When Are ESG/SRI Strategies Likely to Outperform?
Over the past decade, and particularly over the last several years, there has been a dramatic increase in environmental, social and governance (ESG) investing strategies. That has coincided with robust economic and market performance in the U.S. New research examines whether strong ESG returns are likely to be tied to a strong economy and market.
ESG investing (also known as sustainable or socially responsible investing [SRI]) now accounts for more than one-fourth of total assets under management (AUM) in the U.S., with AUM growing to $12 trillion, up 38% from the start of 2016 to the start of 2018. Total assets with a sustainable investing mandate exceeded $30 trillion globally at the start of 2018, with institutions accounting for 75% of the total.
The trend is poised to continue.
Increased investor interest has not only led to cash inflows but to heightened interest in research on ESG investment strategies. Lubos Pastor, Robert Stambaugh and Lucien Taylor contribute to the literature with their December 2019 paper, Sustainable Investing in Equilibrium. They analyzed both financial and real effects of sustainable investing through the lens of a general equilibrium model that “illuminates the key channels through which agents’ preferences for sustainability can move asset prices, tilt portfolio holdings, determine the size of the ESG investment industry, and cause real impact on society.” Their model “implies three-fund separation, whereby each agent holds the market portfolio, the risk-free asset, and an ‘ESG portfolio,’ which is largely long green assets and short brown assets. Agents with stronger-than-average ESG preferences go long the ESG portfolio, whereas agents with weaker preferences go short. Agents with average ESG preferences hold the market portfolio.”