- An increasing body of research indicates that investing with input from ESG data offers meaningful possible benefits to performance.
- Despite its potential for reducing risk and enhancing return, ESG data remains remarkably underutilized by most investors.
- We can enhance the utility of ESG data with thoughtful fundamental research, reflecting deep understanding of the context for different companies and industries.
Demand for ESG (environmental, social, and governance) investment strategies is growing, and as sustainable investing approaches develop, our understanding of ESG data is also evolving. Some view the ESG field with skepticism and wonder whether studies showing its benefits are incomplete. Meanwhile, some sustainable investing enthusiasts may put too much faith in using ESG data alone to identify investment opportunities.
Combining fundamentals with ESG factors holds promise
Evidence shows — no surprise — that reality lies somewhere in the middle. ESG investment data is useful, yet is still improving in volume, quality, and relevance. For example, a large portion of ESG research assesses corporate policies rather than performance. Additionally, ESG data is sometimes compiled without a robust fundamental understanding of the context in which a company operates. We believe that incorporating ESG ratings into an investment process must be accompanied by a commitment to high-quality fundamental analysis.
Curiously, ESG data remains underutilized by many investors, despite rising interest in the field and its intriguing investment potential. The importance of ESG fluency is clear, as sustainability reporting is becoming standard for companies worldwide.
Consider some findings from recent empirical studies relating to ESG data and sustainable investing approaches:
- Product-based exclusionary screens (no guns, tobacco, etc.) fulfill values and mission orientation for some investors, and are often modest drags on performance when considered in isolation.
- More complex inclusionary investment processes (overweighting good ESG performance) have potential to add alpha, but require fundamental understanding to be effective.
- ESG awareness can also help mitigate bankruptcy and performance risk.
For all investors, having higher ESG fluency holds the potential to improve both risk and return. For sustainability-focused strategies, it’s possible to achieve both strong financial performance and strong ESG performance — not either/or.
How fundamental research can contribute
What’s more, active, fundamental asset managers have a unique opportunity to contribute to the progress of sustainable investing. Analysts who already have deep knowledge of companies and industries can provide the contextual understanding that ESG data may lack; they can assess the relevance of ESG data to each company’s operations. Integrating ESG factors with fundamental research creates a more robust foundation for building investment portfolios.
For informational purposes only. Not an investment recommendation.
This material is provided for limited purposes. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or any Putnam product or strategy. References to specific asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations or investment advice. The opinions expressed in this article represent the current, good-faith views of the author(s) at the time of publication. The views are provided for informational purposes only and are subject to change. This material does not take into account any investor’s particular investment objectives, strategies, tax status, or investment horizon. Investors should consult a financial advisor for advice suited to their individual financial needs. Putnam Investments cannot guarantee the accuracy or completeness of any statements or data contained in the article. Predictions, opinions, and other information contained in this article are subject to change. Any forward-looking statements speak only as of the date they are made, and Putnam assumes no duty to update them. Forward-looking statements are subject to numerous assumptions, risks, and uncertainties. Actual results could differ materially from those anticipated. Past performance is not a guarantee of future results. As with any investment, there is a potential for profit as well as the possibility of loss.
Diversification does not guarantee a profit or ensure against loss. It is possible to lose money in a diversified portfolio.
Consider these risks before investing: International investing involves certain risks, such as currency fluctuations, economic instability, and political developments. Investments in small and/or midsize companies increase the risk of greater price fluctuations. Bond investments are subject to interest-rate risk, which means the prices of the fund’s bond investments are likely to fall if interest rates rise. Bond investments also are subject to credit risk, which is the risk that the issuer of the bond may default on payment of interest or principal. Interest-rate risk is generally greater for longer-term bonds, and credit risk is generally greater for below-investment-grade bonds, which may be considered speculative. Unlike bonds, funds that invest in bonds have ongoing fees and expenses. Lower-rated bonds may offer higher yields in return for more risk. Funds that invest in government securities are not guaranteed. Mortgage-backed securities are subject to prepayment risk. Commodities involve the risks of changes in market, political, regulatory, and natural conditions. You can lose money by investing in a mutual fund.
Putnam Retail Management.