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Sustainable and Impact Investing: More than just a feel-good approach

Learn more about how this framework could help you pursue competitive returns while also potentially reducing portfolio risk

SUSTAINABLE AND IMPACT INVESTING, once considered the new kid on the investing block, is proving its staying power. Millions of investors today take sustainability issues into account when deciding how to allocate their investments — and their numbers are growing.

“In today’s structurally changing world, we believe that incorporating the themes of sustainable and impact investing is an imperative for investors who seek to minimize risk and create a potential for return.”

Anna Snider head of Due Diligence, Chief Investment Office, Merrill and Bank of America Private Bank

These investors aren’t just asking questions about a company’s carbon footprint, the wages and conditions of its workers and board diversity, among other things. They’re making these investing decisions because data shows that doing so increasingly makes sense from a financial perspective. “A significant body of research points to the potential for enhanced returns and reduced risk when you incorporate both environmental, social and governance, or ESG, analysis and traditional investment analysis in your decision making,” says Anna Snider, head of Due Diligence in the Chief Investment Office for Merrill and Bank of America Private Bank. In fact, she adds, “In today’s structurally changing world, we believe that incorporating the themes of sustainable and impact investing is an imperative for investors who seek to minimize risk and create a potential for return.”

What the numbers tell us

In a 2020 study, Hermes Investment Management found that companies with good or improving ESG characteristics, on average, outperform companies with poor or worsening characteristics.1 More recently, in 2022’s volatile markets, the broad Morningstar U.S. Sustainability Index outperformed its parent index, the Morningstar U.S. Large-Mid Cap Index, falling 18.09% compared with the latter’s 19.5% decline. It also outperformed the S&P 500 Index, which dropped 19.4% during the same time period.2 BofA Global Research, meanwhile, finds strong connections between diversity in leadership teams and higher corporate revenue related to innovation.3

Because global challenges present considerable risk to the economy and to individual companies, sustainable investing also can help you manage portfolio risk, notes Ekaterina Gradovich, ESG Due Diligence Analyst in the Chief Investment Office for Merrill and Bank of America Private Bank. For example, she says, “the substantial economic transformation required for the energy transition and energy independence may determine which businesses remain competitive and profitable in the not-too-distant future.” 

In addition, a sustainable and impact investing framework could potentially help provide a buffer for your portfolio from companies whose products or practices may expose them to fines, reputational damage, difficulty retaining employees, or other problems. “These factors introduce risks that investors need to consider,” Gradovich says. Of 17 bankruptcies among S&P 500 companies from 2005 to 2015, 15 (90%) involved organizations with histories of poor environmental and social scores, BofA Global Research found.4

The ABCs of sustainable investing

 

Avoid

 

Benefit

 

Contribute

Consider strategies that seek to reduce negative social or environmental effects and help to manage risk by limiting certain exposures. For example: Excluding holdings at risk of regulatory action due to poor labor practices.

 

Explore strategies that seek to support positive social or environmental practices and enhance potential for long-term competitive financial returns. For example: Companies leading on energy efficiency metrics.

 

Look into strategies that seek to advance positive, measurable social or environmental outcomes and target opportunities where impact is intrinsic to financial performance. For example: Social impact bonds.

Avoid

Consider strategies that seek to reduce negative social or environmental effects and help to manage risk by limiting certain exposures. For example: Excluding holdings at risk of regulatory action due to poor labor practices.

 

Benefit

Explore strategies that seek to support positive social or environmental practices and enhance potential for long-term competitive financial returns. For example: Companies leading on energy efficiency metrics.

 
 

Contribute

Look into strategies that seek to advance positive, measurable social or environmental outcomes and target opportunities where impact is intrinsic to financial performance. For example: Social impact bonds.

Source: Chief Investment Office, "Impactonomics®: Performance Realities: Revisited," March 2023.

 

 

ESG ratings — just a starting point

Critics have argued that the slew of ESG ratings services purporting to identify the best (or worst) companies from a sustainability perspective vary in quality and lack consistency of measurement standards. “Some of the criticism is valid,” notes Gradovich. “Ratings are only as good as the underlying data, and they often rely too heavily on past performance, without taking into account where a company is going,” she adds. Or they may ignore that a “good” company in terms of ESG practices has a poor financial record. Companies that perform well in, say, social or governance areas but may be lagging in environmental performance, may still receive high ratings from third-party data providers.

Complicating matters, surging demand has resulted in “greenwashing” by some companies that claim positive environmental or social outcomes in their company statements without transforming their culture and practices in meaningful ways. However, notes Snider, to mitigate risks, “Regulators and strong due diligence managers are demanding greater accountability. As a result, more companies are providing detailed ESG data.”

Putting it all together

Achieving the dual goals of supporting positive change and generating financial returns requires more than just selecting securities from one of the numerous ESG ratings lists, Snider cautions. “While ratings can be a useful tool as part of a broad evaluation of companies or portfolios, they should not be the sole benchmark for investing choices,” she notes. A close analysis of any strategy’s financial approach is paramount.

“Innovations to address global challenges are creating some of the greatest opportunities we’ll see in our lifetimes.”

Anna Snider head of Due Diligence, Chief Investment Office, Merrill and Bank of America Private Bank

When her team evaluates an investment’s ESG strategy, Snider says, “In addition to our fiduciary investment evaluation, we look at the depth and consistency of the manager’s integration of sustainability risk and return factors. Our primary focus is not on a manager’s moral or ethical preferences, but on the forward-looking economic and investment projections determined by this type of analysis.” Once the team is satisfied that the financial underpinnings are sound, they can turn to evaluating the investment’s sustainable impact, she says.

“Sustainable and impact investing seems likely to grow in the years to come,” Snider believes, “and the tools used to measure ESG performance will surely evolve and improve.” To that end, she suggests that investors consider integrating sustainable and impact investing as part of a balanced, strategic portfolio — “one that begins with personal considerations such as overall investment goals and the level of risk you feel comfortable with,” she adds.

“We believe investors who embrace sustainable investing practices will be able to position their portfolios for potential long-term success,” says Snider. After all, she notes, “Innovations to address global challenges are creating some of the greatest opportunities we’ll see in our lifetimes.”

For more insights on sustainable and impact investing — and ways to consider incorporating it into your portfolio — read “Impactonomics®: Performance Realities: Revisited” from the Chief Investment Office.

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