Does ESG Investing Produce Better Stock Returns?

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"An ESG focus has become essential for long-term compounding." -- The Morgan Stanley International Equity Team

"If I try to be a responsible investor, will I lose money?" This is a question many investors ask about the concept of investing not only for personal financial gain, but also in the spirit of making the world a better, healthier, more equitable place (or at least doing as little harm as possible).

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If you're curious about the basics of investing with a focus on environmental, social, and corporate governance (ESG), we have a primer titled "What Is ESG Investing?"

If you're already up to speed on ESG and want to know whether the investment style actually works, read on for a rundown of compelling reasons to add ESG analysis to your investing toolbox.

It's time to put to rest the conventional wisdom that investing for anything other than shareholder value results in poor investor outcomes. There's plenty of evidence that companies prioritizing ESG issues actually generate superior long-term financial performance across a range of metrics -- including sales growth, return on equity (ROE), return on invested capital (ROIC), and even alpha (market outperformance).

When companies pursue a stakeholder-centric approach to value creation by incorporating ESG into their long-term investment strategy, they're able to attract the best talent, build loyal customer bases, prosper through strong corporate governance oversight, mitigate risk, and drive profitable growth by investing in sustainable innovations that positively impact the world.

A company cannot become an ESG powerhouse overnight. It takes time to develop a deeply rooted ESG culture and leadership team capable of systems-based thinking, and dedicated to investing (through research and development, and capital expenditures) in long-term initiatives to drive shared-value creation. High-ESG organizations seek to avoid short-term, bottom-line thinking. Instead, they envision the cause and effect of corporate actions, and seize stakeholder-centric, value-creating opportunities while avoiding stakeholder-related risks. Shareholders still prosper, though not at the expense of employees, customers, suppliers, the community, or the planet -- and usually over a longer time horizon.

Therefore, modeling a business around ESG can be an underappreciated source of sustainable competitive advantage, which is why these companies can boast such strong business fundamentals and generate market outperformance.

If you're already convinced that ESG analysis is a great way to find awesome stock ideas, you might want to check out The Motley Fool's ESG investing framework. Otherwise, read on for a wealth of information on ESG investing sourced from all sectors of the financial industry. You'll also learn about ESG's connection to a key metric, return on invested capital (ROIC).

What is the proof that ESG investing works?

Exploring the links below, you can delve deeper into how ESG can produce better results for you as an investor. To be fair, not all of the research published on this topic supports the notion that ESG factors always lead to better stock returns. There are plenty of variables that can result in varying degrees of success, including elements as simple as time frame, and the fact that not all stock pickers are good stock pickers. (Of course, such elements can affect every investment philosophy and method, not just ESG investing.)

However, a significant amount of research suggests a positive correlation between companies that do good and companies that do well financially -- and by extension, do well for shareholders.

Harvard Business School professor George Serafeim wrote for Barron's: "Even if you do not believe that ESG factors will improve performance, I haven't seen any recent evidence that integrating material information about ESG will hurt performance."

This exploration gravitates toward sources that are fairly current and diversified. These include some of the largest investment firms in the world as well as some smaller boutique firms, and "sell side" equity research firms and investment banks as well as "buy side" asset management firms. Established news media sources are featured as well.

Business and investing success using ESG

Here's an overview of the most esteemed investing sources sharing insights on how ESG drives superior investing returns.

JUST Capital, co-founded by legendary hedge-fund manager Paul Tudor Jones, reported:

Fortune:

Goldman Sachs:

MSCI:

Morgan Stanley:

Bank of America:

Bank of America Merrill Lynch:

RBC Global Asset Management:

A working paper by professors from Harvard Business School and the London Business School:

Harvard Business Review:

The Journal of Applied Corporate Finance:

BlackRock:

The Wall Street Journal:

The Financial Times:

FactSet:

McKinsey & Company:

Lazard:

Robeco:

BlueSky Investment Management:

Nordea Equity Research:

Vontobel Asset Management:

Of all the metrics mentioned in the references above, we want to zero in on ROIC, because it's the primary driver of intrinsic business value and stock-price performance. So, if you're wondering why ESG's connection to ROIC is important, grab another cup of coffee and settle down for round two.

Why the ROIC connection is important

The Journal of Applied Corporate Finance said:

Valuation, a book by McKinsey:

Morgan Stanley:

EY (Ernst & Young) and New Constructs:

New Constructs, elsewhere:

Bank of America:

Polen Capital:

Investec Asset Management:

Lazard:

Epoch Investment Partners:

Brown Brothers Harriman:

Victory Capital's RS Investments:

New York University valuation professor Aswath Damodaran:

McKinsey:

William Blair & Company:

HSBC:

Segall Bryant & Hamill:

Janus (now Janus Henderson):

J.P. Morgan:

On board? Next steps to add ESG analysis to your investing strategy

The interrelationship between ESG, ROIC, and other important business performance metrics can help you build a portfolio that not only provides competitive financial returns, but that you can also feel good about. Be sure to explore the links in this article to read more in depth, and bookmark this page to revisit.

If you're ready to try this style of investing for yourself, check out The Motley Fool's ESG hub, where you can find a variety of content to help guide you; it includes the handy ESG investing framework, and high-ESG stock ideas, too.

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Alyce Lomax has no position in any of the stocks mentioned. John Rotonti has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends FactSet Research Systems. The Motley Fool has a disclosure policy.