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Investment Karma: Does it Pay to Invest Sustainably?

By Galen Lewis

The power of the dollar is changing. Whereas money used to serve simply as a medium of exchange, a store of value, or a measure of wealth, it can now be used as an instrument for creating positive social and environmental change.

Sustainable investing can take many forms. The term “socially responsible investing” (SRI) first gained traction in the U.S. during the Vietnam War when investors sought to avoid putting money into companies that were contributing to the violence. SRI is still common practice today. It tends to be limited to exclusionary screening, which means refraining from investing in any practice the investor is opposed to. These practices may include the use of child labor or the production of fossil fuels, tobacco, alcohol, or weapons.

Other investors choose to integrate environmental, social, and corporate governance (ESG) considerations into the heart of their investment decisions. These investors not only practice exclusionary screening but also actively seek out companies that exhibit superior ESG performance. In contrast to SRI, ESG investors identify companies that are prepared to compete and thrive in a future world that has tighter corporate regulations, dwindling natural resources, frequent manifestations of climate change, and a growing population. These companies tend to create a positive societal impact through exemplary business practices such as efficient resource use, equitable pay, and capital expenditures that are designed to increase sustainability.

Based on the above, it would make sense for companies that perform well on ESG measures to exhibit superior long-run financial performance and resilience during turbulent market conditions. As it turns out, this intuition is largely correct. 62.6% of meta-analytic studies show a positive correlation between ESG performance and long-run corporate financial performance. Moreover, ESG-aware companies have outperformed the broader market by 5.7% since the COVID-19 pandemic escalated in March of this year.

This relationship between sustainability and financial performance is best described in context, and there are many real-life examples of the financial advantages of sustainable corporate practices. Consider Trex, a wood-alternative decking company. Trex cuts costs through efficient resource use and lean manufacturing. Recycled plastic bags, scrap polyethylene, and factory scrap are used in Trex’s manufacturing process to produce long-lived, low-maintenance decking for consumer and commercial use.

Now consider Pacific Gas and Electric (PG&E), a California utilities company that has repeatedly failed to properly identify and manage ESG risks. In 2010, PG&E’s inattention to safety precautions resulted in the explosion of a gas pipeline that killed eight people in San Bruno, California. Seven years later, PG&E’s equipment caused wildfires in Northern California that claimed 45 lives and burned 245,000 acres of land. The following year, poorly-maintained power lines sparked even more wildfires that killed 130 people, burned over 150,000 acres of land, and destroyed thousands of homes and businesses. Between 2010 and 2018, PG&E paid billions of dollars to its shareholders but neglected to properly maintain its equipment. PG&E has since filed for bankruptcy as it faced over 30 billion dollars in potential damages from lawsuits. Evidently, corporate governance and the management of environmental risks can take an enormous toll on corporate financial performance.

Of course, sustainable and equitable business practices are not always immediately profitable. Electing to pay fair trade prices, increase the salaries of minimum wage employees, or devote more resources to diversity and inclusion will increase short-term costs. However, these changes can pay off in the long run. High ESG performers benefit from top-line growth derived from consumer preference for sustainable products, and equitable treatment of employees results in increased employee productivity and more diverse pools of talent to draw from.

On top of this, investor sentiment is changing as sustainable funds see record amounts of inflow. In 2020 there are about 31 trillion dollars in global sustainable investments, up 68 percent since 2014 and tenfold since 2004. This growth can be explained on both individual and institutional levels. Individual investors see climate change, social injustice, and corruption as increasingly disturbing and urgent. On an institutional level, asset managers and other institutional investors are recognizing ESG as a lens through which new risks and opportunities can be identified, rather than a filter that limits investment options and therefore financial returns. Accordingly, capital allocation now serves a new and more powerful purpose than ever before: Rather than solely compounding wealth, ESG investing can do so while creating a more just and sustainable future.


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