Good guys are not doomed to be losers

Good guys don’t necessarily have to finish last when it comes to investing.

For years, conventional wisdom said that dogooders who only wanted to invest in responsible corporations would have to sacrifice rates of returns. Brokers claimed that if you cut out all the big companies that polluted waterways, produced harmful products or engaged in questionable management practices, you were going to leave money on the table.

After all, how many health food companies offer opportunities as high as oil companies, tobacco merchants or hot Silicon Valley startups run by messianic founders?

Two independent financial data analysis firms, though, found that focusing on environmental, social and governance factors — what the industry calls ESG — can actually outperform portfolios loaded with bad boy corporations.

Financial data analysis firm FactSet Insight reviewed companies that meet generally accepted criteria for ESG standards and found their stocks outperform companies that don’t meet them or don’t report them. Suffice it to say, FactSet analyzed years of data and then adjusted the performance for risk before reaching its conclusions.

“Companies that integrate ESG considerations into their operations are able to avoid some financial losses related

to ESG issues, such as environmental fines or labor disputes,” the researchers reported. “On the upside, such companies are also able to more quickly take advantage of new ESGrelated opportunities, e.g., clean technologies.”

The difficulty was creating a balanced portfolio because using ESG standards eliminates nearly half of available stocks. Yet FactSet researchers found they could build two 100 percent ESG portfolios with different investment strategies that could outperform market indexes.

“When looking at the sources of outperformance, we found that in both cases a significant portion came from stock-specific sources which could indirectly be attributed to the ESG signals,” the researchers wrote.

That’sequities,butwhat aboutbonds?Caninvestors lookingforlower-risk investmentsalsoadopt anESGstrategywithout sacrificingincome?

“Environmental and social pillars are a morality play; they are the right thing to do, while the governance pillar is instrumental in ensuring capital preservation,” concluded Pat Reilly, vice president and sales manager for fixed income at FactSet analytics. “It is possible to construct an offering that is similar to a benchmark in terms of duration and spread, but without the risk from select activities or poor governance.”

Another financial data analysis firm, MSCI, found that investors can push more companies toward adopting ESG standards by prioritizing those bonds, while still holding the bonds of companies that can be nudged in the right direction. Only the worst companies should be absolutely excluded from a portfolio, wrote Laura Nishikawa, head of fixed income in ESG research at MSCI.

“We arrived at a consensus to exclude only the worst ESG performers, as defined by their involvement in controversial weapons (cluster munitions, land mines, biological and chemical weapons), and violations of international human rights and environmental norms,” she said. “The second challenge is weighting the remaining stocks toward companies that have a strong ESG profile or are improving their ESG performance.”

When MSCI came up with such a portfolio and looked at past performance, the portfolio not only had a higher ESG rating, with the same riskreturn characteristics, but it outperformed the relevant benchmark.

Proving that it is possible to invest in responsible companies and generate higher returns is important to bond managers, who are under pressure from investors to generate a competitive return and invest responsibly.

Institutional investors have started asking bond managers to sign on to responsible investing standards established by the United Nations in 2006. So far 1,500 managers, representing over $60 trillion in assets under management, have pledged to follow the U.N. rules, FactSet reported.

Whetheryouare lookingtogrowwealth withstocks,wantto preserveitwithbonds oryourepresentamajor institutionlikeauniversity, theresearchshowsthatyou caninvestinresponsible companies without sacrificingareturnonyour investment.

And the more of us who take that route, the more companies will shape up and become more responsible to attract our dollars.