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.

Opinions and conclusions expressed in the Debate Room do not necessarily reflect the views of Bloomberg Businessweek, Businessweek.com, or Bloomberg LP.

Reader Comments

Scott Fullwiler

Mr. Sullivan is raising a straw man. As Mr. Herman explains, this isn't about "socially responsible investing" anymore; it's about understanding how sustainability enhances returns. Herman isn't defending "socially responsible investing," which is the only thing Mr. Sullivan addresses.

HeDaletih

Mr. Herman might like to check with Warren Buffett, who now owns Johns Manville to see how they are doing, quite well, thank you.

Andy Carnahan

This type of debate doesn't make sense if you don't agree on a the definition of "sustainable." There is almost certainly overlap between the companies considered "sustainable" by Mr. Herman and the "vice" stocks of Mr. Sullivan, because (as Mr. Sullivan rightly pointed out) some companies that are not considered "sustainable" for some metrics may be quite "sustainable" in other ways. Some metrics that are considered sustainable (such as resource use) are clearly tied to long-term profitability, while others are not. As an investor, you should question any investment products labeled as "sustainable"; your idea of sustainable might not be the same as theirs.

Melody Dunbar, Corporate Affairs & Communications, Johns Manville

Paul:

We recently read your BusinessWeek article, "Sustainability-Minded Investing Makes Dollars and Sense," and thought you and your readers might appreciate an update on Johns Manville's on-going business activities and focus on sustainability.

You may be interested to learn that Johns Manville, which emerged from bankruptcy in 1988, is helping to lead sustainable business practices in the building materials industry. Acquired by Berkshire Hathaway in 2001, Johns Manville makes building, industrial, OEM, and roofing insulation, commercial roofing systems, and engineered products — most of which are designed to save energy.

At Johns Manville, sustainability is central to our business - from raw material sourcing through manufacturing, packaging, distribution, and end use. In 2002, Johns Manville introduced the industry’s first full line of Formaldehyde-free™ fiber glass building insulation and today we are still the only insulation manufacturer to achieve the status of Climate Action Leader for work we have done in California to quantify and publicly report our greenhouse gas emissions in that State. In fact, the low-carbon process we use to make insulation in our California plant results in such low greenhouse gas emissions that the plant will not need to participate in the State’s cap-and-trade program.

With our focus on the triple bottom line (people, planet, and profits) Johns Manville will continue to be an innovative leader in energy efficiency and other areas of sustainability for many years to come.

Melody Dunbar
Leader, Corporate Affairs & Communications
Johns Manville

R. Paul Herman (HIP)

Update: The above "Pro" perspective builds upon the ideas, investment themes, and evidence co-presented by Dr. Vinay Nair of Ada Investments, and author of the book Investing for Change, and me at the Commit Forum in September 2010.

Dr. Nair's work focuses on many compelling aspects of sustainability, including the duration of profits, and the volatility of the cost of capital.

See the full video of Dr. Nair, Mr. Sullivan, Prof. Karnani, and me here: http://bit.ly/ViceVsNice (case sensitive; free signup required).

Rob Thomas

To Gerry Sullivan's chart:

Why are you comparing a basket of SRI Funds against two individual funds? Why compare an index against two actively managed funds? Maybe to skew results? A quick look at Vice versus similar actively managed Fund Pax Growth:

(All returns as of Sept 30 2011)
1yr 3yr 5yr 10 yr
Vice 5.65% 1.40 -0.04
Pax 5.75% 20.65 2.30

How about this comparison?

MSCI
400 Social 9.33 -5.51 1.04 -0.34
MSCI
USA 10.27 -6.98 0.80 -0.47

We could do this all day, but my point is numbers can support ESG screens as adding value.

Evan

I wouldn't consider the Vice Fund a fair comparison. After all, our wars are dying down and there are laws restricting the use of tobacco, alcohol, and gambling. It would be more interesting to compare a basket of same-industry companies that differ only in their sustainability plans to get a better idea. I have a feeling that we'll find that it makes more of a difference in consumer goods than B2B.

Bigger Picture

I find it shocking that there would even be a debate over sustainable investing and the utilizing of ESG criteria. Given the current conditions of the economies, health issues, toxicity of our food supply, corruption, environmental pollution, war, nuclear radiation from unstable and unsafe nuclear technology etc etc
Perhaps if all investors and business practices conformed to the ESG, PRI, CSR, SRI criteria we would not be in the place we are now. I am fairly sure of one thing though if we do not embed sustainability, social and human impact criteria into our investments and business practices we won't be having this debate but one that is far greater. Everything is connected and everything has IMPACT - the question is: Is the impact POSITIVE or NEGATIVE? That is the bottom line. I contend further that given the changes taking place now on the planet from a "quantum physics" perspective that "energetic" support for positive impact will be far greater than for the negative. It is time for new ways, new systems, innovation and a focus on "People-Driven" "Social Driven" and "Environment Driven" business models. The choices of both consumers and investors in alignment with positive impact will be critical this year - those choices will be what drives Profit and the new "Currency" Choose wisely my friends.

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