Sustainable investing insight

When a portfolio becomes a cause, investors become dedicated to it

Martin Coyle, Head of Business Development, Morningstar Investment Management Europe Ltd

“Doing good” and “doing well” can have subtle differences, but both are possible for clients that are dedicated to a cause. In the world of ESG investing (environmental, social, governance), “doing good” is often used to describe investors who are motivated to improve life on earth. By investing in assets with favourable environmental, social and governance standards, you can have an outsized contribution for the good of the planet. But “doing well” is usually performance based, which is best articulated relative to your individual goals. For most investors in ESG portfolios, the ambition is simple — contribute to a better earth while achieving solid returns on your investments. This may even have an embedded expectation for outperformance.

Sustainability-minded investing is admirable, especially given this cohort have withstood a lot of cheap shots over the years. Unfortunately, they may continue to do so. Anti-ESG sentiments are deeply rooted among the more traditional investment commentators who think that capitalism should not be bridled by nonpecuniary concerns, such as social progress. Such sentiments have prevailed for as long as financial markets have existed. Even studies from the 1980s or 1990s concluded that investors who wanted to make the world a better place should ignore ESG concerns in their investment decision-making and instead simply invest for the highest return, and if they felt guilty about their profits, then just make charitable contributions to soothe their consciences.

Similar anti-ESG sentiments continue to percolate through the investment discussion. One current attack asserts that only governments have the power and authority to make meaningful changes to social and environmental issues, so the investment community shouldn’t even bother trying to advance these causes. Of course, those making these claims also tend to be those who are least likely to support government actions on these issues. Their aim is not to enhance government action, but to discourage all efforts. Even if one rightly concedes that governments must play an essential role in ESG progress, that hardly means that businesses can’t make significant contributions as well or that investors do not have the right to align their preferences with their investments.

It's your world. Are you invested?

It’s easy to see why ESG supporters would want to respond to long-standing claims of ESG underperformance from their critics, but their enthusiasm for outperformance is probably unwise in the long run, too. The underpinning of this recent success is a topic of great interest to Morningstar (and others), but we must acknowledge that it is unlikely for any strategy that actively deviates from the market index to consistently outperform. So how can advisers work through the inevitable valleys in ESG performance? We think it boils down to their dedication towards a worthy cause.

Emphasizing the dual mandate of sustainably-minded investors — 1) meeting long-term financial goals, while 2) investing in a sustainable fashion — offers the best chance at staying the course during difficult periods. For example, ESG investors have generally had a rough start to 2022, as the energy rebound has seen many traditional funds and indexes outpacing sustainable strategies.

For a genuine ESG investor, this type of underperformance is a great opportunity to remind clients that they likely don’t want to be earning returns from investments in fossil fuels and heavy carbon emitters. Additionally, the war in Ukraine, despite its horrific and inhumane consequences, may speed up the existing trends supporting sustainable fuel sources.

It’s understandably tempting for ESG proponents to seize this opportunity for revenge and stake a claim to superiority. But winds change direction and basing the case for ESG on favourable short-term performance is as foolish as shunning it for periods of underperformance, as advocated by ESG critics. And while the argument that money flowing into ESG funds could fuel outperformance among ESG investments is tempting, it’s wise to recall that investment flows into funds tend to chase, rather than cause, stock-price movements. Longer term, a better case for ESG revolves around investors’ rights to have their investments reflect their beliefs and in the potential for that connection to increase their commitment to their investments. This would both increase the potential number of investors and upping their collective willingness to stick with their investments through tough times.

For more and more investors, these things matter

When a portfolio becomes a cause, investors are apt to be more dedicated to it. Wise fund companies have long recognised this possibility. Wise corporations do the same, seeking to make employment at their firms seem like part of a bigger cause or mission and not just a payslip. People want to believe they are part of something bigger, that their actions have significance to the world around them. ESG portfolios hold the potential to forge such bonds.

Of course, there’s no guarantee; other factors like manager celebrity have failed to keep investors onboard, with investors quickly abandoning many star managers when their performance faltered. Still, ESG connects in a firmer way and has the potential to deepen the commitment investors have to their portfolios and thus help them stay the course when others abandon ship. If that’s the case, then ESG investing will be performing a valuable social good – helping to improve the long-term finances of a new generation of investors, by not forcing a divide between their financial and social or environmental goals.

Turning to practicalities, we are pleased to share that Morningstar Investment Management have launched their ESG multi-asset portfolio range on the Fidelity platform. Advisers can seamlessly access Morningstar’s asset allocation, investment selection and portfolio construction expertise, making these ESG managed portfolios a natural fit as a progressive third-party partner. With five risk profiles covering Cautious through to Adventurous, this creates an end-to-end experience for clients, all geared towards their values and preferences. It’s your client’s world—are they dedicated to “doing good” and “doing well”?

For more information on how to access Morningstar Investment Management ESG portfolios on the Fidelity platform please contact your Fidelity Adviser Solutions contact or Morningstar Investment Management on 0203 1072 930.

Since its original publication, this piece may have been edited to reflect the regulatory requirements of regions outside of the country it was originally published in.

Issued by Morningstar Investment Management