Research into the efficacy of environmental, social, and governance (ESG) factors has expanded in recent years, and this growth has naturally fueled further debate about the merits of sustainable investment from a performance perspective.

The research comes amid the growing popularity of responsible investment initiatives, most notably the United Nations-supported Principles for Responsible Investment (PRI), whose signatories accounted for more than $60 trillion in assets under management as of April 2016.  The chart below illustrates.

Does sustainable investment make sense from a performance perspective? If research from consulting firm Mercer is accurate, yes.

But does sustainable investment make sense from a performance perspective? If research from consulting firm Mercer is accurate, yes. In 2007, Mercer published an analysis of 20 multiple academic studies that examined the link between ESG factors and financial performance, which helped address concerns about sustainability objectives limiting return opportunities. Mercer’s report was updated in 2009 to include 16 additional studies, and the results were compelling: 20 of 36 indicated a positive relationship between ESG factors and financial performance, while only 3 studies showed evidence of a negative relationship.

Moreover, with respect to the component E, S, and G factors, Mercer noted that strong corporate governance and social considerations such as racial diversity and employee satisfaction can lead to improved performance. The performance impact for environmental factors was mixed among the academic studies that Mercer reviewed, primarily because of the wide variation in materiality across industries.

InterSec Research has approached the debate from a different angle, comparing returns of PRI signatories and non-signatories across different equity manager universes. As measured by quarterly rolling three-year periods, InterSec found that PRI signatories outperformed non-signatories in both the global core (MSCI World Index) and all country world (MSCI ACWI) equity universes consistently over time.

More recent research into performance effects has tried to differentiate between material and nonmaterial ESG issues across different industries. The recognition of materiality is a positive development, with studies seeking to address the different risks facing energy and healthcare companies, for example.

Using materiality guidance from the Sustainability Accounting Standards Board (SASB), George Serafeim and his colleagues at the Harvard Business School found that firms with better performance on material ESG issues experienced a 9% greater margin improvement on a five-year basis. Controlling for systematic risk, they also analyzed stock prices for each decile of “ESG improvers” on material industry factors, which demonstrated significant outperformance of the top 10% of companies versus the bottom 10%.

As I discussed previously, demographic trends are also propelling ESG into the forefront of investor awareness regardless of the quantitative evidence—namely, the coming of age of millennials, who view themselves as global citizens who have a responsibility to make the world better.

According to the Morgan Stanley Institute for Sustainable Investing, millennials are twice as likely to purchase a brand because of the company’s environmental and/or social impact. They are also nearly twice as likely to invest in companies or funds that target specific sustainable outcomes, as shown in the chart below.

These preferences have certainly not been lost on investment managers, brokerage firms, and service providers, who have responded with a plethora of ESG-themed research and products in recent years. ESG implementation strategies vary widely across asset owner types, depending on unique objectives and beliefs.

Although fairly entrenched in Europe, Canada, and Australia, however, the concept of ESG is less understood among U.S. investors—many of whom still equate it strictly to values-based social screening. But as shown, ESG does have merits from a performance perspective.

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Copyright © 2017 William Blair & Company, L.L.C. "William Blair” is a registered trademark of William Blair & Company, L.L.C. No part of this material may be reproduced in any form, or referred to in any other publication, without express written consent.

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Any statements or opinions expressed are those of the author as of the date of publication, are subject to change without notice as economic and markets conditions dictate, and may not reflect the opinions of other investment teams within William Blair Investment Management, LLC or the Investment Management Division of William Blair & Company, L.L.C.

This content is for informational and educational purposes only and not intended as investment advice or a recommendation to buy or sell any security. Investment advice and recommendations can be provided only after careful consideration of an investor’s objectives, guidelines, and restrictions.

Factual information has been taken from sources we believe to be reliable, but its accuracy, completeness or interpretation cannot be guaranteed. Investments are subject to market risk. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Statements concerning financial market trends are based on current market conditions, which will fluctuate.

William Blair does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax questions and concerns.

Distributed by William Blair & Company, L.L.C., member FINRA/SIPC.

Copyright © 2017 William Blair & Company, L.L.C. "William Blair” is a registered trademark of William Blair & Company, L.L.C. No part of this material may be reproduced in any form, or referred to in any other publication, without express written consent.

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