Investment strategies when selecting sustainable firms

Abstract

“Sustainability” is the most recent construct to describe efforts by modern corporations to include environmental, social, and economic governance considerations in business operations. Such nonfinancial areas of firm performance have received increased focus, especially in recent years as firms seek to differentiate themselves from competitors. Of central concern to analysts and investors is whether the emerging emphasis on sustainability is financially rewarded by market participants. Research on this question has generally supported the idea that firms with greater attention to sustainable business practices outperform their peers financially; presumably because of the perception of lesser future risk. This study examines the efficacy of passive versus active investment strategies when selecting sustainable firms for inclusion within an equity portfolio. Utilizing two groups of “sustainability-focused” firms of varying degrees, this study finds financial support for an active selection of sustainable firms on a risk-adjusted basis. Specifically, the financial performance of the Dow Jones Sustainability Index (DJSI) and a group of Sustainability Leaders are compared with the broader market over a 10-year period. Thus, it can be understood whether an investor would have received a greater risk-adjusted financial return through either (1) an active “sustainability-focused” approach, (2) a passive sustainability-focused approach, or (3) a passive broad-market approach. The evidence presented here supports efforts to identify global sustainability leaders by industry, as they collectively showed greater financial performance over the past decade than both the DJSI and the broader market.