A study released by Morgan Stanley early in the year reported that more than half of individual investors were planning to increase their allocations to responsible investing in 2024. Moreover, 70% of these people believe that this type of investment could lead to better returns than ones that don’t use a responsible investing approach. 

Which raises a question: what, exactly, sets a “responsible” investment apart from the rest? 

Three letters to remember: ESG 

In the world of finance, responsible investing means taking into consideration three major areas when making investment decisions. These three areas are designated by the acronym “ESG”: environment (E), social (S) and governance (G). The first area includes issues such as climate action, energy transition, resource depletion and water management. The second covers human rights, child labour and relations with Indigenous peoples, among other things. Last but not least, the third area is focused specifically on criteria associated with executive compensation and board composition, as well as corporate diversity, equity and inclusion. 

So a ”responsible” mutual fund is one that invests your assets based on one of these criteria, and possibly on all three at once. Fund managers who use a responsible, or sustainable, approach must select each company with care. They may also be signatories of the United Nations Principles for Responsible Investing (PRI), which entails certain obligations. 

What investors are looking for 

There are many responsible investing criteria, as can be seen here, and the choice of which ones matter most is a personal one. The following data, drawn from the same study, give some idea of how things stand. Clearly, while climate action is the top concern, it is far from being the only ESG issue that investors find important. 

That’s why it’s good to know that offerings in the area of responsible investing have become much more refined in recent years. You can now find mutual funds that reflect your personal beliefs and could turn your savings into a real lever for change, in line with the issues that matter to you. The graph below provides an illustration, showing the main fields of action prioritized by Canadian asset managers who use a responsible investing approach. This information is collected each year by the Responsible Investment Association (RIA). 

But is it profitable? 

There still remains the question of returns. According to PRI promoters, a responsible investing approach doesn’t mean sacrificing the performance of your investment portfolio. On the contrary, it could be a way of improving the risk-return ratio by identifying risks and opportunities that might otherwise fly under the radar. For example, a company that is proactively adapting its operations for climatic risks will probably be better prepared for extreme weather events. Similarly, a company that cares about the well-being of its people will probably have a low staff turnover rate, which could be reflected in higher productivity. Another example: a company that’s developing innovative electricity production technologies will likely be in a better position to profit from the energy transition.  

As shown by the following graph, risk reduction and enhanced performance remain a central concern for asset managers who apply an ESG approach to their decisions. 

By looking at the facts, you can analyze various responsible investing stock market indices and compare them with traditional ones. The result of this comparison will vary, of course, depending on the periods and indices used, but one of the most well-known, the MSCI KLD 400 Social Index, can provide a general idea. As of September 30, 2024, its annual return was slightly higher than the MSCI USA IMI index – a similar index that doesn’t include RI criteria – over periods of one year, three years, five years and 10 years, with a risk profile that is the same or better. 

If you’re planning to make responsible investing one of your New Year’s resolutions, keep in mind that it can be possible to align values, attractive returns and sound risk management. However, be sure to have a chat with your advisor to identify the responsible or sustainable mutual funds that would best meet your criteria and your objectives. 
 

* Mutual funds are offered by group savings representatives at SFL Investments, a financial services firm.