I Know This Much Is True:
DOES SUSTAINABLE FINANCE COMPROMISE PERFORMANCE?

Sustainable investing has been a hot term among finance enthusiasts globally. Different sources define sustainable finance distinctly, but the one established by HSBC is worth underlining. The bank states that sustainable finance is “any form of financial service that integrates environmental, social and governance (ESG) criteria into business or investment decisions,” or “financing and investment activities that support the UN Sustainable Development Goals (SDGs), in particular taking action to combat climate change” (2021). Emphasizing the importance of environmental, social, and governance causes in addition to profits, sustainable finance is perceived as an answer to relentless critiques against current, growth-centric, global economic principles that were seen as detrimental to both social and natural worlds. Still, many criticize the plausibility of investing sustainably. Although we cannot discuss all of them, one critique significant to mention is that adding other considerations when investing may galvanize investors from choosing the best financial instrument and, hence, sacrifice their overall investment performance. This article will explore to what extent this claim holds.

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Several traditionalist observers believe that adding intricacy into investment decisions may not be without risks. When being commonplace, the practice of sustainable finance puts pressure on businesses to divert their focus from exclusively attaining profits with other social and environmental factors. Business gains result in returns to investments, and hence, such a diversion that compromises businesses’ willingness to maximize profits will also compromise investors’ gains. Milton Friedman, one of the most notorious proponents of the shareholder theory, mentions that asking business firms to contribute to society is like double taxing them (Friedman, 1970, in Bodhanwala & Bodhanwala, 2019).  In a similar vein, Hudson (2005, in Bodhanwala & Bodhanwala, 2019) establishes that ethical business practices may increase the overall cost of operations as firms would incur higher wages for labor, higher and quick payment to suppliers, more spending, and engagement with the society may pull out cash from the business, that could have been deployed in the firm. Finally, more recent findings from Bernal et al. (2021) also conclude that impact investments underperform the mainstream markets.

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However, increasingly many financiers argue that ESG investing, in fact, tends to outperform the non-ESGs. For instance, analyzing more than 2000 empirical studies, Friede et al. (2015) find that there has been a stable trend wherein the ESG gave impact on corporate financial performance positively over time. Also, Pham et al. (2021) found that from 116 listed Swedish companies in 2019, sustainable practices render a positive relationship with earnings yield, return on asset, return on equity, and return on capital employed. Practitioners also amplify these voices of scholars, and one of these practitioners is Morgan Stanley. The bank shows that sustainable investing may reduce downside risks. In addition, statistical evidence further proves that sustainable finance is more stable during a period of extreme volatility (Morgan Stanley, 2019).

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What’s more, on top of those two contrasting arguments is the view that impact investments perform just as well as their conventional counterparts. For example, Hamilton et al. (1993) show that mutual funds considered socially responsible do not gain significant excess returns and their performances are not statistically different from those of conventional funds.

Hence, it is clear that there has been yet no consensus among observers about the relationship between sustainable investing and investment performance. However, there are a few caveats when we understand different perspectives regarding this issue. Firstly, most of the aforementioned studies emphasize the association between sustainable investing with financial performance. It is essential to underline that we need to consider the benefits acquired from personal value alignment and indirect and long-term impact on the environment and society as a whole, both of which can be weighted differently by any one investor. In addition, amidst the unprecedented urgency of the climate crisis, the green industry has a great chance of being more and more lucrative over time, something that might not be captured yet by retrospective analyses shown above.