Interest in responsible investment reaches new heights

EY and Royal London have collaborated to review existing empirical evidence of how responsible investing affects returns.

As demand for responsible investment grows, the Financial Services industry is keen to understand how to practice responsible investing; what results investors can expect from it; and the positive impact this will have on wider society.

EY and Royal London have worked together to contribute to this debate, reviewing existing empirical evidence of how responsible investing affects returns.

We began by identifying a set of hypotheses setting out how using Environmental, Social and Governance (ESG) principles could maintain or improve investment performance. We reviewed more than 30 academic and other published papers. This included literature reviews and meta-studies looking at over 2,000 global empirical studies during a 25-year period, to determine if the hypotheses are supported by evidence.

This paper summarises our findings, puts them into the context of the changing appetite for responsible investment and suggests some actions that advisers and asset managers can take to harness the power of sustainability for the benefit of investors.

The benefits are clear

Our research of the empirical evidence shows that applying Environmental, Social and Governance (ESG) principles delivers financial benefits, both in corporate performance and in the performance of investment portfolios. This is a significant finding, given the growing level of interest in responsible investing, and is backed up by the resilience of sustainable companies in the face of COVID-19.

Furthermore, this comes at a moment when grass roots demand for responsible investing is being pushed to a new level by the social and environmental effects of the pandemic, and when regulatory changes such as the amendments to MiFID II are adding significant momentum to the ESG agenda.

Together, we expect these three key drivers of evidence, demand and regulation to rapidly accelerate the investment industry’s adoption of sustainable practices in a post-COVID world.  Developing responsible investment capabilities is no longer an option, it’s a necessity.

Challenges and opportunities

We do not underestimate the challenges that remain, especially in the complex areas of definitions and data comparability. However, we also believe that the investment industry doesn’t need to wait for perfect information before incorporating ESG factors into its processes, services and operating models. In our conclusion we set out actions that every financial adviser and asset manager can take immediately to tap the potential of greater sustainability.

In our view, financial advisers, pension providers and asset managers face an unprecedented opportunity to match investors with companies that need their capital to ‘build back better’. In the process, they will unlock financial rewards - for investors and for themselves. In contrast, businesses that are unable to adapt could find themselves left behind by the accelerating transformation of the whole investment industry.

The journey so far

Responsible investing has grown explosively over the last five years, fuelled by investor appetite, belief in outperformance and regulatory change. The rapid increase in scale and sophistication is reflected in the expansion of the United Nations Principles for Responsible Investment (UN PRI) from 68 founding signatories in 2006 to over 1,800 in 2018. By the end of 2019, 96% of the world’s top 50 asset managers were signatories, managing US $31trillion of the world’s roughly US$100trillion of financial assets in some sort of sustainable mandate or fund.

Europe has been at the forefront of this global trend, and the UK has played an important role. Mark Carney’s 2015 speech ‘Breaking the tragedy of the horizon’ was particularly influential. Less than five years later, Mr Carney wrote in an International Monetary Fund article ‘Fifty shades of green’ about the strides already taken, but also of the need to move further and faster to develop a new global system of sustainable finance.

It would not have been surprising if the global downturn sparked by the COVID-19 pandemic had halted the growth of responsible investing or led investors to abandon ESG principles altogether. In fact, the pandemic has strengthened the drivers of sustainability. Yes, questions over responsible ESG investing persist, especially among advisers and trustees who are unsure how to address sustainability in the context of their fiduciary responsibilities. But regulation has maintained its established direction. Investor appetite has continued to grow, boosted by grass roots activism and campaigns such as Make My Money Matter. And – even on a sector neutral basis – ESG’s bias towards high quality, well-governed companies appears to have delivered for investors during the crisis.

The time feels right to take a fresh look at the evidence for ESG performance. EY and Royal London hope our paper will add depth to the global debate around responsible investing.