Sustainability-Minded Investing Makes Dollars and Sense
Investors are wise to buy portfolios of companies that embed sustainability into their strategies, operations, and business practices. Pro or con?
Pro: Enhance Returns, Reduce Risks
Can you make bigger profits and build a better world? In the 21st century, integrating sustainability—and quantifying its value to business and society—can enhance shareholder returns and reduce volatility in portfolios (which was not the case in 20th century socially responsible investing).
First, profit potential can drive revenue higher as customers seek products and services with more benefit to society: renewable energy, compostable packaging, organic foods. Double-digit growth rates in these markets are higher than overall industry growth, according to Pegasus Capital.
Second, the bottom line can benefit from lower costs and reduced volatility in fuel, energy, and materials prices when companies become more resource-savvy and emissions-efficient. Society wins with less pollution and better health for citizens. Shareholders can win, too, as Carbon Disclosure Project leaders tend to outperform.
Third, the duration of profit matters to shareholders: Century-old companies such as IBM (IBM), Dow (DOW), and Coca-Cola (KO) are becoming more water-efficient in all their operations and outlive such companies as Johns Manville (asbestos).
Fourth, the cost of capital (e.g., the required returns for equity) is higher for unsustainable companies such as tobacco and alcohol producers. This can also increase portfolio volatility, as it represents higher risk.
These quantifiable human, social, and environmental impacts are neglected by most investors today. Mutual fund Portfolio 21 (PORTX) focuses on eco-efficient companies, resulting in stronger risk-adjusted returns, even exceeding those of the Vice Fund (VICEX). Additionally, Portfolio 21 offers a more positive HIP (Human Impact + Profit) score than the overall market, while the Vice Fund’s sustainability is much lower, given its investments in alcohol, tobacco, defense, and gaming.
Con: SRI Investments Underwhelm
Since Dec. 31, 2002, mutual funds that followed socially responsible investing (SRI) strategies underperformed the broad market, on average, and significantly underperformed the Vice Fund. The Vice Fund invests in stocks of tobacco, gaming, alcohol, and defense companies.
I have identified at least 22 mutual funds available on Dec. 31, 2002, that followed socially responsible investing and 30 available in 2011. “Social value” was the main criterion for portfolio inclusion in these funds. The available SRI funds followed a diverse range of investment focus.
Historical underperformance of the basket of SRI funds vs. the S&P 500 and Vice Fund is well documented (Click to see chart). The Vice Fund beat the SRI basket by 3.09 percent per year for 8.75 years and beat all of the 22 SRI funds available on 12/31/02.
Inclusion in the Vice Fund does not mean a company can’t be socially responsible. Las Vegas Sands (LVS) and Molson Coors (TAP) focus on profit and shareholder value, yet they have improved their business processes to include some smart environmental controls. Profit is still the primary focus at these companies.
It is obvious that a significant majority of companies that value social responsibility over profit underperform the market in the long term. Since Dec. 31, 1993, the Dow Jones Industrial Average has beaten the Dow Jones Sustainable World Index by an average of 2.23 percent per year. That translates to a total of 65 percent more return over the past 17.75 years.