions

1960s+

Increased investor interest, with “sin” sectors excluded from portfolios

1990s+

1987 United
Nations report
prompts investing
around
sustainable
development

2000s+

“ESG” coined
around 2006
launch of the
UN Principles
for Responsible
Investment

MID-2010s

Broader industry
uptake following
UN Sustainable
Development
Goals (2015)
and UN Paris
Agreement
(2016)

TODAY

Widespread
adoption
of ESG
considerations
and Responsible
Investing styles
and objectives

1800s+

Religious groups introduce responsible investing based on certain exclusions

1960s+

Increased investor interest, with “sin” sectors excluded from portfolios

1990s+

1987 United
Nations report
prompts investing
around
sustainable
development

2000s+

“ESG” coined
around 2006
launch of the
UN Principles
for Responsible
Investment

MID-2010s

Broader industry
uptake following
UN Sustainable
Development
Goals (2015)
and UN Paris
Agreement
(2016)

TODAY

Widespread
adoption
of ESG
considerations
and Responsible
Investing styles
and objectives

Learn More about ESG at Janus Henderson

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