Global Chief Investment Officer for Equities Steve Berexa discusses Sustainable Investing and the importance of proprietary research: “Investing sustainably, incorporating ESG research into the investment process and accompanying that with our engagement program, is more than just a matter of ‘doing good,’ it’s a matter of doing good business, particularly as it relates to the portfolio’s expected returns.”
Why Sustainable Investing?
At Allianz Global Investors, Environmental, Social and Governance (ESG) factors are central to our work. Why? Because, as evidenced by a growing body of empirical research, understanding ESG factors can help us better manage risk and enhance potential long-term returns.
Understanding ESG risk starts with research. ESG research is vital because, as the risk spectrum evolves, traditional fundamental analysis no longer captures all of the myriad risk factors that can impact long-term investment performance. Further, the knowledge needed for successful ESG investing, in our view, demands a level of depth not currently reflected in third-party, off-the-shelf analytical solutions. In other words, proprietary research is key to success.
Further, demand for Sustainable Investing is increasing rapidly: ESG allocations now account for more than one of every four dollars professionally managed in the US.¹ As a result, incorporating sustainability into investment decisions and actively engaging with portfolio companies to promote good ESG practices goes beyond just “doing good,” it’s also good business.
Rising allocations to Sustainable Investing suggests this is the future
Growth of ESG incorporation by money managers, 2005–2018
Despite the rapid growth of Sustainable Investing, some common misconceptions persist. However, a growing body of academic research and empirical evidence debunks the most common myths about Sustainable Investing.
A growing body of evidence shows a positive relationship between ESG factors and investment returns.
Academic research suggests that Sustainable Investing can produce returns that are comparable to traditional investing, but with lower levels of risk. Why? Because ESG factors can reveal previously hidden risks, helping investors potentially reduce the possibility of major drawdowns. That, in turn, can result in potentially higher risk-adjusted returns.
Research also suggests that companies with higher ESG rating can have lower costs of capital and can deliver higher shareholder value.² In the coming years, ESG factors, in our view, could become increasingly important drivers of both corporate performance and investment returns.
When Allianz Global Investors signed the UN‘s Principles for Responsible Investment (PRI) in 2007, we were among the first 50 signatories. Today, more than 3,000 asset managers, asset owners and others are signatories and half of all global institutional funds (more than $86 trillion) are managed according to PRI principles. In the US, ESG allocations increased 38% between 2016 and 2018 to $12 trillion—more than one out of every four dollars managed professionally.³
The forces propelling Sustainable Investing into the mainstream are many, including investors’ realization that they can make an impact on society by choosing how to invest their funds, especially among young market participants; increased promotion of Sustainable Investing by regulators, especially in Europe; and the growth and economic viability of new technologies associated with Sustainable Investing; among others.
Some people are willing to pay more to ensure their investments have a positive impact on society and/or the environment. Luckily, investors today don’t have to make that choice: Actively managed ESG funds can produce higher risk-adjusted returns relative to traditional, non-ESG strategies, net of fees.
Academic research shows a positive relationship between ESG factors and investment returns. However, research also shows that the benefits of Sustainable Investing can only be realized fully through active asset management .4
In other words, passive strategies using third-party ESG research to simply filter or exclude certain investments can be ineffective, regardless of cost. By contrast, strategies actively incorporating ESG factors into security selection can enhance risk mitigation and improve portfolio returns. This can result in higher risk-adjusted returns net of fees.
Active management can also enhance social and environmental impact. For example, investment professionals at Allianz Global Investors regularly press executives at potential portfolio companies to promote positive ESG behaviors. This active engagement can increase the total returns—environmental, social and financial—that investors receive in return for management fees.
Financial theory suggests that restricting investment choices can reduce portfolio diversification, leaving some investors to fear that Sustainable Investing will produce portfolios that are overly concentrated in some areas and lacking exposure to others.
However, academic research shows conclusively that incorporating ESG factors into portfolios does not hurt diversification or potential returns. For example, a recent analysis of sovereign-bond portfolios finds that excluding worst-in-class ESG-rated securities does not result in lower diversification or returns.5
In other words, even after taking into account potential imbalances in portfolio weightings, portfolios that incorporate ESG considerations into their security-selection process are no more risky—and can actually have less risk—than traditional portfolios.
It’s a myth that Sustainable Investing is only for investors who prioritize social and environmental impact over financial performance. Today, a large and growing body of evidence shows a relationship between positive ESG practices and financial outperformance.
This evidence is making Sustainable Investing compelling to an expanding universe of investors who understand that they can both make an impact and improve their potential risk-adjusted returns. That’s why according to a recent Allianz Global Investors’ survey, 71% of institutional investors hope to manage their portfolios in accordance with ESG principles by 2030.
Over the past two decades, subsidies helped make the US renewable energy and other emerging sustainable technologies viable and also helped to promote the concept of Sustainable Investing.
Times have changed. Today, sustainable businesses help produce healthy profits without subsidies. For example, it is typically cheaper to build and operate new solar and onshore wind installations in the US than to operate an existing coal plant without financial assistance.
Meanwhile, a growing body of evidence shows that a range of environmental, social and governance factors enhance corporate performance.6 In other words, companies that take actions such things as hiring more women in senior roles, improving diversity and cutting their carbon footprint tend to perform better financially. The same holds true in investment portfolios, where Sustainable Investing can lower portfolio risk and volatility while also potentially improving returns.
Demand for sustainable investments among institutional investors is growing
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