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Can ESG investments perform better than traditional ones?

The demand for ESG investing is surging, thanks to growing social and environmental awareness. At the same time, investors wish to align their personal values with their financial goals, while achieving investment returns. Research reveals that ESG investing can offer numerous benefits including financial outperformance.

How do ESG investments perform vs non-ESG ones?

In general, outperformance refers to one investment delivering better performance (higher financial returns) than another, such as a benchmark fund or index. According to a 10-year study, funds that consider environmental, social and governance (ESG) factors were able to outlast and outperform their traditional counterparts, over the medium to longer term. It found that over 77% of these ESG-labelled funds still exist today, while more than half (53%) of traditional funds have dissolved.1

What ESG strategies have in common

What’s more, ESG funds have also performed well during periods of market volatility. At the onset of 2020’s pandemic-driven volatility, signals of ESG-related strength were widely noted, both at the company level and in ESG-focused equity investment strategies. The result of a Morningstar study debunks one common misunderstanding that investments with ESG inclusion would compromise financial performance — this is not case. In fact, the study shows that ESG strategies have not only outperformed traditional funds during periods of volatility, but they tend to outperform and outlast over the medium to long term. 1

The resilient characteristics of ESG investments

What was the key to this resilience? One reason is a widespread energy sector underweight among ESG investment approaches. As COVID-19 dealt a serious blow to the near-term prospects for global economic growth, that helped trigger an oil price collapse and major volatility across the energy sector. A structural view against the future prospects of traditional energy companies, it appeared, helped the performance of a broad number of ESG funds versus their traditionally managed peers.

In this moment, ESG factors showed their close alliance—even an identity—with the most operative contemporary definitions of quality – those characteristics associated with a mix of quantitative and qualitative signals of sustainability, including factors that have often been called nonfinancial, intangible, or pre-financial. ESG companies tend to carry some attractive characteristics like cost savings, operational efficiency, risk management, innovation, retained talent and enhanced shareholder value. Research shows a positive relationship between ESG consideration and the financial performance for 58% of the “corporate” studies focused on operational metrics such as ROE, ROA, or stock price, while only 8% showed a negative relationship.1 What’s more, ESG-focused companies had more innovation, higher operational efficiency, and better risk management — factors that can enhance shareholder returns.

1 Manulife Investment Management, “5 benefits of ESG investing”, 17 May 2022.