The benefits of incorporating ESG into your investment strategy

Looking to improve your investment returns while supporting responsible business practices? ESG investing might be the answer.

Here’s a quick summary of the key benefits of incorporating Environmental, Social, and Governance (ESG) principles into your investment strategy:

• Better Financial Performance: 62.6% of studies show a positive link between ESG practices and financial returns.

• Lower Risk: ESG-focused companies experience up to 28% lower annual risk.

• Stronger Returns: Top ESG funds delivered a 13.57% average annual return over 10 years.

• Market Growth: ESG investments in the U.S. reached $8.4 trillion by the end of 2022, and global ESG assets are projected to hit $53 trillion by 2025.

• Risk Management: Companies with strong ESG practices are less exposed to regulatory, reputational, and market risks.

Why ESG matters:

• Companies with high ESG scores often have better governance, reduced costs, and fewer ethical risks.

• ESG investing isn’t just about doing good - it’s about finding businesses set up for long-term success.

Quick Overview of ESG Components:

Ready to align your portfolio with ESG principles? Let’s dive deeper into the strategies, performance data, and tools that can guide your ESG journey.

ESG Investing Explained: How to Align Your Portfolio with ...

ESG Financial Performance

In the U.S., the rise of ESG investments has shown a clear link between sustainable practices and strong financial results. ESG investing not only creates positive outcomes but also drives better financial performance. This makes it a key part of a balanced and forward-looking investment strategy.

Long-term Returns Data

A meta-analysis of 2,250 studies revealed that 62.6% found a positive connection between ESG investing and financial performance ^[5]. Sustainable funds have delivered impressive results:

Companies with high ESG ratings often experience reduced costs, lower volatility, and fewer unethical risks ^[3]. This translates into steadier earnings and better risk-adjusted returns.

"A good ESG investment does not sacrifice performance for sustainability - rather, it reduces some downside risk or tilts to sustainable leaders without reducing expected returns." - Sam Adams, co-founder and CEO of Vert Asset Management ^[4]

These findings highlight how ESG practices can lead to financial success.

Success Stories

In real-world applications, ESG-driven companies outperformed their peers in eight out of twelve industries, with an average positive effect of 14.08% in these sectors ^[5].

Key performance metrics underline ESG's financial benefits:

• The Sharpe ratio shows ESG stocks achieving 7.67% better efficiency than comparable stocks ^[5].

• The Treynor ratio indicates ESG stocks outperforming in 9 of 12 industries by an average of 11.81% ^[5].

Companies with strong ESG ratings often display:

• Competitive market advantages

• Higher profitability and dividend payouts

• Fewer major financial setbacks

• More consistent earnings ^[3]

"Clients are concerned about the risks to the financial performance of their portfolios and the risks to the planet of holding fossil fuel and polluting companies. Clients want to know that we, as asset managers, consider both ESG risks and opportunities when making investment decisions. They also want to see these smart investment tools incorporated into their portfolios." - Kristin Hull, founder and CIO of Nia Impact Capital ^[4]

Interestingly, ESG factors help stabilise performance across industries. For instance, conventional companies showed a 47% volatility gap between the most and least volatile sectors, whereas ESG-focused companies reduced this gap to just 11% ^[5]. This demonstrates how ESG practices can bring greater stability to diverse industries.

ESG Risk Management

Managing ESG risks is crucial for safeguarding investments in today’s market. Data shows that organisations addressing these risks head-on tend to bounce back stronger and see better financial results.

Common ESG Risks

Investment portfolios often face key ESG risks that can affect returns:

For example, in March 2023, Shell’s Nigerian subsidiary faced environmental issues in the Niger Delta. This incident highlighted how poor ESG risk management can harm both reputation and finances.

Studies show companies actively managing ESG risks tend to perform better:

• 89% show stronger market performance ^[7]

• 85% report higher returns on assets and equity ^[7]

• 100% experience reduced capital costs for debt and equity financing ^[7]

Risk Assessment Methods

ESG risk assessment merges traditional financial analysis with ESG-specific metrics. Investment managers often use scoring systems to evaluate risks:

"Navigating ESG risks and opportunities holistically ensures preparedness and adaptability to evolving business landscapes, reinforcing organisation's resilience and supporting your efforts to build trust and achieve external and internal sustainability ambitions." - David Sütterlin, Partner, Head of Risk Consulting | EY Switzerland ^[6]

To manage risks effectively, organisations should:

• Conduct regular materiality assessments

• Use third-party tools to monitor supply chains

• Incorporate sustainability metrics into Risk Appetite Frameworks

• Perform periodic ESG reviews of portfolio companies

The growing focus on ESG is evident in corporate structures. Over 81% of companies now have Chief Sustainability Officers ^[6], and 90% of executives report direct board oversight of sustainability initiatives ^[6]. This demonstrates how ESG risk management has become a strategic priority.

Investment managers can improve their assessments by combining ESG ratings from established providers with custom frameworks. This dual strategy captures both standardised data and unique risks tied to specific sectors or investments.

Taking these steps ensures that ESG goals are seamlessly integrated into investment strategies.

Meeting ESG Goals

Incorporating ESG principles can lead to measurable impacts and solid returns. By 2026, ESG investments are expected to hit $33.9 trillion, accounting for 20% of all assets under management ^[8].

Impact Measurement

To achieve ESG success, it’s crucial to track outcomes with clear metrics and consistent monitoring. Using standardised KPIs helps evaluate both financial and environmental performance effectively:

McKinsey research highlights that over 70% of consumers are willing to pay up to 5% more for sustainable products with comparable performance to conventional ones ^[10]. The Robeco Sustainable Global Stars Equities strategy also showcases the potential of ESG measurement, contributing 22% to excess returns between 2017 and 2022 through its integrated approach ^[9].

Using clear and consistent metrics not only evaluates performance but also identifies areas where ESG efforts create the most value.

High-Impact Sectors

Accurate measurement can spotlight sectors where ESG efforts deliver both environmental progress and strong financial returns. Currently, the green economy accounts for 10% of global listed market capitalisation, outpacing the energy and retail sectors ^[11].

Key sectors for investment include agricultural innovation, resource management, and tech-driven solutions. Companies in these areas often generate over 50% of their revenue from green activities, providing measurable returns ^[2].

Investors should:

• Prioritise companies earning more than 50% of their revenue from green economy activities ^[11].

• Focus on ESG factors that directly impact financial performance ^[9].

With climate change projected to cost $178 trillion over the next 50 years, the urgency to prioritize high-impact sectors cannot be overstated ^[8]. ESG performance data reveals a positive link with financial returns in 62.6% of studies, while negative outcomes were reported in fewer than 10% of cases ^[9]. This underscores the potential for ESG-focused investments to drive both environmental progress and financial growth.

ESG Implementation Guide

Getting Started with ESG

A solid ESG plan can help improve operations and reduce expenses ^[1]. Here's a simple three-step approach to get started:

1. Set Clear Objectives
   Define specific ESG goals with measurable timelines. Focus on balancing carbon reduction in your portfolio while maintaining competitive returns.

2. Establish Your Budget
   Use market data to decide how much to allocate. Consider your risk tolerance and expected returns to guide your financial planning.

3. Build Your Team
   Create a dedicated ESG team. This can include internal staff, external partners, or a mix of both.

"We observe that companies and funds that develop stakeholder engagement programs are likely to start in-house, focusing on employees, and work their way towards monitoring their supply chain and improving their relationship with tenants." ^[12]

Once you’ve set your goals and gathered the right resources, the next step is to use analysis tools to guide your ESG efforts.

ESG Analysis Tools

The right tools can help you assess risks, measure impact, and track emissions. Here’s a quick overview of some popular options:

"IRIS+ makes it easier for investors to translate their impact intentions into impact results." ^[13]

Using these tools alongside clear action plans can help you achieve both your ESG and financial goals.

Profit and ESG Balance

After laying the groundwork with a strategy and analysis, the next step is aligning ESG goals with financial performance. Research shows that strong ESG performance often leads to better financial outcomes ^[1]. One example is Verizon’s $1 billion green bond, a standout initiative in the U.S. telecom industry ^[1].

"Employees are going to be looking for organisations that are going to help them become better citizens and that align with their values. The new generations are especially very concerned about the environment." – Carolina M. Veira, VP, Community and Corporate Partnerships, CareMax ^[1]

Companies that implement well-rounded ESG strategies often see benefits like reduced compliance expenses, lower employee turnover, and improved operational efficiency ^[1].

Conclusion

Main Points

ESG investing has moved from being a specialised approach to becoming a central focus in the investment world. Research shows that companies with strong ESG practices often enjoy advantages like lower capital costs, reduced market volatility, and fewer cases of bribery, corruption, and fraud ^[3]. Additionally, over a 10-year period, sustainable funds outperformed traditional ones 58.8% of the time ^[1].

Here’s a quick look at the benefits of ESG integration discussed in this guide:

These findings highlight how ESG strategies can lead to better financial results, smarter risk management, and operational improvements.

ESG Market Outlook

The future of ESG investing looks strong. By 2026, ESG-mandated assets are expected to grow to about $33.9 trillion, representing one-fifth of U.S. assets under management ^[8]. Over the next 50 years, climate change is projected to have a $178 trillion economic impact ^[8]. In 2021 alone, U.S. managers launched 149 new ESG mutual funds and ETFs - making up 22% of all new fund launches. ESG funds also grew at a rate of 80%, compared to 34% for traditional funds ^[14].

These numbers show that ESG investing isn’t just about environmental responsibility - it’s about identifying companies that are set up for long-term success.