Can investors do well while also doing good?

Events like BP’s Gulf of Mexico oil spill are stark reminders of the risks of ignoring environmental, social and governance issues. Even so, many investors are reluctant to embrace “sustainable” investing, fearful of the effect on performance. We highlight recent research that suggests such worries may be misplaced.

18 May 2015

Events like BP’s Gulf of Mexico oil spill, or the discovery that major banks have been manipulating the $5 trillion foreign exchange market, are stark reminders of the risks of ignoring environmental, social and governance (ESG) issues. Losses to a company’s reputation, profits and, increasingly, its share price, can be immediate. In BP’s case, the shares halved in little more than two months following the 2010 disaster, while – to date – the five banks involved in the foreign exchange scandal have been fined a collective £2.6 billion.

Despite these and other high profile disasters, many investors have been reluctant to embrace “sustainable” investing, wary of its possible effect on long-term returns. We understand such concerns, but would point to recent research that suggests that worries about underperformance may be misplaced. Indeed, it may be that investors who incorporate ESG or other sustainable criteria into their investment decisions can actually enjoy better returns than those who only rely on more traditional methods.

One of the more interesting bits of analysis has been a “study of studies” conducted jointly by Oxford University and Arabesque Asset Management1 published towards the end of 2014. This confirmed that companies deemed to be operating sustainably tended to outperform their more traditional rivals. The authors looked at 190 academic analyses to arrive at their conclusions, which were divided up according to various different measures of performance.

Sustainability and the cost of capital

One very telling finding was that an overwhelming 90% of studies confirmed that adopting good ESG standards lowered a company’s cost of capital. Few might be surprised that good governance would reduce the cost of debt, but the research shows that high environmental and social scores have the same effect. Moreover, “according to recent studies, the converse relationship also holds. Firms with significant environmental concerns have to pay significantly higher credit spreads on their loans. For instance within the pulp and paper industry firms that release more toxic chemicals have significantly
higher bond yields than firms that release fewer toxic chemicals.”2

This is confirmed by rating agencies, which tend to give better ratings to issuers with good ESG policies. And, of course, more than four years on from the BP disaster, the 10-year credit spread on the oil company’s debt (as measured by credit default swaps) is, at more than 100 basis points, still about double the level at which it stood before the incident.

It’s a similar story with respect to equity cost. According to one analysis3 , well-governed firms enjoyed an equity cost advantage of anywhere between 0.8% and 1.3%. Another found a reduction of 1.8% in the cost of equity for firms with “good” corporate social responsibility and which were reporting their policies for the first time.

1 From the Stockholder to the Stakeholder, Smith School of Enterprise and the Environment, University of Oxford and Arabesque Asset Management, September 2014.
2 Oxford-Arabesque, as above
3
 Corporate Governance and the Cost of Equity Capital, Hollis Ashbaugh, Ryan LaFond, both University of Wisconsin, and
Daniel W. Collins, University of Iowa, October 2004.

Important Information: The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change.  To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada. For all other users, this content is issued by Schroder Investment Management Limited, 31 Gresham Street, London, EC2V 7QA. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.