How to survive the next crisis : Is SRI the silver bullet?
| 30 April 2011 |
Unsustainable business practices such as providing sub-prime loans to people who could not afford them, excessive risk-taking fuelled by dysfunctional incentive schemes and poor corporate governance were among the prime causes of the financial crisis.
All of the above are also traditional concerns of Socially Responsible Investment (SRI). But although the crisis has vindicated many of the tenets of social investors, this did not materialise in a significantly better downside protection or superior financial performance of SRI portfolios during this difficult period. |
The Study
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A recent working paper by Pictet Asset Management's Christoph Butz and Laurent Nguyen (1) takes on this apparent paradox and concludes that a meaningful environmental, social and governance screening (ESG) is a necessary but not a sufficient condition for building more resilient portfolios and obtaining the desired investment outcome.
They take a closer look at companies' financial fundamentals, particularly those with a potential to becoming disruptive in a crisis, thereby putting at risk the stability of the entire economic system. In doing so, the authors not only expand the realm of traditional ESG analysis to a group of particularly negative and destabilising externalities widely ignored today by current sustainable investment approaches. By singling out and testing specific 'financial sustainability factors', particularly those that have been associated with abnormal returns in the financial literature, they set out to construct portfolios that are not only less risky – both in an extra-financial and financial sense - but also hold the promise of financial outperformance.
They test their idea by constructing sustainable portfolios for one global and three major regional core equity markets and simulating their historical performance over the last decade, a period marked by different – and sometimes extreme – market environments. Their findings are intriguing. Their results suggest that by following their novelty approach, more is indeed to be had for less, i.e. it is finally possible to build sustainability portfolios that are indeed less risky both from an environmental, social, governance and financial point of view, whilst holding the promise of superior risk-adjusted returns.
The authors conclude that if SRI is to step out of its present niche and live up to its full potential of becoming a dominant mainstream investment strategy, then tilting ESG-screened portfolios towards their financial sustainability looks like the road to take.
(1) How to survive the next crisis? A new approach to Socially Responsible Investment (SRI). Pictet Asset Management. 2011. |
