ESG means sacrificing returns - and other ethical investing myths busted

Ryan Smith debunks stubborn fictions about responsible investing.

 - Explore Money Observers new ethical portfolio

Myth 1: Investing responsibly means giving up returns

Academic studies increasingly disprove this. Empirical evidence supports the premise that thinking carefully about sustainability as part of an investment process can enhance investment returns. At Kames, we believe that considering material environmental, social and governance factors in our investment decision-making:

• Deepens our knowledge and enables us to better understand the environments in which companies operate, which helps us to quantify risks and opportunities;
• Strengthens our conviction enabling the management of concentrated, high-conviction portfolios;
• Promotes a long-term focus and helps us to avoid short-term distractions.

Ultimately, investing is about employing an effective set of tools consistently in order to tip the odds in your favour. Sustainability analysis is one of these tools and it fills a key role in our toolbox, but it’s one that many investors still don’t consciously utilise.

Myth 2: There is no place for ethics in investment

Gordon Gekko would sell his granny. In contrast, we think that there is value in judging a company on the sustainability of its products or services. Industries or companies that perform no social function impose costs on society and, ultimately, it is highly probable that such activity will simply be regulated out of existence. The sustainability of a company’s products or services is therefore vital to its long-term strategic success. Strategic positioning and vision can be a long-term tailwind or headwind. An unsustainable product, for example, coal, is a huge strategic headache for any management team, just as a sustainable one should create a tailwind of opportunities.

Myth 3: Thinking sustainably is only a downside risk tool

Thinking about sustainability, combined with other risk metrics can provide investors with powerful downside protection. However, risk is a backward-looking measure. Thinking sustainably promotes a long-term focus, helps us to avoid short-term distractions and can also be useful for identifying sources of competitive advantage.

In the Kames ethical and sustainable strategies, we look for growth stock investment opportunities and typically find that disruptive, innovative growth companies are more likely to provide responsive investment opportunities and be willing to engage and improve.

Myth 4: Just invest in the best

"There are an increasing number of ESG products being launched, many of which use off-the-shelf third-party ESG ratings to construct their portfolios, or indices."

In most instances, they adopt a “best-in-class” approach; because the best ESG companies must be the best investment, right? Maybe, but in our experience, it’s often a bit more nuanced. “Best-in-class stocks”, according to these ratings, also tend to be large-cap, well-known and well researched, and hence provide less opportunity for mispricing opportunity to capture alpha.

Which is fine, because our focus is on the small and mid-cap space, where we believe better investment opportunities often occur. And to provide our clients with the breadth of negative screens that they seek, our ethical funds are always actively managed. Then, once invested, we take our stewardship responsibilities very seriously; meeting with management, challenging them, and if we need to, selling our position.

Ryan Smith is head of ESG research at Kames Capital.

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